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Essentials of Investments (BKM 7 th Ed.) Answers to Selected Problems – Lecture 3 Note: The solutions to Example 6.4 and the concept checks are provided in the text. Chapter 6 : 19. a. The risk of the diversified portfolio consists primarily of systematic risk. Beta measures systematic risk, which is the slope of the security characteristic line (SCL). The two figures depict the stocks' SCLs. Stock B's SCL is steeper, and hence Stock B's systematic risk is greater. The slope of the SCL, and hence the systematic risk, of Stock A is lower. Thus, for this investor, stock B is the riskiest. b. The undiversified investor is exposed to both systematic and firm-specific risk. Stock A has higher total risk because the total variation of the observations around the SCL is larger for Stock A than for Stock B. Stock A is therefore riskiest to this investor. 25. In the regression of the excess return of Stock ABC on the market, the square of the correlation coefficient is 0.296 (this is the R 2 of the regression). This indicates that 29.6% of the variance of the excess return of ABC is explained by the market (systematic risk). Chapter 7 : 3. E(R p ) = R f + β p [E(R M ) - R f ] 0.20 = 0.05 + β (0.15 - 0.05) β = 0.15/0.10 = 1.5 6. a) False: β =0 implies E(R)=R f , not zero. b)

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