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Unformatted text preview: 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. 2. If the market expected the growth rate in the coming year to be 2 percent, then there would be no change in security prices if this expectation had been fully anticipated and priced. However, if the market had been expecting a growth rate different than 2 percent and the expectation was incorporated into security prices, then the government’s announcement would most likely cause security prices in general to change; prices would typically drop if the anticipated growth rate had been more than 2 percent, and prices would typically rise if the anticipated growth rate had been less than 2 percent. 3. a. systematic b. unsystematic c. both; probably mostly systematic d. unsystematic e. unsystematic f. systematic 4. a. This is a systematic risk; market prices in general will most likely decline. b. This is a firm specific risk; the company price will most likely stay constant. c. This is a systematic risk; market prices in general will most likely stay constant. d. This is a firm specific risk; the company price will most likely decline. e. This is a systematic risk; market prices in general will most likely stay constant. 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 and expected return on a well-diversified portfolio are functions 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. 9. Such layoffs generally occur in the context of corporate restructurings. To the extent that the market views a restructuring as value-creating, stock prices will rise. So, it’s not the layoffs per se that are being cheered on but the cost savings associated with the layoffs. Nonetheless, Wall Street does encourage corporations to take actions to create value, even if such actions involve layoffs....
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