August 17, 2022

Diversification is _____. It _____.

buying more than three stocks; reduces overall portfolio risk

the mixing of different assets within a portfolio; increases the expected return

the mixing of different assets within a portfolio; reduces overall portfolio risk

buying more than three stocks; increases the expected return

Part 1

As different securities are added to a portfolio, the portfolio’s total risk _____.

falls to zero

is unaffected

decreases

increases

Intro

Nautilus Clothing’s stock has a 40% chance of producing a 15% return, a 20% chance of producing a 18% return, and a 40% chance of producing a -13% return.

Intro

The table below shows the expected rates of return for three stocks and their weight in some portfolio:

	Stock A	Stock B	Stock C
Expected return	0.08	0.03	0.12
Weight	0.2	0.2	0.6

Intro

The table below shows the expected rates of return for three stocks and their weights in some portfolio:

		Stock A	Stock B	Stock C
	Portfolio weights	0.4	0.2	0.4
State	Probability		Expected returns
Recession	0.3	0.06	0.03	0.15
Boom	0.7	0.11	0.05	0.16

Part 1

What is the portfolio return during a recession?

Part 3

What is the standard deviation of the portfolio returns?

Part 1

Securities whose prices move less than the market have _____ betas.

lower

higher

negative

		Portfolio weights
A	1.7	0.3	0.1
B	1.1	0.5	0.4
C	0.4	0.2	0.5

Part 3

If you are more concerned about risk than return, which portfolio should you pick?

Portfolio 1

Portfolio 2

Intro

You’ve assembled the following portfolio:

Stock	Expected return	Beta	Portfolio weight
1	0.074	1.8	0.2
2	0.053	1.1	0.5
3	0.047	0.9	0.3

Part 2

What is the expected return of your portfolio?

Part 1

The graphical representation of the CAPM is called the _____.

security characteristic line

yield curve

CAPM line

security market line

Intro

A stock has a beta of 1.8. The risk-free rate is 4%. Assume that the CAPM holds.

Part 1

What is the expected return for the stock if the expected return on the market is 8%?

Part 2

What is the expected return for the stock if the expected market risk premium is 8%?

Intro

Use the expected return-beta equation from the CAPM.

Part 1

What is the expected return for a stock if the risk-free rate is 2%, beta 0.6 and the expected return for the market portfolio is 6%?

Part 2

What is the risk-free rate if beta is 1.1, the expected return 6.3% and the expected return for the market portfolio is 6%?

Part 3

What is beta if the risk-free rate is 2%, the expected return 12% and the expected return for the market is 6%?

Part 4

What is the expected return for the market if the risk-free rate is 2%, beta 0.6 and the expected return 12%?

Intro

We know the following expected returns for stocks A and B, given different states of the economy:

State (s)	Probability	E(rA,s)	E(rB,s)
Recession	0.3	-0.04	0.04
Normal	0.5	0.11	0.07
Expansion	0.2	0.19	0.11

The expected return on the market portfolio is 0.08 and the risk-free rate is 0.02.

Part 1

What is the standard deviation of returns for stock A?

Part 2

What is the standard deviation of returns for stock B?

Part 5

Which stock has more total risk?

The stock with the lower standard deviation

The stock with the higher standard deviation

The stock with the higher beta

The stock with the lower beta

Part 6

Which stock has more systematic risk?

The stock with the lower beta

The stock with the higher beta

The stock with the higher standard deviation

The stock with the lower standard deviation

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