Security returns

Question

Security returns

BlackTom AI · Accepted Answer

Return on a security has two components: systematic (macro) and idiosyncratic (firm‑specific).

1. Relevant knowledge points and concepts
- Systematic (market or macro) risk: factors like GDP, interest rates, inflation, or market‑wide news that affect many securities simultaneously. Captured in models as beta × market return (e.g., CAPM).
- Idiosyncratic (firm‑specific) risk: events unique to a firm (management changes, lawsuits, product success) that affect only that firm’s return.
- Total return decomposition: security return = expected return + systematic component + idiosyncratic (residual) component.

2. Step‑by‑step reasoning
- Start with the decomposition: R_i = α_i + β_i R_m + ε_i, where β_i R_m is the macro/systematic effect and ε_i is firm‑specific.
- Macro events (R_m) simultaneously move many securities, generating co‑movement across returns.
- Firm‑specific shocks (ε_i) move only a single security and can be diversified away in a portfolio.
- Therefore security returns depend on both macro events (through β) and firm‑specific events (through ε).

3. Calculations (conceptual)
- No numeric calculation is required; the algebraic decomposition R_i = β_i R_m + ε_i demonstrates the two distinct components. Variance(R_i) = β_i^2 Var(R_m) + Var(ε_i) + 2β_i Cov(R_m, ε_i) (ε_i typically assumed uncorrelated with market).

4. Why the correct answer is correct
- The option "are based on both macro events and firm‑specific events" directly matches the decomposition above: both types of factors determine individual security returns.

5. Why other options are incorrect
- "Firm‑specific events only": false because market/macro factors clearly influence prices (systematic risk).
- "Usually positively correlated with each other": incorrect because correlation depends on exposures; some securities may be uncorrelated or negatively correlated depending on industry and betas.
- Combined options asserting both firm‑specific only and usually positively correlated are internally inconsistent or incorrect for the same reasons.

6. Conclusion
- Confirmed: the correct choice is "are based on both macro events and firm‑specific events," which matches the provided answer.

Security returnsSingle choice

Similar Questions

SI International had a free cash flow to equity (FCFE) of $122.1 million last year. The company has 12.43 million shares outstanding. SI’s required return on equity is 11.3% and WACC is 9.8%. If FCFE is expected to grow at 7.0% per year forever, the intrinsic value of SI's share is

You have a new client who has presented to your practice with depression. Your clinical assessment indicates high alcohol intake. How would you work with this client?

Which of the following occurs more commonly in boys than girls?

According to the Developmental Psychopathology framework, which of the following is true of Resilience?

What is the final assessment in this subject?

What is the minimum number of tutorials you need to attend to complete the hurdle requirement for this subject (without writing additional hurdle make up assignments)?

What is the second assessment for this subject?

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler