Risk and Valuation Lectures 13 & 14

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What is the expected return on investment R1?

32%

17%

25% (correct)

23%

What is the definition of E[R]?

The minimum return on investment

The actual return on investment

The maximum return on investment

The return you expect to receive on average (correct)

What is the primary objective of the course on risk and valuation?

To consider the important distinction between ex ante and ex post returns

To calculate ex post returns and variance of returns

To describe how to calculate 'ex ante' expected returns and variance of returns (correct)

To understand the effect of portfolio diversification on returns

What is the formula to calculate the variance of return?

$\sigma[R]^2 = \sum\pi(s_i)R(s_i)^2 - E[R]^2$ Signup and view all the answers

What has historically delivered higher and more volatile returns than gilts or T-Bills?

LSE shares Signup and view all the answers

What is the relationship between the states of the world s1, s2, and s3?

They are mutually exclusive and exhaustive Signup and view all the answers

What determines the required rate of return for different shares?

The expected rate of return of the investor Signup and view all the answers

What is the interpretation of U in the equation R = E[R] + U?

Unexpected return Signup and view all the answers

What is the primary concern for investors when they invest in shares?

The expected return on investment Signup and view all the answers

What is the condition for E[U i]?

E[U i] = 0 Signup and view all the answers

What is the key distinction between systematic and unsystematic risk?

Systematic risk affects the entire market, while unsystematic risk affects individual companies Signup and view all the answers

What is the primary benefit of portfolio diversification?

Reducing the risk of the portfolio by spreading it across different assets Signup and view all the answers

What is the standard deviation of return R1?

19.39% Signup and view all the answers

What is the primary concern of investors when modeling uncertainty about future returns?

The standard deviation of the expected return Signup and view all the answers

What is the purpose of calculating the expected return and standard deviation of return?

To evaluate the risk and return of an investment Signup and view all the answers

What is the primary focus of the dividend discount model?

Discounting future dividends by the investors' required rate of return Signup and view all the answers

What is the primary benefit of portfolio diversification in terms of risk?

Eliminating diversifiable risk and leaving only systematic risk Signup and view all the answers

What is the relationship between the portfolio standard deviation and the weighted average of standard deviation of returns on the constituent securities?

The portfolio standard deviation is always less than the weighted average Signup and view all the answers

What is the primary determinant of security prices according to the systematic risk principle?

Systematic risk Signup and view all the answers

What is the purpose of modeling uncertain returns by their return in different states of the world?

To understand the behavior of a security in different economic scenarios Signup and view all the answers

What is the sum of the portfolio weights in a portfolio?

1 Signup and view all the answers

What is the relationship between the expected return of a portfolio and the expected returns of the constituent securities?

The expected return of the portfolio is a weighted average of the expected returns of the constituent securities Signup and view all the answers

What is the source of risk that affects many securities to various extents?

Information surprises about inflation Signup and view all the answers

What type of risk is eliminated through portfolio diversification?

Diversifiable risk Signup and view all the answers

Which type of risk is diversified away through portfolio diversification?

Unsystematic risk Signup and view all the answers

What is the name of the principle that states that securities with higher systematic risk promise higher expected returns?

Systematic risk principle Signup and view all the answers

What is the principle that states investors require higher expected returns to compensate them for systematic risk?

Systematic risk principle Signup and view all the answers

What is the relationship between expected returns and risk premium?

Riskier securities give expected returns that include a higher risk premium Signup and view all the answers

What is the total risk comprised of?

Systematic risk and unsystematic risk Signup and view all the answers

What type of risk is associated with information surprises about a company's boardroom problems?

Unsystematic risk Signup and view all the answers

What is the formula for total risk?

R = E[R] + m + ε Signup and view all the answers

What is the purpose of portfolio diversification in relation to risk?

To eliminate unsystematic risk Signup and view all the answers

What is the total amount invested in the securities with amounts £25,000, £5,000, £10,000, and £20,000?

£60,000 Signup and view all the answers

What is the portfolio return when the state of the world is s1, s2, or s3?

Weighted average of security returns Signup and view all the answers

What is the expected return of a portfolio with weights 3/5 and 2/5 for two securities?

22.6% Signup and view all the answers

What is the variance of a portfolio return Rp?

139.26 Signup and view all the answers

What is the standard deviation of a portfolio return with variance 139.26?

11.8% Signup and view all the answers

What is the benefit of portfolio diversification?

Reduces risk Signup and view all the answers

What is the correlation coefficient (ρ) for two securities with covariance 473 and standard deviations 19 and 28.4?

-0.0187 Signup and view all the answers

What percentage of risk is diversifiable in a portfolio of randomly selected UK stocks?

55% Signup and view all the answers