Chapter 8- Risk and Rates Return
Kasi ang nagagawa lang ng diversification ay malessen and
Self test questionnaires
1. What does investment risk mean?
Definition: Investment risk can be defined as the probability or
likelihood of occurrence of losses relative to the expected
return on any particular investment.
Description: Stating simply, it is a measure of the level of
uncertainty of achieving the returns as per the expectations of
the investor. It is the extent of unexpected results to be
realized.
2. Explain why you agree or disagree with this statement:
Most investors are risk-averse.
Agree: Ang investors, gusto nila ng mababang risk at mataas
na return. Meaning kaya lang sila sumusugal sa mataas na
risk, is because yung return ay mataas din
3. How does risk aversion affect rates of return?
In a market dominated by risk-averse investors, riskier
securities compared to less risky securities must have higher
expected returns as estimated by the marginal investor
4. Explain the following statement: An asset held as part of a
portfolio is generally less risky than the same asset held in
isolation.
True an asset is less risky held in a portfolio because risk is
diversified. This is important, because most financial assets
are not held in isolation; rather, they are held as parts of
portfolios. From the investor’s standpoint, what is important
is the return on his or her portfolio, and the portfolio’s risk—
not the fact that a particular stock goes up or down. Thus, the
risk and return of an individual security should be analyzed in
terms of how it affects the risk and return of the portfolio in
which it is held.
5. What is meant by perfect positive correlation, perfect
negative correlation, and zero correlation?
Stocks can be positively correlated when they move up or
down in tandem. A correlation value of 1 means two stocks
have a perfect positive correlation.
If one stock moves up while the other goes down, they would
have a perfect negative correlation, noted by a value of -1.
If each stock seems to move completely independently of the
other, they could be considered uncorrelated and have a value of
0.
6. In general, can the riskiness of a portfolio be reduced to zero
by increasing the number of stocks in the portfolio? Explain.
No.
risk, pero hindi maeliminate completely.
7. What is an average-risk stock? What is the beta of such a
stock?
An average risk stock is one that moves in sync with the market
and has a beta of 1.0
8. Why is it argued that beta is the best measure of a stock’s risk?
Stock's beta coefficient determines how the stock affects the
riskiness of a diverse portfolio.
We use historical data and assume that the stock's historical beta
will give us a reasonable estimate of how the stock will move
relative to the market in the future
9. How can a firm influence the size of its beta?
Through changes in the composition of its assets and through
changes in the amount of debit it uses.
10. Have there been any studies that question the validity of the
CAPM? Explain.
Yes. For example, a study by Eugene Fama of the University of
Chicago and Kenneth French of Dartmouth found no historical
relationship between stocks’ returns and their market betas,
confirming a position long held by some professors and stock
market analysts. As an alternative to the traditional CAPM,
researchers and practitioners are developing models with more
explanatory variables than just beta. These multivariable models
represent an attractive generalization of the traditional CAPM
model’s insight that market risk—risk that cannot be diversified
away—underlies the pricing of assets. In the multivariable
models, risk is assumed to be caused by several different factors,
whereas the CAPM gauges risk only relative to returns on the
market portfolio. These multivariable models represent a
potentially important step forward in finance theory; they also
have some deficiencies when applied in practice. As a result, the
basic CAPM is still the most widely used method for estimating
required rates of return on stocks