Chapter 6 The Meaning and Measurement of Risk and Return

10) Assume that you have $100,000 invested in a stock that is returning 14%, $150,000 invested in a stock that is returning 18%, and $200,000 invested in a stock that is returning 15%. What is the expected return of your portfolio?

A) 13.25%

B) 14.97%

C) 15.67%

D) 15.78%

11) You are given the following probability distribution for XYZ common stock's returns during the next year, which are assumed to be normally distributed. Show all work below, and complete the following:

Return	Probability
12%	20%
16%	60%
20%	20%

a. Calculate the standard deviation of the returns, and round to the nearest one-half percent.

b. Draw a graphical representation of XYZ's normal distribution below (ye old bell-shaped curve). LABEL THE AXES OF THE GRAPH OR THE FOLLOWING RESULTS WILL BE MEANINGLESS. Using your result in part A for the standard deviation (rounded to the nearest one-half percent)explain and indicate on the graph, the probability that XYZ will return more than 13.5%, assuming a normal distribution.

12) Discuss whether the standard deviation of a portfolio is, or is not, a weighted average of the standard deviations of the assets in the portfolio. Fully explain your answer.

13) Bay Land, Inc. has the following distribution of returns:

State	Return	Probability
Boom	0.3	0.25
Normal	0.4	0.15
Bust	0.3	0.30

Assuming that these returns are normally distributed, what is the probability that Bay Land, Inc. will return less than 7.25%? Show all work, and clearly explain and state your answer.

Learning Objective 3

1) Historically, investments with the highest returns have the lowest standard deviations because investors do not like risk.

2) An investor with a required return of 8% for stock A will purchase stock A if the expected return for stock A is less than or equal to 8%.

3) In general, the required rate of return is a function of (1) the time value of money, (2) the risk of an asset, and (3) the investor's attitude toward risk.

4) As the required rate of return of an investment decreases, the market price of the investment decreases.

5) In an efficient market, a stock with a standard deviation of returns of 12% could have a higher expected return than a stock with a standard deviation of 10% because the beta for the higher standard deviation stock could be lower than the beta for the lower standard deviation stock.

6) Small company stocks have historically had higher average annual returns than large company stocks, and also a higher risk premium.