Chapter 2: Q16I (page 185)
Assume expected returns and standard deviations for all securities, as well as the risk free rate for lending and borrowing, are known. Will investors arrive at the same optimal risky portfolio? Explain.
Yes, in case lending and borrowing rates are equal without having no other constraints.
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Characterize each company in the previous problem as underpriced, overpriced, or properly priced.
What would be the fair return for each company, according to the capital asset pricing model (CAPM)?
Which of the following statements about the standard deviation is/are true? A standard deviation:
a. Is the square root of the variance.
b. Is denominated in the same units as the original data.
c. Can be a positive or a negative number.
Suppose that as the economy moves through a business cycle, risk premiums also change. For example, in a recession when people are concerned about their jobs, risk tolerance might be lower and risk premiums might be higher. In a booming economy, tolerance for risk might be higher and risk premiums lower.
a. Would a predictably shifting risk premium such as described here be a violation of the efficient market hypothesis?
b. How might a cycle of increasing and decreasing risk premiums create an appearance that stock prices “overreact,” first falling excessively and then seeming to recover?
Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 6%. A stock with a beta of 1 on IP and .4 on IR currently is expected to provide a rate of return of 14%. If industrial production actually grows by 5%, while the inflation rate turns out to be 7%, what is your best guess for the rate of return on the stock?
Use the following data in answering CFA Questions:
Investor “satisfaction” with portfolio increases with expected return and decreases with variance according to the “utility” formula: U = E(r) - ½ Aσ2where A = 4.
Question: The variable ( A ) in the utility formula represents the:
a. Investor’s return requirement.
b. Investor’s aversion to risk.
c. Certainty equivalent rate of the portfolio.
d. Preference for one unit of return per four units of risk.
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