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Chapter 17: Q5. (page 369)

Sammy buys stock in a suntan-lotion maker and also stock in an umbrella maker. One stock does well when the weather is good; the other does well when the weather is bad. Sammy’s portfolio indicates that “weather risk” is a _______ risk.

  1. diversifiable

  2. nondiversifiable

  3. automatic

Short Answer

Expert verified

The correct option is (a): diversifiable

Step by step solution

01

Step 1. Explanation

Sammy buys two stock where one performs well in good weather and one perform in bad weather. If Sammy invests all his money in one stock, the return will be low when the stock is not performing. If Sammy invests all his money in two different stocks, if one is not performing and one is performing, the return will be more than investing all money in one. Thus, Sammy is diversifying risk.

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Most popular questions from this chapter

Why is it reasonable to ignore diversifiable risk and care only about non-diversifiable risk? What about investors who put all their money into only a single risky stock? Can they properly ignore diversifiable risk?

Identify each of the following investments as either an economic investment or a financial investment.

a. A company builds a new factory.

b. A pension plan buys some Google stock.

c. A mining company sets up a new gold mine.

d. A woman buys a 100-year-old farmhouse in the countryside.

e. A man buys a newly built home in the city.

f. A company buys an old factory.

Suppose that the equation for the SLM is Y = 0.05 + 0.04X, where Y is the average expected rate of return, 0.05 is the vertical intercept, 0.04 is the slope, and X is the risk level as measured by beta. What is the risk-free interest rate for this SML? What is the average expected rate of return at a beta of 1.5? What is the value of beta at an average expected rate of return is 7 percent?

Consider an asset that costs \(120 today. You are going to hold it for 1 year and then sell it. Suppose that there is a 25 percent chance that it will be worth \)100 in a year, a 25 percent chance that it will be worth \(115 in a year, and a 50 percent chance that it will be worth \)140 in a year. What is its average expected rate of return? Next, figure out what the investment’s average expected rate of return would be if its current price were $130 today. Does the increase in the current price increase or decrease the asset’s average expected rate of return? At what price would the asset have a zero average expected rate of return?

If an investment has 35 percent more non-diversifiable risk than the market portfolio, its beta will be:

  1. 35

  2. 1.35

  3. 0.35
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