Problem 1: Risk that can be eliminated through diversification is called ______ risk.
a. unique
b. firm-specific
c. diversifiable
d. all of the above
Problem 2: Asset A has an expected return of 20% and a standard deviation of 25%. The risk free rate is 10%. What is the reward-to-variability ratio?
a. .40
b. .50
c. .75
d. .80
Problem 3: Diversification is most effective when security returns are _________.
a. high
b. negatively correlated
c. positively correlated
d. uncorrelated
Problem 4: A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________.
a. 23.00%
b. 19.76%
c. 18.45%
d. 17.67%
Problem 5: Which risk can be diversified away as additional securities are added to a portfolio?
a. market risk
b. Systematic risk
c. Firm specific risk
d. Capital Allocation Risk
Problem 6: Which of the following provides the best example of a systematic risk event?
a. A strike by union workers hurts a firm's quarterly earnings.
b. Mad Cow disease in Montana hurts local ranchers and buyers of beef.
c. The Federal Reserve increases interest rates 50 basis points.
d. A senior executive at a firm embezzles $10 million and escapes to South America.
Problem 6: You are considering adding two stocks to your portfolio. Stock ALP has an expected return of 10% and a standard deviation of 15%. Stock BET has an expected return of 15% and a standard deviation of 20%. Which stock is a riskier addition to your portfolio? Please explain.
Problem 8: Briefly explain the difference between systematic risk and non-systematic risk. Please provide an example of each risk. Which risk can be eliminated through diversification?