13.

Question 1

Expected Returns

Answer 1

Expected Returns are based on prob. of possible outcomes. Expected- average if process is repeated.

Question 2

Expected return has to be possible return?

Answer 2

Doesn’t even have to be possible return

Question 3

info about var and sd

Answer 3

can use unequal probabilities for the entire
range of possibilities.

Question 4

Portfolio

Answer 4

a collection of assets

Question 5

Info about asset risk and return

Answer 5

its important in how it affects the risk ad ret. of the portfolio.

Question 6

Risk return trade off is measured by

Answer 6

the portfolio expected return and standard
deviation, just as with individual assets.

Question 7

Diversification

Answer 7

If two stocks are positively correlated, there is a risk-return trade-off between the two securities.
Benefits of diverf. p<1.0

Question 8

feasible set

Answer 8

the curve that comprises all the possible portfolio combinations. AKA opportunity set

Question 9

efficient set

Answer 9

the portion of the feasible set that only includes the efficient portfolios (where the
maximum return is achieved for a given level of risk, or where the minimum risk is accepted for a given level of return)

Question 10

Min. Variance Portf.

Answer 10

the possible portfolio with the least amount of risk

Question 11

Realized return = expected returns

Answer 11

No, Realized returns are generally not equal to expected returns.

Question 12

Expected comp. and unexpected comp.

Answer 12

-Any point, unexp. ret. can be either + or -
-Overtime the avg. of the unexp. comp. is 0

Question 13

Announcement and news

Answer 13

contain both an exp. comp. and a surprise component.
* It is the surprise component that affects a stock’s price and therefore its return.
* This is obvious when we watch how stock prices move when an unexpected announcement is made or earnings are different than anticipated

Question 14

Efficient mkt

Answer 14

result of investors trading on the unexpected portion of announcements.
* The easier it is to trade on surprises, the more efficient markets should be.
* Efficient markets involve random price changes because we cannot predict surprises

Question 15

Systematic Risk/ Non diversifiable, market

Answer 15

-factors that affect large no. of assets
-Includes changes in GDP, inflation, int. rate

Question 16

Unsystematic risk/unique and asset specific risk

Answer 16

-factors that affect ltd no. of assets
-Includes labour strikes, shortage

Question 17

Principle of Diversification

Answer 17

-Diversification can substantially reduce the variability of returns without an equivalent reduction in expected returns.
* This reduction in risk arises because worse-than- expected returns from one asset are offset by better-than-expected returns from another.
* However, there is a minimum level of risk that cannot be diversified away and that is the systematic portion.

Question 18

Unsystematic Risk

Answer 18

• The risk that can be eliminated by combining assets into a portfolio.
• Synonymous with unsystematic, unique or asset- specific risk.
• If we hold only one asset, or assets in the same industry, then we are exposing ourselves to risk that we could diversify away.
• The market will not compensate investors for assuming unnecessary risk

Question 19

Systematic Risk Principle

Answer 19

• The risk that can be eliminated by combining assets into a portfolio.
• Synonymous with unsystematic, unique or asset-specific risk.
• If we hold only one asset, or assets in the same industry, then we are exposing ourselves to risk that we could diversify away.
• The market will not compensate investors for assuming unnecessary risk

Question 20

How do you measure systematic risk

Answer 20

We use the beta coefficient to measure systematic risk

Question 21

What does beta tell us

Answer 21

− A beta of 1 implies the asset has the same
systematic risk as the overall market
− A beta < 1 implies the asset has less systematic risk than the overall market
− A beta > 1 implies the asset has more systematic risk than the overall market

Question 22

Can we define the relationship between the risk premium and beta so that we can estimate the expected return

Answer 22

Yes

Question 23

The capital asset pricing model(CAPM)

Answer 23

defines the relationship between risk and return
E(RA) = Rf + A(E(RM) – Rf)
* If we know an asset’s systematic risk, we can use the CAPM to determine its expected return. This is true whether we are talking about financial assets or physical assets.

Question 24

Factors affecting exp. ret. of a security

Answer 24

• Pure time value of money - measured by the risk-free rate.
• Reward for bearing systematic risk - measured by the market risk premium.
• Amount of systematic risk in the security - measured by beta.

Question 25

Arbitrage Pricing Theory

Answer 25

(APT) can handle multiple factors that the CAPM ignores. * Unexpected return is related to several market factors

Question 26

APT Theory

Answer 26

* Using the period 1970-84, the empirical results of the study indicated that expected monthly returns on a sample of 100 TSX stocks could be described as a function of the risk premiums associated with the following five factors: 1. The rate of growth in industrial production 2. The changes in the slope of the term structure of interest rates 3. The default risk premium for bonds 4. The inflation 5. The value-weighted return on the market portfolio.