What is meant by perfect positive correlation, perfect negative correlation, and zero correlation?

BB. In general, can the riskiness of a portfolio be reduced to zero by increasing the number of stocks in the portfolio?

CC. What is an average-risk stock? What is the beta of such a stock?

DD. Why is it argued that beta is the best measure of a stocks risk?

EE. An investor has a two-stock portfolio with $25,000 invested in Stock X and $50,000 invested in Stock Y. Xs beta is 1.50, and Ys beta is 0.60. What is the beta of the investors portfolio?

FF. Differentiate between a stocks expected rate of return , required rate of return (r), and realized, after-the-fact historical return . Which would have to be larger to induce you to buy the stock, or r? At a given point in time, would , r, and typically be the same or different? Explain.

GG. What are the differences between the typical relative volatility graph, where betas are made, and the typical SML graph, where betas are used? Explain how both graphs are constructed and what information they convey.

HH. What is meant by the term, positive alpha? Negative alpha? How can a firm influence the size of its beta?

II. What would happen to the SML graph if expected inflation increased or decreased? What happens to the SML graph when risk aversion increases or decreases?

What would the SML look like if investors were indifferent to risk, that is, if they had zero risk aversion?

JJ. A stock has a beta of 1.2. Assume that the risk-free rate is 4.5%, and the market risk premium is 5%. What is the stocks required rate of return?

KK Explain the following statement: The stand-alone risk of an individual corporate project may be quite high, but viewed in the context of its effect on stockholders risk, the projects true risk may not be very large. How does the correlation between returns on a project and returns on the firms other assets affect the projects risk?

LL A life insurance policy is a financial asset, with the premiums paid representing the investments cost. How would you calculate the expected return on a 1-year life insurance policy?

Suppose the owner of a life insurance policy has no other financial assetsthe persons only other asset is human capital, or earnings capacity. What is the correlation coefficient between the return on the insurance policy and the return on the human capital? Life insurance companies must pay administrative costs and sales representatives commissions; hence, the expected rate of return on insurance premiums is generally low or even negative. Use portfolio concepts to explain why people buy life insurance in spite of low expected returns.

MM If the market interest rate for a given bond increased, the price of the bond would decline. Applying this same logic to stocks, explain (a) how a decrease in risk aversion would affect stocks prices and earned rates of return, (b) how this would affect risk premiums as measured by the historical difference between returns on stocks and returns on bonds, and (c) what the implications of this would be for the use of historical risk premiums when applying the SML equation.

NN HR Industries (HRI) has a beta of 1.6; LR Industriess (LRI) beta is 0.8. The risk-free rate is 6%, and the required rate of return on an average stock is 13%. The expected rate of inflation built into falls by 1.5 percentage points, the real risk-free rate remains constant, the required return on the market falls to 10.5%, and all betas remain constant. After all of these changes, what will be the difference in the required returns for HRI and LRI?