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solutions_nss_nc_8 - LearningObjectives Chapter8 ,...

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Chapter 8 Risk and Rates of Return Learning Objectives After reading this chapter, students should be able to: Define risk and calculate the expected rate of return, standard deviation, and coefficient of variation for  a probability distribution. Specify how risk aversion influences required rates of return. Graph diversifiable risk and market risk; explain which of these is relevant to a well-diversified investor. State the basic proposition of the Capital Asset Pricing Model (CAPM) and explain how and why a  portfolio’s risk may be reduced. Explain the significance of a stock’s beta coefficient, and use the Security Market Line to calculate a  stock’s required rate of return. List changes in the market or within a firm that would cause the required rate of return on a firm’s stock  to change. Identify concerns about beta and the CAPM. Explain the implications of risk and return for corporate managers and investors. Chapter 8:  Risk and Rates of Return Learning Objectives 179
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Lecture Suggestions Risk analysis is an important topic, but it is difficult to teach at the introductory level.  We just try to give  students an intuitive overview of how risk can be defined and measured, and leave a technical treatment to  advanced courses.  Our primary goals are to be sure students understand (1) that investment risk is the  uncertainty about returns on an asset, (2) the concept of portfolio risk, and (3) the effects of risk on required  rates of return. What we cover, and the way we cover it, can be seen by scanning the slides and Integrated Case  solution for Chapter 8, which appears at the end of this chapter solution.  For other suggestions about the  lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes. DAYS ON CHAPTER:  3 OF 58 DAYS (50-minute periods) 180 Lecture Suggestions Chapter 8:  Risk and Rates of Return
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Answers to End-of-Chapter Questions 8-1 a. No, it is not riskless.  The portfolio would be free of default risk and liquidity risk, but inflation  could erode the portfolio’s purchasing power.  If the actual inflation rate is greater than that  expected, interest rates in general will rise to incorporate a larger inflation premium (IP) and— as we saw in Chapter 7—the value of the portfolio would decline. b. No, you would be subject to reinvestment rate risk.  You might expect to “roll over” the Treasury  bills at a constant (or even increasing) rate of interest, but if interest rates fall, your investment  income will decrease.
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