Bma Chapter 07

Chapter 07 - Introduction to Risk and Return

CHAPTER 7 Introduction to Risk and Return

Answers to Problem Sets

1. Expected payoff is $100 and expected return is zero. Variance is 20,000 (% squared) and standard deviation is 141%.

2.

a. b.

Standard deviation = 19.3% Average real return = -2.2%

3.

Ms. Sauros had a slightly higher average return (14.6% vs. 14.4% for the market). However, the fund also had a higher standard deviation (13.6% vs. 9.4% for the market). a. b. c. d. e. f. g. h. False True False False False True True False

4.

5. 6.

d

7-1

Chapter 07 - Introduction to Risk and Return

7.

a. b. c. d.

26% zero .75 Less than 1.0 (the portfolio’s risk is the same as the market, but some of this risk is unique risk).

8.

1.3 (Diversification does not affect market risk.)

9.

A, 1.0; B, 2.0; C, 1.5; D, 0; E, 21.0

10.

Recall from Chapter 4 that: (1 + rnominal) = (1 + rreal) × (1 + inflation rate) Therefore: rreal = [(1 + rnominal)/(1 + inflation rate)] – 1 a. The real return on the stock market in each year was: 1929: 1930: 1931: 1932: 1933: b. c. -14.7% -23.7% -38.0% 0.5% 56.5%

From the results for Part (a), the average real return was: -3.89% The risk premium for each year was: 1929: 1930: 1931: 1932: 1933: -19.3% -30.7% -45.0% -10.9% 57.0%

d. e.

From the results for Part (c), the average risk premium was: –9.78% The standard deviation (σ) of the risk premium is calculated as follows:

⎛ 1 ⎞ 2 2 2 σ2 =⎜ ⎜ 5 − 1⎟ × ( −0.193 − (− 0.0978)) + ( − 0.307 − ( −0.0978)) + ( − 0.450 − ( −0.0978)) ⎟ ⎝ ⎠

[

7-2

Chapter 07 - Introduction to Risk and Return

+ ( −0.109 − ( − 0.0978)) 2 + (0.570 − ( − 0.0978)) 2 ] = 0.155739 σ = 0.155739 = 0.394637 = 39.46%

11.

a.

A long-term United States government bond is always absolutely safe in terms of the dollars received. However, the price of the bond fluctuates as interest rates change and the rate at which coupon payments received can be...