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The systematic principle states that the reward for bearing risk depends only on the diversifiable risk...

The systematic principle states that the reward for bearing risk depends only on the diversifiable risk of an investment. True or false?

Securities and portfolios lie above SML are underpricing. True or false?

When we apply WACC to evaluate projects with different levels of risk, we could correctly reject low risk and accept high risk projects. True or false?

Solutions

Expert Solution

1:False

Diversifiable risk refers to the risk that can be eliminated by diversifying into different investments. The total risk of investment comprises of systematic and unsystematic risk. As per the systematic risk principle the reward for Risk bearing is dependent only on systematic risk. Systematic risk is also known as market risk or risk that cannot be diversified. Hence the statement that the reward for Risk bearing depends only on diversifiable risk is false.

2: True

The security market line shows different levels of systematic or un diversifiable risk of securities along with the expected return. If a security lies above the SML it is under priced since this particular security offers a greater return as compared to its inherent risk.

3:False

In cases when the projects have different levels of risk we should use risk adjusted WACC Since projects with higher risk should be discounted at a higher rate as compared to projects with lower levels of risk.

jeff jeffy answered 2 years ago
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