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Chapter 6 Review Quest

The document is an assignment cover page for a student named Ahmir Slaughter for their BUS 208-A Fund of Financial Management class. It includes the assignment which is to complete chapter 6 review questions. The review questions cover topics such as the required rate of return for investors, measuring risk, unique and systematic risk, beta, the security market line, portfolio beta, unsystematic risk, historical returns data from 1926-2014, and the benefits of diversification.

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27 views4 pages

Chapter 6 Review Quest

The document is an assignment cover page for a student named Ahmir Slaughter for their BUS 208-A Fund of Financial Management class. It includes the assignment which is to complete chapter 6 review questions. The review questions cover topics such as the required rate of return for investors, measuring risk, unique and systematic risk, beta, the security market line, portfolio beta, unsystematic risk, historical returns data from 1926-2014, and the benefits of diversification.

Uploaded by

slat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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BUS 208-A: Fund of Financial Management

Assignment Cover Page

Student: Ahmir Slaughter

Professor: Professor Ridgley

Date: March 16, 2024

Assignment: Homework - Chapter 6 review questions


1. A) The required rate of return for an investor represents the lowest level of return

needed to entice them into acquiring or retaining a security.

B) Risk is the potential variability in returns on an investment. Thus, the greater the

uncertainty as to the exact outcome, the greater is the risk. Risk may be measured in

terms of the standard deviation of rates of return or by the variance of rates of return,

which is simply the standard deviation squared.

C) A large standard deviation of the returns indicates greater riskiness associated with an

investment. Future cash flows have a greater potential variation. However, whether the

standard deviation is large relative to the returns has to be examined with respect to other

investment opportunities. Alternatively, probability analysis is a meaningful approach to

capture greater understanding of the significance of a standard deviation figure. However,

we have chosen not to incorporate such an analysis into our explanation of the valuation

process.

2. a. Unique risk is the variability in a firm's stock price that is associated with the specific

firm and not the result of some broader influence. An employee strike is an example of

a company-unique influence.

b. Systematic risk is the variability in a firm's stock price that is the result of general

influences within the industry or resulting from overall market or economic influences.

A general change in interest rates charged by banks is an example of systematic risk.

3. Beta indicates the responsiveness of a security's return to changes in the market return.

According to the CAPM, beta is multiplied by the market risk premium and added to

the risk-free rate of return to calculate a required rate of return.


4. The security market line is a graphical representation of the risk-return trade-off that

exists in the market. The line indicates the minimum acceptable rate of return for

investors given the level of systematic risk of a security.

5. The beta for a portfolio is equal to the weighted average of the betas of individual

stocks, weighted by the percentage invested in each stock.

6. If a stock has a great amount of variability about its characteristic line (the line of best

fit in the graph of the stock's returns against the market's returns), then it has a high

amount of unsystematic or company-unique risk. If, however, the stock's returns closely

follow the market movements, then there is little unsystematic risk.

7. Data have been compiled by Ibbotson Associates, Inc. on the actual returns for the

following portfolios of securities, plus the inflation rate, from 1926-2014.

1. Common stocks of large firms

2. Common stocks for small firms

3. Corporate bonds

4. Intermediate U.S. government bonds

5. U.S. Treasury bills

Investors historically have received greater returns for greater risk-taking with the

exception of the U.S. government bonds. All portfolios generated returns that exceeded

the inflation rate. The portfolio that, on average, has consistently generated the highest

rate of return has been a portfolio made up of common stocks.

8. Through diversification, we can potentially accomplish one of two results: (1) We can

decrease the variability in returns without lowering the expected rate of return of the

portfolio, or (2) we can increase the expected rate of return without increasing the
variability in returns. The extent of these effects is in part determined by the types of

assets in the portfolio. For instance, diversification has greater effect when investing in

different types of assets, such as government securities and stocks, rather than just

investing in different stocks.

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