INVESTMENTS-CONNECT PLUS ACCESS
11th Edition
ISBN: 2810022611546
Author: Bodie
Publisher: MCG
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Chapter 8, Problem 4PS
Summary Introduction
To discuss: Alpha as a nonmarket return premium and reason for considering investments with high alpha. Also, the effect of increase in alpha on Sharpe ratio needs to be discussed.
Introduction: An investor may invest in various stocks to reduce the risk of losses. Such a theory is called correlation theory. It is believed that an investor takes a lot of risk to achieve higher
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The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium.
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To construct a capital market line, we use expected return as y-axis and beta as x-axis
On the capital market line debt securities are located to the right of the market portfolio
To construct a security market line, we use expected return as y-axis and beta as x-axis
Market portfolio lays at an intersection of the average indifference curve of a risk-averse investor and the efficient portfolio
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- Which of the following statements is true? A. Because of flotation costs, dollars raised by retaining earnings must work harder than dollars raised by selling new shares. B. All other things being equal, a call option price will increase, and a put option price will decrease if an exercise price increases. C. Security market line (SML) plots return against total risk which is measured by the standard deviation of returns. D. Because potential long-term returns, income from rent-payments, diversification, and inflation hedge, real-estate would be a good investment.arrow_forwardAn efficient capital market is best defined as a market in which security prices reflect which one of the following? Multiple Choice A Current inflation B A risk premium C All available information D The historical arithmetic rate of return E The historical geometric rate of returnarrow_forwardWhich one of the following expressions about risk and returns is wrong? A. In general, one reason why a stock is riskier than a bond is that because cash flows from a bond are known and promised, whereas cash flows from a stock are neither known nor promised. B. According to CAPM model, a well-diversified portfolio will have a beta which equals to 0. C. Risk premium is the extra return provided on risky assets to compensate for risk. The difference between risky return and the risk-free return. D. Unexpected return happened because new information came to light which caused our expectations about prices and returns to change.arrow_forward
- What is the correlation coefficient between returns on any efficient portfolio and returns on the market portfolio in CAPM? 0.5 -0.5 -1 1 Oarrow_forwardSuppose that stocks are exposed to systematic risks only so that stock i has the following return structure: Ri,t = mį + Si,t where mi is the average return, and si,t is the systematic risk. When we construct a portfolio including more and more stocks, which of the following would happen? The portfolio volatility gradually decreases and eventually converges to a certain positive value. ● The portfolio volatility gradually decreases and eventually converges to zero. The portfolio volatility stays unchanged.arrow_forward1. The diversifiable risk of a portfolio: a. Is correlated with systematic risk. b. Can be made sufficiently small. c. Is zero in the real world. d. Is the risk that investors lose because of transaction costs. Which one of the following conditions determines the investor’s overall optimal portfolio? a. The marginal ratio of substitution of the investor’s utility function must be equal to the Sharpe ratio of the optimal risky portfolio. b. The standard-deviation of the overall portfolio in minimised. c. The expected return of the overall portfolio is maximised. d. The slope of the Sharpe-ratio is equal to zero. 4. Markets can never be strong-form efficient because: a. There are too many traders in them. b. Investors are rational. c. Information is costly to acquire. d. All information is public. 5. Which one of the following is not a property of a pure arbitrage portfolio? a. Zero investment. b. Zero systematic risk. c. Positive net return. d. All of the above.arrow_forward
- Is the following statement true or false? Explain your answer. As more securities are added to a portfolio, total risk is generally expected to fall, and fall at a decreasing rate as the number (n) of securities added increases.arrow_forwardCould a more optimal portfolio, that is, one containing some other combination of stocks that would have either increased returns relative to an increase in risk or maintained returns while decreasing risk, been attained by varying the weight (proportion) of the two securities in the portfolio?arrow_forwardn general, can the risk of a portfolio be reduced to zero byincreasing the number of stocks in the portfolio? Explainarrow_forward
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