Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 7, Problem 4PS
Portfolio risk True or false?
- a. Investors prefer diversified companies because they are less risky.
- b. If stocks were perfectly positively correlated, diversification would not reduce risk.
- c. Diversification over a large number of assets completely eliminates risk.
- d. Diversification works only when assets are uncorrelated.
- e. A stock with a low standard deviation always contributes less to portfolio risk than a stock with a higher standard deviation.
- f. The contribution of a stock to the risk of a well-diversified portfolio depends on its market risk.
- g. A well-diversified portfolio with a beta of 2.0 is twice as risky as the market portfolio.
- h. An undiversified portfolio with a beta of 2.0 is less than twice as risky as the market portfolio.
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Students have asked these similar questions
Which one of the following expressions about risk and returns is wrong?
A. In general, one reason why a stock is riskier than a bond is that because cash flows from a bond are known and promised, whereas cash flows from a stock are neither known nor promised.
B. According to CAPM model, a well-diversified portfolio will have a beta which equals to 0.
C. Risk premium is the extra return provided on risky assets to compensate for risk. The difference between risky return and the risk-free return.
D. Unexpected return happened because new information came to light which caused our expectations about prices and returns to change.
Which of the following statements is CORRECT?
a. Portfolio diversification reduces the variability of returns on an individual stock.
b. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events.
c. The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.
d. A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio.
e. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
Which of the following statements is FALSE?
A. When we combine many stocks in a large portfolio, the firm-specific risks for each stock will average out and be diversified.
B. The volatility in a large portfolio will decline as the size of the portfolio increases until only the systematic risk remains.
OC. The risk premium of a security is determined by its systematic risk and does not depend on its diversifiable risk.
OD. Fluctuations of a stock's returns that are due to firm-specific news are common risks.
Chapter 7 Solutions
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 7 - Expected return and standard deviation A game of...Ch. 7 - Standard deviation of returns The following table...Ch. 7 - Average returns and standard deviation During the...Ch. 7 - Portfolio risk True or false? a. Investors prefer...Ch. 7 - Risk and diversification In which of the following...Ch. 7 - Portfolio risk To calculate the variance of a...Ch. 7 - Portfolio betas Suppose the standard deviation of...Ch. 7 - Portfolio betas A portfolio contains equal...Ch. 7 - Prob. 9PSCh. 7 - Prob. 10PS
Ch. 7 - Stocks vs. bonds Each of the following statements...Ch. 7 - Prob. 12PSCh. 7 - Prob. 13PSCh. 7 - Portfolio risk Hyacinth Macaw invests 60% of her...Ch. 7 - Portfolio risk a) How many variance terms and how...Ch. 7 - Portfolio risk Table 7.9 shows standard deviations...Ch. 7 - Portfolio risk Your eccentric Aunt Claudia has...Ch. 7 - Stock betas There are few, if any, real companies...Ch. 7 - Portfolio risk You can form a portfolio of two...Ch. 7 - Portfolio risk Here are some historical data on...Ch. 7 - Portfolio risk Suppose that Treasury bills offer a...Ch. 7 - Beta Calculate the beta of each of the stocks in...
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- Which statement is NOT correct? Investors can NOT eliminate market risk by adding more stocks to the portfolio. Firm specific risk cannot be eliminated through diversification. Standard deviation of return is a good measure of total risk for a stand-alone security. The only relevant risk for a well-diversified portfolio is non-diversifiable risk.arrow_forwardWhich of the following is true? a. Beta of a stock cannot be negative b. SML is an acronym for Stock Market Line c. Holding multiple stocks from the same industry is meaningful diversification d. Undiversifiable risk is known as the systematic riskarrow_forwarda. Why do investors believe that low price-earnings stocks are trading cheap in the market b. An investment strategy that seeks to create a portfolio of stocks with low price-earnings ratios is believed to be able to earn excess market returns. Explain why this is not the case in perfect capital market under certainty. c. Explain how in an imperfect capital market where there is risk, that a low price-earnings ratio strategy may be able to generate excess market returns.arrow_forward
- 2. Stock prices and stand-alone risk Risk is the potential for an investment to generate more than one return. A security that will produce only one known return is referred to as a risk-free asset, as there is no potential for deviation from the known expected outcome. Investments that have the chance of producing more than one possible outcome are called risky assets. Risk, or potential variability in an investment's possible returns, occurs when there is uncertainty about an investment's future outcome, such as the return expected to be generated by the investment and realized by an investor. Generally, investors would prefer to invest in assets that have: O A higher-than-average expected rate of return given the perceived risk O A lower-than-average expected rate of return given the perceived risk Read the following descriptions and identify the type of risk or term being described: Description This type of risk relates to the possibility that a firm will not be able to service its…arrow_forwardWhich of the following statements related to risk is (are) true: (i) Beta measures risk that cannot be diversified. (ii) As more shares are included in a portfolio the total risk of that portfolio goes down. (iii) Investors are normally risk averse and, therefore, they demand a risk premium.arrow_forwardWhy should stock market investors ignore specific risks when calculating required rates of return? There is no method for quantifying specific risks. Specific can be diversified away. Specific risks are compensated by the risk-free rate. Beta includes a component to compensate for specific risk.arrow_forward
- When seeking to diversify and eliminate unsystematic risk in your portfolio, do you want stocks whose movements have high correlation (i.e. move together) or low correlation (i.e. don't move togeter). a) High correlation b) Low correlationarrow_forwardAccording to the Capital Asset Pricing Model (CAPM), risky stocks pay a risk premium based on their level of systematic risk. Thus, a risky stock should have a higher expected return than a risk-free security unless it has a zero or negative beta. True Falsearrow_forwardAccording to the theory of arbitrage:a. High-beta stocks are consistently overpriced.b. Low-beta stocks are consistently overpriced.c. Positive alpha investment opportunities will quickly disappear.d. Rational investors will pursue arbitrage opportunities consistent with their risk tolerance.arrow_forward
- Indicate whether the following statements are true or false. a. Investors prefer diversified companies because they are less risky. multiple choice 1 True False b. If stocks were perfectly positively correlated, diversification would not reduce risk. multiple choice 2 True False c. Diversification over a large number of assets completely eliminates risk. multiple choice 3 True False d. Diversification works only when assets are uncorrelated. multiple choice 4 True False e. Diversification reduces the portfolio beta. multiple choice 5 True False f. A portfolio of stocks, each with a beta of 1.0, will have a beta of less than 1.0 unless the returns are perfectly correlated. multiple choice 6 True False g. A stock with a low standard deviation always contributes less to portfolio risk than a stock with a higher standard deviation. multiple choice 7 True…arrow_forwardwhich of the following is FALSE regarding portfolio diversification and risk? Market risk is also known as systematic risk Through diversification, systematic risk can be eliminated. Diversification can reduce risk without an equivalent reduction in expected return Firm specific risk is also known as unsystematic risk Forming a well-diversified portfolio can eliminate about half the risk associated with owning a single stockarrow_forwardExposure to systematic or market risk can be reduced by? A. adding low or negative beta stocks to the portfolio. B. investing in a variety of economic sectors. C. cannot be reduced or avoided. D. diversifying internationally.arrow_forward
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Chapter 8 Risk and Return; Author: Michael Nugent;https://www.youtube.com/watch?v=7n0ciQ54VAI;License: Standard Youtube License