ADMS 3531 Chapter Notes - Chapter 1: Capital Loss, Scotiabank, Risk Premium

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pucewildebeest131

24 Feb 2014

School

York University

Department

Administrative Studies

Course

ADMS 3531

Professor

Dale Domian

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Chapter 1: a brief history of risk and return. Suppose at the age of 25, you begin saving ,000/year. 40 years later, you retire at age 65. If you earn 10%, you will have about . 3 million. Based on the history of financial markets, the answer appears to be yes. (between 1950 and 2010, the toronto stock. History of risk and return is made day by day in global financial markets. The fact that risk and return go together is probably the single most important fact to understand about investments. The only way to earn a higher return is to take on greater risk. If you buy an asset of any type, your gain (or loss) from that investment is called the return on your investment. Suppose you purchase 100 shares of stock in toronto dominion (td) bank on january 1st. At that time, td bank was selling for per share, so your 100 shares cost you ,500.

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Reaching a financial goal Erika and Kitty, who are twins, just received $15,000 each for their 23th birthdays. They both have aspirations to become millionaires. Each plans to make a $5,000 annual contribution to her "early retirement fund" on her birthday, beginning a year from today. Erika opened an account with the Safety First Bond Fund, a mutual fund that invests in high-quality bonds whose investors have earned 5% per year in the past. Kitty invested in the New Issue Bio-Tech Fund, which invests in small, newly issued bio-tech stocks and whose investors have earned an average of 16% per year in the fund's relatively short history. a. If Erika's fund earns the same returns in the future as in the past, how old will she be when she becomes a millionaire? Round your answer to two decimal places. ________ years b. If Kitty's fund earns the same returns in the future as in the past, how old will she be when she becomes a millionaire? Round your answer to two decimal places. ________ years c. How large would Erika's annual contributions have to be for her to become a millionaire at the same age as Kitty, assuming their expected returns are realized? Round your answer to the nearest cent. $ ________ d. Is it rational or irrational for Erika to invest in the bond fund rather than in stocks? I. High expected returns in the market are almost always accompanied by a lot of risk. We couldn't say whether Erika is rational or irrational, just that she seems to have less tolerance for risk than Kitty does. II. High expected returns in the market are almost always accompanied by less risk. We couldn't say whether Erika is rational or irrational, just that she seems to have more tolerance for risk than Kitty does. III. High expected returns in the market are almost always accompanied by a lot of risk. We couldn't say whether Erika is rational or irrational, just that she seems to have more tolerance for risk than Kitty does. IV. Highexpectedreturnsinthemarketarealmostalwaysaccompaniedbylessrisk.Wecouldn'tsay whether Erika is rational or irrational, just that she seems to have less tolerance for risk than Kitty does. V. Highexpectedreturnsinthemarketarealmostalwaysaccompaniedbyalotofrisk.Wecouldn'tsay whether Erika is rational or irrational, just that she seems to have about the same tolerance for risk than Kitty does. _________________

Scenario 7 Investment Portfolio You know that there is a trade-off between risk and return when you choose an investment. The greater the return you expect to receive, the larger the risk you must take. Most people cannot afford to risk much of their money on investments that offer a high return. This, however, does not mean that they must accept only low returns on their investments. Through diversification, a fair return can be achieved without taking unreasonable risks. Asset allocation is the process of choosing a variety of investments that offers different combinations of risk and return. Then, if one investment fails to do well, others may make up for its poor performance by being successful. The objective for each investor is to select a portfolio of investments that meets his or her individual financial goals. Your cousin, Maya (28 years) and her husband, Peter (32 years), have very different views when it comes down to investments. Peter wants to save some money for a down payment on a house and wants to put all their money in bank accounts, whereas Maya wants to put all their money into growth stocks so that they can accumulate the money faster. They are seeking your advice. What would you suggest them to do and why? (Use vocabulary â asset allocation, rule of 72, time factor, age, types of stocks, bonds, treasury securities, mutual funds)

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1. If we are able to eliminate all of the unsystematic or diversifiable risk in a portfolio then, what is the result?

a.

a risk-free portfolio
b.
a portfolio that has an expected return of zero
c.

a portfolio that contains only systematic risk

2. A portfolio consists 20% of a risk-free asset and 80% of a stock. The risk-free return is 4%. The stock has an expected return of 15% and a standard deviation of 30%. Whatâs the expected return of the portfolio?

a.
9.5%
b.
15.0%
c.
12.8%

d.
2%

3. The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of 1.5, what is its expected return?

a.
12%
b.
19.5%
c.

17%

4. For what value of the correlation coefficient for the returns of a pair of stocks will the benefits of diversification the largest?

a.

1.0
b.

-1.0
c.

0.0
d.

0.5

5. Which of the following is an example of systematic risk?
a.
IBM posts lower than expected earnings.
b.
The overall stock market becomes more risky due to super fasting trading algorithms.
c.

Intel announces record earnings.

6. According to the CAPM (capital asset pricing model), the security market line is a straight line. The intercept of this line should be equal to

a.
zero
b.
the expected risk premium on the market portfolio
c.
the expected return on the market portfolio
d.
the risk-free rate

7. A portfolio has 40% invested in Asset 1, 50% invested in Asset 2 and 10% invested in Asset 3. Asset 1 has a beta of 1.2, Asset 2 has a beta of 0.8 and Asset 3 has a beta of 1.8, whatâs the beta of the portfolio?

a.
0.80
b.
1.06
c.
1.27

8. Suppose you can borrow and lend at the risk free-rate of 3%. Which of the following four risky portfolios has the best return relative to risk. (Hint: Calculate Sharpe Ratios the ratio of risk premium to standard deviation for each portfolio)

a.
portfolio with a standard deviation of 15% and an expected return of 12%
b.
portfolio with a standard deviation of 12% and an expected return of 9%
c.
portfolio with a standard deviation of 25% and an expected return of 18%
d.
portfolio with a standard deviation of 19% and an expected return of 15%

9. Which statements are TRUE regarding risk and return?

Statement I:
Diversification is the process of removing systematic risk from a portfolio.
Statement II:
In general, the greater the risk, the greater the return required by an investor.
Statement III:
Investors should focus on real returns if they are concerned about the purchasing power of their wealth.

a.
Statements II and III only
b.
Statement I only
c.
Statements I and III only
d.
Statements I and II only

10. The beta of the risk-free asset is:
a.

1.0
b.

0.5
c.

0.0
d.

-1.0

ADMS 3531 Chapter Notes - Chapter 1: Capital Loss, Scotiabank, Risk Premium

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