Chapters 2 and 3
Risk and Return
ANSWERS TO ENDOFCHAPTER QUESTIONS
22
a.
The probability distribution for complete certainty is a vertical line.
b.
The probability distribution for total uncertainty is the X axis from 
to +
.
23
Security A is less risky if held in a diversified portfolio because of its lower beta and
negative correlation with other stocks.
In a singleasset portfolio, Security A would be
more risky because
σ
A
>
σ
B
and CV
A
> CV
B
.
24
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 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.
c. A U.S. governmentbacked bond that provided interest with constant purchasing
power (that is, an indexed bond) would be close to riskless.
25
The risk premium on a high beta stock would increase more.
RP
j
= Risk Premium for Stock j = (r
M
 r
RF
)b
j
.
If risk aversion increases, the slope of the SML will increase, and so will the market risk
premium (r
M
– r
RF
).
The product (r
M
– r
RF
)b
j
is the risk premium of the jth stock.
If b
This preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
This is the end of the preview.
Sign up
to
access the rest of the document.
 Summer '08
 Jensen,M
 Finance, Ri, Rrf

Click to edit the document details