Question

1) What type of risk is not rewarded by the stock market since it can be diversified away?

Systematic risk

Bete

Standard deviation

Unsystematic risk

2) Which of the following is NOTa step for valuing a risky asset?

		Determine the asset's expected cash flows.
		Choose a discount rate that reflects the asset's risk.
		Calculate the present value.
		Determine the asset's beta.

3) The additional return offered by an investment, relative to an alternative, because it is riskier than the alternative, is the definition of:

		Risk premium
		Total return
		Standard deviation
		Diversification

4) A 10-year, 5% bond has a par value of $1,000. If the required rate of return in the market is 6%, this bond will sell at

		par value
		a discount.
		There is not enough information to make a determination.
		a premium

Answer 1

1. Unsystematic risk can be diversified away by holding a portfolio of uncorrelated stocks and therefore it is not rewarded by the stock market.

The market rewards investors who take systematic risk, because it cannot be diversified away. Beta measures the systematic risk and Standard Deviation measures the total risk: Systematic risk and Unsystematic risk.

2. Determining the asset beta is not a step in valuing a risky asset.

The below are steps involved in valuing a risky asset.

		Determine the asset's expected cash flows.
		Choose a discount rate that reflects the asset's risk.
		Calculate the present value

3. Risk premium is the addition return offered to the investor who takes additional risk relative to the alternative.

Total return is the return on the asset. It is a combination of risk-free return and other risk premiums.

Standard Deviation measures the total risk: Systematic risk and Unsystematic risk.

Diversification is a process in which many stocks whose returns are uncorrleated are pooled into a portfolio to reduce unsystematic risk.

4) Coupon rate (5%) < required return (6%). So, the bond sells at a discount.

If coupon rate > required return, the bond sells at a premium.

If coupon rate = required return, the bond sells at par.