İŞLETME FİNANSI I

E(R_A)=R_F+B(E(R_M)-R_F) will give the expected return of asset A (R_A) given the expected market return (E(R_M)) and risk-free return (R_F). Thus:

12=6+(10-6)B

6=4B

1.5=B

Average rate = (0.05 + 0.07 + 0.09 + 0.03)/4 = 0.06

Variance=(1/4)*((0.05-0.06)²+(0.07-0.06)²+(0.09-0.06)²+(0.03-0.06)²)=(1/4)*(0.0001+0.0001+0.0009+0.0009)=0.0005

That is definition of correlation. If the correlation is negative then the prices or returns are moving in inverse directions, if the correlation is positive they are moving in same directions and if correlation is zero then there is no relation.

Expected return of a portfolio is the weighted average of returns of securities in that portfolio. The share of C=1-0.5-0.3=0.2

Thus, expected return will be:

ER=0.3*10+0.5*8+0.2*5=3+4+1=8%

Suppose that weight of X in portfolio is w. Then the weight of Y will be 1-w, given 0

since 0

multiplying all sides with 5: 0<5w<5

adding 5 to all sides:     5<5+5w<10. Thus the expected return of portfolio will be between 5 and 10. Therefore correct answer is D.

Combining assets with negaive correlation decreases both the risk and rate of return of a portfolio.

The risk which can be diminished by diversification is called unsystematic risk because the source of the risk is not the market.

Beta measures the co-movement of a securities returns with the market return. It is stimated by standardizing the covariance between a given security and market portfolio with the variance of the market.

The securities above the security market line (SML) are over-valued. So A and B are overvalued, D and C are under-valued, E is correctly valued.

X is preferable to Y because they have same rate of return but X is less risky. Also, X is preferable to Z because for same level of risk, X provides higher rate of return. Y and Z are feasible but not efficient. X is the single efficient point among them.

Semistrong form of the EMH states that all publicly available information is fully reflected in prices. If semistrong form efficiency holds, it should not be possible for investors using publicly available information to obtain consistent excess profits.

Since covariance is standardized by dividing by the standard deviations, the correlation always lies between +1 (perfect positive correlation) and -1 (perfect negative correlation). Zero correlation would mean there is no relation at all.

Market, portfolio or systematic risk is the uncertainty inherent to the market that cannot be controllable. On the other hand, the diversifiable, unique or unsystematic risk is the uncertainty that is related to the invested asset. Therefore, unsystematic risk can be reduced through diversification whereas systematic risk cannot.

The Capital Market Line (CML) is the line that connects the risk-free asset with the market portfolio, where the line is just tangent to the efficient frontier on an expected return/ standard deviation graph.

Capital-Asset-Pricing Model is a model describing the relationship between the systematic risk of a security, namely beta, and expected returns. As long as the market risk premium is positive, higher beta value bring higher returns.

Risk-free return is the rate of return that investors require to invest in risk free investments in that environment. The short term T-Bill rate is usually used to measure it. The Risk premium is the return in excess of the risk-free rate that investors require to compensate for the risk of an investment.

Strong form of the EMH states that all privately and publicly available information is fully reflected in prices. If strong form efficiency holds, it should not even be possible for insiders like managers, owners, bankers, politicians, or judges using private information to obtain consistent excess profits. Even insiders trading on their information (independent of legal and ethical considerations) are engaging in useless activities.

Expected return of a portfolio is simply the weighted average of the returns of securities.

Unexpected returns are the result of new unexpected information arriving to the market during the period. Some examples of relevant new information arriving to the market could be things like:

• Announcement of the latest growth rate of the economy • Large swings in the value of the national currency • Announcement of a new contract to sell large quantity of products to another country • News of a large accident at the factory • Announcement of a new facility being built that will significantly increase the production capacity of the company

Beta is used to measure the risk level of securities in relation to the overall market. Beta values do not have a limit, they can range from negative infinity to positive infinity. However, the vast majority of beta values will lie between 0 and +2. Beta values can be interpreted using the following guidelines:

(i) If Beta > 1, the security has above average risk and returns are expected to be more extreme and in the same direction as the market. If market returns go up 1%, security returns on average go up >1%.

(ii) If Beta = 1, then the security has average risk and returns are expected to be similar to the market. If market returns go up 1%, security returns on average go up 1%.

(iii) If 1> Beta >0, then the security has below average risk and returns are expected to be less extreme and in the same direction as the market. If market returns go up 1%, security returns on average go up <1%.

(iv) If Beta = 0, then the security has below average risk. The security returns may be constant or if not constant then varying totally independently from market returns.

(v) If Beta < 0, then security has very low risk and returns are expected to move in opposite direction with the market. This type of security is not common and may be insurance related. These securities may be very useful in reducing portfolio risk.