7. Risk

Question 1

Describe the following risks:
Capital
Income
Shortfall
Liquidity & access
Interest
Inflation
Currency
Systemic
Systematic
Non-systematic
Gearing

Answer 1

Capital; losing investment
Income; nominal or real reduction of income
Shortfall; doesn’t meet expectations
Liquidity & access
Interest; variable rates reduce or fixed rates get beaten by market rates rising
Inflation
Currency
Systemic; interdependence in economy/sector
Systematic; general market risk from external factors
Non-systematic; specific sector/investment risk, solved by diversification
Gearing; returns need to cover interest & amplified losses

Question 2

How is volatility measured

Answer 2

An investment’s standard deviation from the expected return (average or benchmark)

Question 3

How do you interpret an investment’s beta value?

Answer 3

<1 price moves less than benchmark
0 no fluctuation - cash based
1 price moves in line with benchmark
>1 price moves more widely than benchmark

Question 4

What is alpha and how do you calculate and interpret it?

Answer 4

An asset’s ROI in excess of a risk-free rate

AR - (RF + beta x (MR - RF))

Actual return
Risk-free rate (short term deposit)
Market rate

Positive: asset return higher than risk-adjusted expected return
Negative: asset return lower than risk-adjusted expected return (not worth the risk)

Question 5

How do you calculate the real rate of return?

Answer 5

1 + nominal rate
_________________ - 1

1 + inflation rate

Question 6

What are the %s of time a return will be within 1 and 2 standard deviations?

Answer 6

1: 68%

2: 95%