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Topics: Capital asset pricing model, Modern portfolio theory, Investment Pages: 57 (14570 words) Published: August 22, 2012
CHAPTER 6
RISK, RETURN, AND THE CAPITAL ASSET PRICING MODEL

True/False

Easy:

| |(6.2) Payoff matrix |Answer: a |EASY | |[i]. |A payoff matrix shows the set of possible rates of return on an investment, along with their probabilities of occurrence, and the | | |investment's expected rate of return as found by multiplying each outcome or "state" by its probability. | | | | | | |[ii]. |When adding a new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and | | |those already in the portfolio, the less the additional stock will reduce the portfolio's risk. | | | | | | |[iii]. |Diversification can reduce the riskiness of a portfolio of stocks. | | | | | | |[iv]. |The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio. | | | | | | |[v]. |The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by | | |its standard deviation. | | | | | | |[vi]. |The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a | | |standardized measure of the risk per unit of expected return. | | | | | | |[vii]. |The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being| | |compared differ significantly. | | | | | | |[viii]. |Risk-averse investors require higher rates of return on investments whose returns are highly uncertain. | | | | | | |[ix]. |Companies should under no conditions take actions that increase their risk relative to the market, regardless of how much those | | |actions would increase the firm's expected rate of return. | | | | | | |[x]. |One key conclusion of the Capital Asset Pricing Model is that the value an asset should be measured by considering both the risk and| | |the expected return of the asset assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in | | |isolation...