When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk. Diversification will normally reduce the riskiness of a portfolio of stocks.
What happens when you add a new stock to your portfolio?
When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk. Nice work! You just studied 65 terms! Now up your study game with Learn mode.
What happens when two stocks sell at the same price?
The two stocks should not sell at the same price. If their prices are equal, then a disequilibrium must exist. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5.
What determines a firm's required return on common stock?
b. The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.
What is the expected return on the stock?
The stock's required return must be equal to or less than 5%. d. The stock's price one year from now is expected to be 5% above the current price. e. The expected return on the stock is 5% a year.
Can a firm change its beta through managerial decisions?
A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions. Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.
Which portfolio should earn the highest average annual return?
The U.S. stock market has long been considered the source of the greatest historical returns for investors, outperforming all other types of financial securities and the housing market over the past century or so.
How much money do I need to invest to make $1000 a month?
Assuming a deduction rate of 5%, savings of $240,000 would be required to pull out $1,000 per month: $240,000 savings x 5% = $12,000 per year or $1,000 per month.
Can you lose money in stocks if you don't sell?
FAQs about investing in the stock market Yes, you can lose any amount of money invested in stocks. A company can lose all its value, which will likely translate into a declining stock price.
What does the Y axis intercept of the SML mean?
43. The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.
How is the slope of the SML determined?
40. The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.
Why is standard deviation not an adequate measure of risk?
17. Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.
How to find the beta of a stock?
e. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. This calculated historical beta may differ from the beta that exists in the future.
What is the coefficient of variation?
The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.
What happens to the required rate of return on each stock as measured by the CAPM?
Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation. a. true
What is market risk?
9. Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.
What is the standard deviation of portfolio P?
a. Portfolio P has a standard deviation that is greater than 25%.
What happens to the required returns on two stocks if the expected rate of inflation increases?
If the expected rate of inflation increases but the market risk premium is unchanged , the required returns on the two stocks should increase by the same amount.
What happens to the required return on both stocks if the market risk premium declines?
If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.
What is preemptive right?
The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value.
How do corporations earn returns?
Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.
How to determine if a stock is in equilibrium?
Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.
When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of answer?
When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk
How can diversifiable risk be lowered?
An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.
Why is beta important in stocks?
A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.
What happens to the SML if investors become less averse to risk?
If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.
What is realized return?
The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.
Why is paid in full beta so high?
This suggests that Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.
How is risk measured in a portfolio?
A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
How many securities are in a portfolio A?
Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
What happens if expected inflation increases but the market risk premium is unchanged?
e. If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount.
What happens to the required return on both stocks if expected inflation declines?
a. If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y.
What is preemptive right?
The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value.
How do corporations earn returns?
Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.
How to determine if a stock is in equilibrium?
Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.
What does it mean for markets to be in equilibrium?
For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,
When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of answer?
When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.
