BNKF5001 Risk & Return 3

Unsystematic risk is:

• affected by the economy.

• minimised by holding a portfolio containing approximately 25 shares.

• minimised by holding a portfolio with less than 10 shares.

• all of the above

Systematic risk:

• is measured by the standard deviation.

• affects all companies

• cannot be diversified away.

• B and C only.

Systematic risk:

• is measured by beta.

• can be reduced by holding a portfolio of assets

• is a risk that requires no compensation because it is a risk that affects everyone.

• is a risk that investors can ignore.

The capital asset pricing model:

• is used to calculate the required rate of return on risk-free assets.

• shows that the required return on an asset equals the risk-free rate plus a premium for risk.

• shows that an asset’s risk and expected return always fall on the security market line.

• is the return investors require for investing in the market portfolio.

The security market line (SML) shows:

• the expected return of a security, or portfolio, in relation to its unsystematic risk.

• the expected return of a security, or portfolio, in relation to its systematic risk.

• that the expected return and risk of any asset, or portfolio, plotted below the line is undervalued.

• Both B and C.

The capital market line (CML) shows:

• the expected return of a security, or portfolio, in relation to its unsystematic risk.

• the expected return of a security, or portfolio, in relation to its systematic risk.

• the expected return of a security, or portfolio, in relation to its total risk.

• Both A and B.

The CAPM equation is given by:

• market risk premium + beta x (risk-free return)

• risk-free return + beta x (market return)

• market return + beta x (market risk premium)

• risk-free return + beta x (market return - risk-free return)

Assume that Genray Ltd has a beta of 1.25, the risk-free return is 1.75% and the market return is 3.1%. Calculate Genray’s expected return using the CAPM.

• 5.62%

• 5.29%

• 3.44%

• 1.69%

Assume that Masonware Inc has a beta of 0.8, the risk-free return is 1.75% and the market return is 3.1%. If Masonware’s actual return is 2.72%, which of the following is true?

• Masonware's actual return is greater than its required return so in theory, it is a good buy.

• Masonware's actual return is less than its required return so in theory, it is a good buy.

• Masonware's actual return is greater than its required return and so in theory, it is a bad buy.

• Masonware's actual return is less than its required return and so in theory, it is a bad buy.

When an asset's actual return is greater than its CAPM required return, in theory:

• the asset is considered to be undervalued, and hence a good buy.

• the asset is considered to be overvalued, and hence a good buy.

• the asset is considered to be undervalued, and hence not a good buy.

• the asset is considered to be overvalued, and hence not a good buy.