Chap06 (1) - Understanding CAL The return on the risky...

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1 Understanding CAL The return on the risky portfolio is 15%. The risk- free rate as well as the investor's borrowing rate is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is _________. A. 6.00% B. 8.75 % C. 10.00% D. 16.25% Chapter 6: Efficient Diversification
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2 Chapter 6: Efficient Diversification Chapter 6: Diversification and Efficient Frontier Effect of diversification Two risky-asset portfolio Optimal allocation between risky assets and risk- free asset
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3 Chapter 6: Efficient Diversification Diversification and Portfolio Risk Diversification: Don’t put all your eggs in one basket Decompose portfolio risk Market risk, systematic risk, non-diversifiable risk Risk factors common to the whole economy Unique risk, firm-specific risk, nonsystematic risk, diversifiable risk Risk that can be eliminated by diversification
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4 Understanding systematic risk Which of the following provides the best example of a systematic risk event? A. A strike by union workers hurts a firm's quarterly earnings. B. Mad Cow disease in Montana hurts local ranchers and buyers of beef. C. The Federal Reserve increases interest rates 50 basis points. D. A senior executive at a firm embezzles $10 million and escapes to South America. Chapter 6: Efficient Diversification
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5 Chapter 6: Efficient Diversification Portfolio Risk as a function of the Number of Stocks
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6 Chapter 6: Efficient Diversification Portfolio risk decreases as diversification increases
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7 Chapter 6: Efficient Diversification Rate of Return Scenario Probability Stock fund Bond fund Portfolio Recession 0.25 -8% 16% ? Normal 0.50 12% 8% ? Boom 0.25 28% -4% ? Expected return 11.00% 7.00% ? Variance
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Chap06 (1) - Understanding CAL The return on the risky...

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