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ch 6 solutions

# ch 6 solutions - CHAPTER 6 ANALYSIS OF RISK AND RETURN...

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CHAPTER 6 ANALYSIS OF RISK AND RETURN ANSWERS TO QUESTIONS: 1. a. Risk refers to the chance for some unfavorable event to occur. In finance, risk is the possibility that actual returns or cash flows from an investment will be less than expected. b. Probability distributions define the percentage chance of occurrence of each of one or more possible outcomes. c. The standard deviation is a statistical measure of the dispersion of a variable about the mean. It is an absolute measure of risk and is measured as the square root of the weighted average squared deviations of individual observations from the mean. d. The required rate of return of an investment is the level of return investors demand, given the risk of the investment. e. The coefficient of variation is a measure of relative risk. It is defined as the ratio of the standard deviation to the mean of some variable. f. A portfolio is efficient if, for a given standard deviation, there is no other portfolio with a higher expected return, or, for a given expected return, there is no other portfolio with a lower standard deviation. g. The efficient frontier consists of the set of efficient portfolios h. The capital market line is a line joining the risk-free rate and the market portfolio. It indicates the risk and expected returns that can be obtained by investing various proportions of one’s wealth in the risk-free security and the market portfolio of (risky) securities. i. Beta is a measure of the systematic risk of an asset or security. It is defined as the ratio of the covariance of returns for some asset or security j and the market portfolio m to the variance of returns on the market portfolio. j. CAPM is the C apital A sset P ricing M odel, a theory which describes the relationship between risk and required return for securities and other assets. k. The correlation coefficient is a relative statistical measure of the degree to which two series of numbers, such as the returns from two securities, tend to move or vary together. l. A portfolio is a collection of two or more assets or securities. m. The characteristic line is a regression line relating the periodic holding period returns 65

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Chapter 6 Analysis of Risk and Return for a specific security to the periodic holding period returns on the market portfolio. n. The security market line defines the relationship between systematic risk and the required returns for individual securities. o. The covariance is an absolute statistical measure of the degree to which two series of numbers tend to move or vary together. p. Systematic risk is that portion of the variability in a security's return that is caused by factors affecting the market as a whole. It is also called nondiversifiable risk. q. Unsystematic risk is risk that is unique to a firm. It is also called diversifiable risk.
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