MBA 702 EXAM 4 QUESTIONS &
ACTUAL CORRECT ANSWERS 100%
Total Risk - CORRECT ANSWER systematic risk + unsystematic risk
company risk AND market risk
Unsystematic Risk - CORRECT ANSWER a risk that affects at most a small number of
assets. Also, unique, diversifiable risk, or asset-specific risk.
can be reduced through diversification
once diversified, investors are STILL subject to market-wide systematic risk
ex: regulatory change, shift in management, or a product recall
Systematic Risk - CORRECT ANSWER A risk that influences a large number of assets.
Also, market risk, undiversifiable risk, or volatility risk
affects overall market, not a particular stock or market
ex: inflation, war, weather events, changes in interest rates
What are two ways of measuring risk? - CORRECT ANSWER Standard Deviation and
Beta (CAPM)
Standard Deviation - CORRECT ANSWER A measure of how much the individual
return on the stock deviate from expected value or the mean
Beta (CAPM) - CORRECT ANSWER A measure of how much the individual returns on
the stock 'move with' the overall market. Such as S&P 500.
Market risk
Expected Return - CORRECT ANSWER The best guess of what will happen based on
all the information currently available
Unexpected Return - CORRECT ANSWER The part of the rate that cannot be
forecasted. The 'surprise'
Systematic portion + unsystematic portion
Announcement - CORRECT ANSWER Release of information not previously available.
, Two parts: expected and surprise
Expected Part - CORRECT ANSWER "Discounted" information used by the market to
estimate the expected return
Surprise Part - CORRECT ANSWER News that influences that unexpected return
Ex: announcing layoff, stock falling
CAPM (Capital Asset Pricing Model) - CORRECT ANSWER For any stock, the risk
premium is the stock's expected return MINUS the risk-free rate.
The higher the beta, the greater the risk premium.
It's the relationship between the risk premium and beta that allows us to estimate the
expected return.
Risk Premium (RP) - CORRECT ANSWER E(r) - rf
R = - CORRECT ANSWER Required rate of return for a stock held in a well diversified
portfolio: rf + (MRP * beta)
Market price of portfolio - CORRECT ANSWER Return on 'the market' - risk free rate is
the 'market premium' or MRP
rm- rf
r= rf + (rm-rf) *beta
r- rf + (MRP* beta)
Expected Portfolio Returns - CORRECT ANSWER The weighted average of the
returns of the securities in the portfolio, weighted by the amount of money invested in
each security
Risk from portfolio perspective - CORRECT ANSWER The market will COMPENSATE
investors for taking market risk.
Returns are positively related to ONLY systematic risk
Beta - CORRECT ANSWER A measure of systematic or non-diversifiable (market) risk
Expected Risk Premium - CORRECT ANSWER On a stock is equal to the expected
return on stock MINUS the risk-free rate
Net Present Value (NPV) - CORRECT ANSWER The difference between the PV of
future cash inflows and PV of future cash outflows over a period of time
the amount of the change a proposed project will have on the value of the firm
ACTUAL CORRECT ANSWERS 100%
Total Risk - CORRECT ANSWER systematic risk + unsystematic risk
company risk AND market risk
Unsystematic Risk - CORRECT ANSWER a risk that affects at most a small number of
assets. Also, unique, diversifiable risk, or asset-specific risk.
can be reduced through diversification
once diversified, investors are STILL subject to market-wide systematic risk
ex: regulatory change, shift in management, or a product recall
Systematic Risk - CORRECT ANSWER A risk that influences a large number of assets.
Also, market risk, undiversifiable risk, or volatility risk
affects overall market, not a particular stock or market
ex: inflation, war, weather events, changes in interest rates
What are two ways of measuring risk? - CORRECT ANSWER Standard Deviation and
Beta (CAPM)
Standard Deviation - CORRECT ANSWER A measure of how much the individual
return on the stock deviate from expected value or the mean
Beta (CAPM) - CORRECT ANSWER A measure of how much the individual returns on
the stock 'move with' the overall market. Such as S&P 500.
Market risk
Expected Return - CORRECT ANSWER The best guess of what will happen based on
all the information currently available
Unexpected Return - CORRECT ANSWER The part of the rate that cannot be
forecasted. The 'surprise'
Systematic portion + unsystematic portion
Announcement - CORRECT ANSWER Release of information not previously available.
, Two parts: expected and surprise
Expected Part - CORRECT ANSWER "Discounted" information used by the market to
estimate the expected return
Surprise Part - CORRECT ANSWER News that influences that unexpected return
Ex: announcing layoff, stock falling
CAPM (Capital Asset Pricing Model) - CORRECT ANSWER For any stock, the risk
premium is the stock's expected return MINUS the risk-free rate.
The higher the beta, the greater the risk premium.
It's the relationship between the risk premium and beta that allows us to estimate the
expected return.
Risk Premium (RP) - CORRECT ANSWER E(r) - rf
R = - CORRECT ANSWER Required rate of return for a stock held in a well diversified
portfolio: rf + (MRP * beta)
Market price of portfolio - CORRECT ANSWER Return on 'the market' - risk free rate is
the 'market premium' or MRP
rm- rf
r= rf + (rm-rf) *beta
r- rf + (MRP* beta)
Expected Portfolio Returns - CORRECT ANSWER The weighted average of the
returns of the securities in the portfolio, weighted by the amount of money invested in
each security
Risk from portfolio perspective - CORRECT ANSWER The market will COMPENSATE
investors for taking market risk.
Returns are positively related to ONLY systematic risk
Beta - CORRECT ANSWER A measure of systematic or non-diversifiable (market) risk
Expected Risk Premium - CORRECT ANSWER On a stock is equal to the expected
return on stock MINUS the risk-free rate
Net Present Value (NPV) - CORRECT ANSWER The difference between the PV of
future cash inflows and PV of future cash outflows over a period of time
the amount of the change a proposed project will have on the value of the firm
