Briefly discuss why there is no reason to believe that the market will reward investors with additional returns for assuming unsystematic risk.
Answer: Through diversification, risk can be lowered without sacrificing returns. The market rewards investors for the systematic risk that cannot be eliminated through proper asset allocation in a diversified portfolio.
Provide an intuitive discussion of beta and its importance for measuring risk.
Answer: Beta is an important measure that indicates the systematic risk of a given investment. Since systematic risk cannot be diversified away, investors are compensated for taking this risk. Beta compares the market risk of a particular investment with the market risk of the market, and the risk premium necessary for a stock is directly proportional to the risk premium for the market as a whole. When the risk premium is added to the risk free rate, this results in the required return for the stock.
The risk-return relationship for each financial asset is shown on
A) the capital market line.
B) the New York Stock Exchange market line.
C) the security market line.
D) none of the above.
Siebling Manufacturing Company's common stock has a beta of .8. If the expected risk-free return is 2% and the market offers a premium of 8% over the risk-free rate, what is the expected return on Siebling's common stock?
A) 7.8%
B) 13.4%
C) 14.4%
D) 8.4%
Huit Industries' common stock has an expected return of 11.4% and a beta of 1.2. If the expected risk-free return is 3%, what is the expected return for the market (round your answer to the nearest .1%)?
A) 7.7%
B) 9.6%
C) 10.0%
D) 11.4%
