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RISK, RETURN, AND THE SECURITY MARKET LINE

Answers to Concepts Review and Critical Thinking Questions 1. Some of the risk in holding any asset is unique to the asset in question. By investing in a variety of assets, this unique portion of the total risk can be eliminated at little cost. On the other hand, there are some risks that affect all investments. This portion of the total risk of an asset cannot be costlessly eliminated. In other words, systematic risk can be controlled, but only by a costly reduction in expected returns. 2. If the market expected the growth rate in the coming year to be 2 percent, then there would be no change in security prices if this expectation had been fully anticipated and priced. However, if the market had been expecting a growth rate other than 2 percent and the expectation was incorporated into security prices, then the government’s announcement would most likely cause security prices in general to change; prices would drop if the anticipated growth rate had been more than 2 percent, and prices would rise if the anticipated growth rate had been less than 2 percent. 3. a. systematic b. unsystematic c. both; probably mostly systematic d. unsystematic e. unsystematic f. systematic

4. a. a change in systematic risk has occurred; market prices in general will most likely decline. b. no change in unsystematic risk; company price will most likely stay constant. c. no change in systematic risk; market prices in general will most likely stay constant. d. a change in unsystematic risk has occurred; company price will most likely decline. e. no change in systematic risk; market prices in general will most likely stay constant.

5. No to both questions. The portfolio expected return is a weighted average of the asset returns, so it must be less than the largest asset return and greater...

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