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Chapter 17: Q8. (page 369)
The interest rate on short-term U.S. government bonds is 4 percent. The risk premium for any asset with a beta = 1.0 is 6 percent. What is the average expected rate of return on the market portfolio?
0 percent
4 percent
6 percent
10 percent
The correct option is (d): 10 percent
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How do stocks and bonds differ in terms of the future payments that they are expected to make? Which type of investment (stocks or bonds) is considered to be more risky? Given what you know, which investment (stocks or bonds) do you think commonly goes by the nickname “fixed income”?
Corporations often distribute profits to their shareholders in the form of dividends, which are quarterly payments sent to shareholders. Suppose that you have the chance to buy a share in a fashion company called Rogue Designs for \(35 and that the company will pay dividends of \)2 per year on that share. What is the annual percentage rate of return? Next, suppose that you and other investors could get a 12 percent per year rate of return on the stocks of other very similar fashion companies. If investors care only about rates of return, what should happen to the share price of Rogue Designs? (Hint: This is an arbitrage situation.)
Asset X is expected to deliver 3 future payments. They have present values of, respectively, \(1,000, \)2,000, and \(7,000. Asset Y is expected to deliver 10 future payments, each having a present value of \)1,000. Which of the following statements correctly describes the relationship between the current price of Asset X and the current price of Asset Y?
Asset X and Asset Y should have the same current price.
Asset X should have a higher current price than Asset Y.
Asset X should have a lower current price than Asset Y.
Suppose that you invest $100 today in a risk-free investment and let the 4 percent annual interest rate compound. Rounded to full dollars, what will be the value of your investment 4 years from now?
Why is it reasonable to ignore diversifiable risk and care only about non-diversifiable risk? What about investors who put all their money into only a single risky stock? Can they properly ignore diversifiable risk?
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