Chapter 6

Question 1

holding-period return

Answer 1

the rate of return earned on an investment

Question 2

expected rate of return

Answer 2

average of the possible rates of return

Question 3

risk

Answer 3

• potential variability in future cash flows

- the wider the range of possible future events that can occur, the greater the risk

Question 4

standard deviation

Answer 4

measure of risk (high standard deviation = high risk)

Question 5

portfolio

Answer 5

refers to combining several assets

Question 6

total risk of portfolio is due to two types of risk:

Answer 6

1. systematic (or market risk): is risk that affects all firms
2. unsystematic (or company unique risk): is risk that affects only a specific firm

Question 7

characteristic line

Answer 7

line of best fit

Question 8

beta

Answer 8

the risk that remains for a company even after we have diversified our portfolio

Question 9

beta 0,1)

Answer 9

beta = 0 then no systematic risk
beta = 1 systematic risk equal to the typical stock in the marketplace
beta > 1 has systematic risk greater than the typical stock

Question 10

asset allocation

Answer 10

moving from an all stock portfolio to a mixture of stocks and bonds and finally to an all bond portfolio
reduces variability of returns and rates of return

Question 11

required rate of return

Answer 11

minimum rate of return necessary to attract an investor to purchase or hold a security

Question 12

risk free rate of return

Answer 12

required rate of return for risk-less investments

Question 13

risk premium

Answer 13

additional return we must expect to receive for assuming risk

Question 14

Capital asset pricing model

Answer 14

relationship between risk and expected return

Question 15

security market line

Answer 15

line that shows appropriate required rate of return given a stocks systematic risk