Exam 12: Systematic Risk and the Equity Risk Premium

Your retirement portfolio comprises 200 shares of the S&P 500 fund (SPY) and 100 shares of iShares Barclays Aggregate Bond Fund (AGG). The price of SPY is $134 and that of AGG is $110. If you expect the return on SPY to be 10% in the next year and the return on AGG to be 8%, what is the expected return for your retirement portfolio?

If two stocks are perfectly negatively correlated, a portfolio with equal weighting in each stock will always have a volatility (standard deviation) of 0.

A portfolio comprises two stocks, A and B, with equal amounts of money invested in each. If stock A's stock price increases and that of stock B decreases, the weight of stock A in the portfolio will increase.

Use the table for the question(s) below. Consider the following expected returns, volatilities, and correlations: -Which of the following combinations of two stocks would give you the biggest reduction in risk?

Which of the following equations is INCORRECT?

The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money.

UPS, a delivery services company, has a beta of 1.4, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance in Wal-Mart?

Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas.

The volatility of Home Depot share prices is 20% and that of General Motors shares is 20%. When I hold both stocks in my portfolio, the overall volatility of the portfolio is ________.

Since total risk is greater than systematic risk, should standard deviation be always greater than beta?

You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM) to be 0.9 over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over the next year. Which stock has more systematic risk? Which stock has more total risk?

What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?

What role does the standard deviations of two assets play in computation of the expected return of the two asset portfolio?

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4%, and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Consider the following expected returns, volatilities, and correlations: The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to ________.

Diversification reduces the risk of a portfolio because ________, and some of the risks are averaged out of the portfolio.

Which of the following statements is FALSE?

A stock market comprises 2100 shares of stock A and 2100 shares of stock B. The share prices for stocks A and B are $25 and $15, respectively. What proportion of the market portfolio is comprised of each stock?

For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by ________ due to risks that it has in common with the market.

Stocks tend to move together if they are affected by ________.