Chapter 11 Reading quiz Name_____________________________________________

Average Standard Deviation= Variance

Variance= Average of Squared Deviations ( of SquaredDeviations

of years )

1) What is the average annual return on T-Bills & stocks from 1900-2013?
Tbills return: 3.9% Stock return: 11.5%
Pg 330

2) What is the average standard deviation of returns for T-Bills and stocks 1900-2013? Tbills Std Dev: 2.8?

Stock Std Dev: 19.9%?

Pg 338

3) Looking at table 11.5, note that almost all the stocks have a higher standard deviation than the market (the
standard deviation from question 2) even though they are part of the market. In fact, almost all stocks, not just
most of this list, have a higher standard deviation of return than the market. Why does the market have a lower
standard deviation than most stocks that make up the market?

Because the market is made up of a highly diversified portfolio of stocks. Prices of different stocks do not move exactly
together, but diversification works best when returns are negatively correlated.
4) For two stocks to diversify each other they must be, at a minimum (choose one)
imperfectly correlated negatively correlated perfectly correlated

5) Portfolio return is the weighted average of Returns on Individual Assets

Portfolio Rate of Return= fraction of portfolio rate of return + fractionof portfolio ratereturn
( )( )
first on first asset second asset on second asset

The portfolio return is the weighted average of returns on the individual assets with weights equal to the proportion of

the portfolio invested in each asset. For a portfolio formed from only two assets

6) What are the two kinds of risk for equity returns?

net income assets sales after - tax operating income net income
ROE= =
equity equity assets sales after - tax operating income
equity: the value of shares issued by a company

Market Risk

Specific Risk

7) Total Risk, or Standard Deviation is made up of two types of risk. Name the risk that is diversifiable

The risk that can be eliminated through diversification is known as specific risk

8) Name the risk that is not diversifiable

Market Risk: the risk that the market as a whole will slump.

9) For a well-diversified equity portfolio only one type of risk matters: Market Risk
10) Can diversification reduce risk in your portfolio to zero? Yes No
11) What figure in the book demonstrates how risk declines with diversification? 11.8 11.9?