Question

Which of the following statements are true regarding UNSYSTEMATIC RISK?

I. Unsystematic risk can be effectively eliminated through portfolio diversification.

II. Unsystematic is compensated for by a risk premium.

III. Unsystematic risk is measured by beta.

IV. As rational investors hold well-diversified portfolios, the market will not pay a risk premium for holding unsystematic risk.

	A.	I and IV only
	B.	II only
	C.	II and III only.
	D.	I, III, and IV only.
	E.	III and IV only.

You recently purchased a stock that is expected to earn 19% in a booming economy, 8% in a normal economy and lose 3% in a recessionary economy. There is a 25% probability of a boom, a 60% chance of a normal economy, and a 15% chance of a recession. What is your expected rate of return on this stock?

.

	A.	9.10%
	B.	6.80%
	C.	12.67%
	D.	12.88%
	E.	8.30%

Answer 1

Solution:

1) Which of the following statements are true regarding UNSYSTEMATIC RISK:

I. Unsystematic risk can be effectively eliminated by portfolio diversification.

IV. As rational investors hold well-diversified portfolios, the market will not pay a risk premium for holding unsystematic risk.

So the Right Option is A) I and IV only.

2) Calculation of the Expected Rate of Return on this Stock:

Therefore, the Expected Rate of Return on this Stock is 9.10%.

Right Option is A) 9.10%.