Chapter 11 Solutions

Chapter 11 Solutions - CHAPTER 11 B-1 Chapter 11: Risk and...

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C HAPTER 11 B-1 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 well-diversified 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 risk-free rate. It is also possible to have a negative beta; the return would be less than the risk-free 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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C HAPTER 11 B-2 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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Chapter 11 Solutions - CHAPTER 11 B-1 Chapter 11: Risk and...

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