Risk & Rates of Return

Question 1

Coefficient Variation (CV)

Answer 1

A standardized measure of risk per unit of expected return. Smaller = Less Risk

Question 2

Standard Deviation

Answer 2

Not as good at measuring risk as the Coefficient Variation.

Represents how far the real return is away from the expected return.

Larger = Greater distance/riskier.

T-Bill = 0

Question 3

Diversifiable Risk

Answer 3

Portion of a portfolio’s stand-alone risk that can be reduced through diversification.

Question 4

Market Risk

Answer 4

Measured by beta.

Cannot be lowered by diversification.

Affected by inflation, recession, and high interest rates.

Question 5

Beta (b)

Answer 5

Measures the sensitivity of a stock’s returns to the returns of the overall market

1 = Security is AVG
>1 = Riskier than AVG
<1 = Safer than AVG

-1 = the stock moves in the opposite direction of the market with the same magnitude

aka “Systematic Risk”

Question 6

Capital Asset Pricing Model (CAPM)

Answer 6

Relevant risk of a stock is its contribution to the riskiness of a well-diversified portfolio.

Question 7

Expected Rate of Return Formula

Answer 7

= SUM (probability)(rate)….

Question 8

Coefficient Variation (CV) Formula

Answer 8

= Standard Deviation / Expected Return

Question 9

Portfolio Beta (b) Formula

Answer 9

= SUM (W1)(B1)….

Question 10

Expected Rate or Return CAPM Formula

(SML)

(Market Risk Premium)

Answer 10

Portfolio Required Rate of Return = Risk Free Rate + (Market Premium x Beta)

Question 11

Security Market Line (SML)

Answer 11

Rate of return must be the risk-free return plus a risk premium of stock’s risk after diversification.