Chapter 12: Risk, Return, and Capital Budgeting

Question 1

market portfolio

Answer 1

portfolio of all assets in the economy; in practice, a broad stock market index is used to represent the market

Question 2

beta

Answer 2

sensitivity of a stock’s return to the return on the market portfolio

Question 3

market risk premium (MRP)

Answer 3

risk premium of market portfolio; expected extra return on the market portfolio relative to the return on risk-free treasury bills

Question 4

capital asset pricing model (CAPM)

Answer 4

theory of the relationship between risk and return that states the expected risk premium on any security equals its beta times the market risk premium

Question 5

security market line

Answer 5

relationship between expected return and beta

Question 6

company cost of capital

Answer 6

expected rate of return demanded by investors in a company, determined by the average risk of the company’s assets and operations

Question 7

project cost of capital

Answer 7

minimum acceptable expected rate of return on a project given its risk

Question 8

pure-play approach

Answer 8

estimating project cost of capital using the cost of capital of another company involved exclusively in the same type of project