Question 1

Explain the concepts of unique risk, market risk, and how the total level of portfolio risk can change by adding additional securities.

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Question 2

Calculate the expected return, variance, and standard deviations for investments in either stock A or stock B, or an equally weighted portfolio of both.
 $$\begin{array} { | l | c | c | c | } 
\hline  { \text { Scenario } } & \text { Probability } & \text { Return an A } & \text { Return an B } \
\hline \text { Recession } & 25 \% & - 4 \% & 9 \% \
\hline \text { Nonmal } & 40 \% & 8 \% & 4 \% \
\hline \text { Boom } & 35 \% & 20 \% & - 4 \% \
\hline
\end{array}$$

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Question 3

Discuss the statement, "Only market risk matters to a diversified investor."

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Question 4

Why does diversification reduce risk?

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Question 5

An investor is considering purchasing two stocks for a portfolio.Stock A will comprise of 40% of the portfolio and Stock B 60%.It is expected that three economics states may occur, with a 40% probability of a boom economy, 50% probability of an average economy, and a 10% probability of a bust economy.If a boom economy transpires, Stock A will yield an 11% return and Stock B 15%.An average economy will see at 7% and 11% returns for Stock A and B respectively.In a bust economy, Stock A will have a return of -20% and Stock B -5%.Given the above information, calculate the portfolio standard deviation.

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Question 6

Discuss the concept of a "negative risk asset."

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Question 7

An investor is considering purchasing two stocks for a portfolio.Stock A will comprise of 40% of the portfolio and Stock B 60%.It is expected that three economic states may occur, with a 40% probability of a boom economy, 50% probability of an average economy and a 10% probability of a bust economy.If a boom economy transpires, stock A will yield an 11% return and stock B 15%.An average economy will see a 7% and 11% returns for stocks A and B respectively.In a bust economy, stock A will have return of -20% and stock B -5%.Given the above information, calculate the portfolio expected return.

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Question 8

Calculate the expected return, variance, and standard deviation for the following portfolio of four stocks:
 $$\begin{array} { | c | c | } 
\hline \text { Stock 1 } & 16.4 \% \text { retum } \
\hline \text { Stock 2 } & - 9.2 \% \text { retum } \
\hline \text { Stock 3 } & 7.9 \% \text { retum } \
\hline \text { Stock 4 } & 22.0 \% \text { retum } \
\hline
\end{array}$$

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Question 9

Define the term "risk" and explain how it is related to the expected return.

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Question 10

If the stock market return in 2020 turns out to be 30 percent, what will happen to our estimate of the "normal" risk premium? Does this make sense?

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Question 11

An investor is considering purchasing two stocks for a portfolio.Both stocks will have equal weighting in the portfolio.It is expected that three economic states may occur, each with equal probability of occurring.If a boom economy transpires, stock A will yield a 20% return and stock B 10%.An average economy will see a 10% and 5% returns for stocks A and B respectively.In a bust economy, stock A will have a return of -5% and stock B 1%.Given the above information, calculate the standard deviations of each stock along with the portfolio.

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Question 12

What are the components of total return and total risk?

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Question 13

Discuss the relationship between risk and return.

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Question 14

Justify the historic ranking of returns for the following three categories of investment, listed from highest to lowest return: Common stocks, long-term Treasury bonds, and Treasury bills.

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Question 15

How is the standard deviation of returns for individual common stocks or for a stock portfolio calculated?

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Question 16

What is the difference between unique risk, which can be diversified away, and market risk, which cannot?

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Question 17

How can one estimate the opportunity cost of capital for an "average risk" project?

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Question 18

How much is an investor's tolerance for risk worth over a long horizon? Calculate the difference in accumulation in real terms for an investor who initially invests $25,000 and ignores it for 20 years in either a long-term Treasury bond portfolio or a portfolio of diversified common stocks.Assume the historic real returns of 2.1 percent annually for bonds and 9.3 percent for common stocks.

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Question 19

An analyst predicts three economic states of a Boom, Average and Bust economic states, with probabilities of 40%, 50% and 10% respectively.If a boom economic state occurs, stock A will provide a 10% return and stock B will provide a 2% return; if an average economy occurs, stock A will provide a 6% return and stock B will provide a 5% return.During a bust economy, stock A will provide a -5% return and stock B a 12% return.Given this information, determine which stock is riskier.

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Question 20

Calculate the nominal return, real return, and risk premium for the following common stock investment:
 $$\begin{array} { | c | c | } 
\hline \text { Purchase price } & \$ 60.00 \text { per share } \
\hline \text { Dividend } & \$ 3.50 \text { per year } \
\hline \text { Sales price } & \$ 73.00 \text { per share } \
\hline \text { Treasury bill yield } & 8.5 \% \
\hline \text { Inflation rate } & 7.5 \% \
\hline
\end{array}$$

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Quiz 11: Introduction to Risk, Return, and the Opportunity Cost of Capital

Explain the concepts of unique risk, market risk, and how the total level of portfolio risk can change by adding additional securities.

Discuss the statement, "Only market risk matters to a diversified investor."

Why does diversification reduce risk?

Discuss the concept of a "negative risk asset."

Define the term "risk" and explain how it is related to the expected return.

If the stock market return in 2020 turns out to be 30 percent, what will happen to our estimate of the "normal" risk premium? Does this make sense?

What are the components of total return and total risk?

Discuss the relationship between risk and return.

Justify the historic ranking of returns for the following three categories of investment, listed from highest to lowest return: Common stocks, long-term Treasury bonds, and Treasury bills.

How is the standard deviation of returns for individual common stocks or for a stock portfolio calculated?

What is the difference between unique risk, which can be diversified away, and market risk, which cannot?

How can one estimate the opportunity cost of capital for an "average risk" project?