Explain the following statement: “An asset held as part of a portfo-
lio is generally less risky than the same asset held in isolation.”
What is meant by perfect positive correlation, perfect negative correlation,
and zero correlation?
In general, can the riskiness of a portfolio be reduced to zero by
increasing the number of stocks in the portfolio? Explain.
What is an average-risk stock? What is the beta of such a stock?
Why is it argued that beta is the best measure of a stock’s risk?
If you plotted a particular stock’s returns versus those on the
Dow Jones Index over the past five years, what would the slope of
the regression line indicate about the stock’s risk?
Differentiate among a stock’s expected rate of return (rˆ), required
rate of return (r), and realized, after-the-fact, historical return (r-).
Which would have to be larger to induce you to buy the stock, rˆ or r?
At a given point in time, would rˆ, r, and r– typically be the same or
different? Explain.
What are the differences between the relative volatility graph
(Figure 8-9), where “betas are made,” and the SML graph (Figure
8-10), where “betas are used”? Explain how both graphs are con-
structed and the information they convey.
What would happen to the SML graph in Figure 8-10 if inflation
increased or decreased?
What happens to the SML graph when risk aversion increases or
decreases?
What would the SML look like if investors were indifferent to risk,
that is, if they had zero risk aversion?
How can a firm influence the size of its beta?
A stock has a beta of 1.2. Assume that the risk-free rate is 4.5 percent
and the market risk premium is 5 percent. What is the stock’s
required rate of return? (10.5%)
