Conceptual Questions for the Final Exam Risk& Return 1. 2. 3. Is standard deviat

Question

Conceptual Questions for the Final Exam Risk& Return 1. 2. 3. Is standard deviation better to use as a measure of risk for an undiversified I-asset portfolio or for a stock held as a part of a well-diversified portfolio? Total Risk = Diversifiable risk + Systematic Risk Which source of risk becomes the relevant risk for a stock held as in a well-diversified portfolio? What is the main measure of systematic risk? 5. 6. 7. 8. the total diversification benefit? Most of the benefits of diversification can be achieved by investing in only What is the difference between the market return and the equity market risk premium? What is the beta of the (a) risk-free asset and (b) market portfolio? If you believe that the market will be rising during the next year or two, should you choose a stock with a beta of 2, 1, or 0.5? What about the case of an expected decline in the market? stocks. 7 1 9. For the following decisions, indicate if they are consistent with risk averse or risk loving behavior? a. Buying a lottery ticket. b. Buying fire insurance for your home c. Backing up your computer 10. What causes the slope of the security market line to become steeper? Capital Budgeting

Explanation / Answer

As per rules I am answering the first 4 sub-parts of the question

1. Standard deviation is a better measure of risk for an undiversified portfolio rather than a well diversified portfolio. The risk of a well diversified portfolio depends on the risk of the individual securities which are included in that portfolio which is measured by beta. Standard deviation comprises of systematic risk and unsystematic risk. If the portfolio is not well diversified then most of the risk is unsystematic risk. Send standard deviation is a measure of stand alone risk or unsystematic risk it is more relevant in case of 1 asset portfolio.

2. The systematic risk also known as beta becomes the relevant risk for a stock held in a well diversified portfolio. This is because the diversifiable risk has already been mitigated in such a Portfolio.

3. The main measure of systematic risk is beta.

4. Adding low or negatively correlated mutual funds to an existing portfolio adds diversification benefits. Hence a correlation coefficient of -1 will provide greatest benefits.

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