Chapter 7: Risk and Return

Question 1

Total holding period return (concept)

Answer 1

• the total return on an asset over a specific period of time or holding period
• it consists of two components:
  1.) capital appreciation (The capital appreciation component of a return, RCA, arises from a change in the price of the asset over the investment or holding period)
  2.) income

Question 2

total return?

Answer 2

Is this same at total holding period return?

Question 3

expected return (concept)

Answer 3

an average of the possible returns from an investment, where each return is weighted by the probability that it will occur

Question 4

variance (o^2)

Answer 4

a measure of the uncertainty associated with an outcome

Question 5

standard deviation (o)

Answer 5

the square root of the variance

Question 6

diversification (concept)

Answer 6

reducing risk by investing in two or more assets whose values do not always move in the same direction at the same time

Question 7

unsystematic (or diversifiable) risk (concept)

Answer 7

• risk that can be eliminated through diversification
• Investors do not require higher returns for the unsystematic risk that they can eliminate through diversification
• Because unsystematic risk can be diversified away, investors can and will eliminate their exposure to this risk.

Question 8

systematic (or nondiversifiable) risk (concept)

Answer 8

• risk that cannot be eliminated through diversification
• Only systematic risk—risk that cannot be diversified away—affects expected returns on an investment

-The required rate of return on an asset depends only on the systematic risk associated with that asset

Question 9

Beta (greek letter B) (concept)

Answer 9

• a measure of nondiversifiable, systematic (or market) risk
• in finance, we call the slope of the line of best fit beta

B = 1, asset has same systematic risk as market
B > 1, asset has more systematic risk than market
B < 1, asset has less systematic risk than market
b = 0, No systematic risk (such as a US treasury bill)

Question 10

Capital asset pricing model (CAPM)

Answer 10

• a model that describes the relation between risk and expected return