C
HAPTER
11
B1
Chapter 11: Risk and Return
Answers to Concepts Review and Critical Thinking Questions
1.
Some of the risk in holding any asset is unique to the asset in question. By investing
in a variety of assets, this unsystematic portion of the total risk can be eliminated at
little cost. On the other hand, there are systematic risks that affect all investments.
This portion of the total risk of an asset cannot be costlessly eliminated. In other
words, systematic risk can be controlled, but only by a costly reduction in expected
returns.
3.
a.
systematic
b.
unsystematic
c.
both; probably mostly systematic
d.
unsystematic
e.
unsystematic
f.
systematic
5.
No to both questions. The portfolio expected return is a weighted average of the
asset returns, so it must be less than the largest asset return and greater than the
smallest asset return.
6.
False. The variance of the individual assets is a measure of the total risk. The
variance on a welldiversified portfolio is a function of systematic risk only.
7.
Yes, the standard deviation can be less than that of every asset in the portfolio.
However,
β
cannot be less than the smallest beta because
β
P
is a weighted average of
the individual asset betas.
8.
Yes. It is possible, in theory, to construct a zero beta portfolio of risky assets whose
return would be equal to the riskfree rate. It is also possible to have a negative beta;
the return would be less than the riskfree rate. A negative beta asset would carry a
negative risk premium because of its value as a diversification instrument.
10.
Earnings contain information about recent sales and costs. This information is useful
for projecting future growth rates and cash flows. Thus, unexpectedly low earnings often
lead market participants
to reduce estimates of future growth rates and cash flows;
lower prices are the result. The reverse is
often true for unexpectedly high earnings.
Solutions to Questions and Problems
1.
The portfolio weight of an asset is total investment in that asset divided by the total
portfolio value. First, we will find the portfolio value, which is:
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HAPTER
11
B2
Total value = 75($69) + 50($52)
Total value = $7,775
The portfolio weight for each stock is:
Weight
A
= 75($69)/$7,775
Weight
A
= .6656
Weight
B
= 50($52)/$7,775
Weight
B
= .3344
2.
The expected return of a portfolio is the sum of the weight of each asset times the
expected return of each asset. The total value of the portfolio is:
Total value = $900 + 1,700
Total value = $2,600
So, the expected return of this portfolio is:
E(R
p
) = ($900/$2,600)(0.10) + ($1,700/$2,600)(0.16)
E(R
p
) = .1392 or 13.92%
5.
The expected return of an asset is the sum of the probability of each return occurring
times the probability of that return occurring. So, the expected return of the asset is:
E(R) = .20(–.08) + .80(.21)
R(R) = .1520 or 15.20%
6.
The expected return of an asset is the sum of the probability of each return occurring
times the probability of that return occurring. So, the expected return of the asset is:
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 Fall '08
 DICLE
 Variance, Investing, Probability theory, Boom

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