8 Market risk is: Choose one answer. A. Non-systematic risk. B. The risk of an i

Question

8 Market risk is: Choose one answer. A. Non-systematic risk.

B. The risk of an individual stock.

C. The risk component that cannot be diversified away by holding more than one security in a portfolio.

D. Diversifiable risk.

9 Nimby Ltd has a beta of 1.3. The yield on a 10-year government bond is 5.6%. The average return on the market is 11% per annum. Estimate the expected return for Nimby Ltd. Answer:

10 The required return is equal to the risk-free return less a risk premium. Answer: true or false

Explanation / Answer

8) Correct Choice is C. Market risk is risk component that cannot be diversified away by holding more than one security in a portfolio. Such risk are called systematic risk and are measured by beta. Market risk are economic risks, technological changes risks, legal risks something which cannot be controlled by the company. Hence a portfolio manager can never diversify market risk by choosing any number of stocks. Non systematic risks are company specific risks which can be reduced by diversification.

9) Risk free rate = 5.6% ; Beta = 1.3; Market return = 11%

CAPM Required Return = Risk free rate + Beta (market rate - risk free rate) = 5.6% + 1.3(11% -5.6%) = 12.62%

10) False. The required return is equal to risk free rate plus risk premium for various factors (if CAPM is used then only one factor is used , however there are multifactor models to compute required return)

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