Module 7 - Risk and Return

Question 1

Two key financial considerations in most important business decisions

Answer 1

risk and return

Question 2

a collection, or group, of assets

Answer 2

portfolio

Question 3

is a measure of uncertainty surrounding the return that an investment will earn or, more formally, the variability of returns associated with a given asset

Answer 3

Risk

Question 4

the total gain or loss experienced on an investment over a given period of time; calculated by dividing the asset’s cash distributions during the period, plus change in value, by its beginning-of-period investment value

Answer 4

Return

Question 5

T or F: stocks are riskier than bonds, and therefore offer higher potential returns

Answer 5

True

Question 6

investors require an increased return for an increase in risk

Answer 6

risk averse

Question 7

investors choose the investment with the higher return regardless of its risk

Answer 7

risk neutral

Question 8

investors prefer investments with greater risk even if they have lower expected returns

Answer 8

risk seeking

Question 9

economists use these three categories to describe how investors respond to risk, or their attitude towards risk

Answer 9

Risk averse, risk neutral, risk seeking

Question 10

risk neutral is also referred to as

Answer 10

risk indifferent

Question 11

an approach for assessing risk that uses several possible alternative outcomes (scenarios) to obtain a sense of the variability among returns

Answer 11

Scenario analysis

Question 12

a measure of an asset’s risk, which is found by substracting the return associated with the pessimistic (worst) outcome from the return associated with the optimistic (best) outcome

Answer 12

Range

Question 13

the chance that a given outcome will occur

Answer 13

probability

Question 14

a model that relates probabilities to the associated outcomes

Answer 14

probability distribution

Question 15

the simplest type of probability distribution; shows only a limited number of outcomes and associated probabilities for a given event

Answer 15

bar chart

Question 16

the most common statistical indicator of an asset’s risk; it measures the dispersion around the expected value

Answer 16

Standard deviation

Question 17

the average return that an investment is expected to produce over time

Answer 17

expected value of a return

Question 18

a measure of relative dispersion that is useful in comparing the risks of assets with differing expected returns

Answer 18

coefficient of variation

Question 19

a higher coefficient of variation means that:

Answer 19

an investment has more volatility relative to its expected return

Question 20

a portfolio that provides maximum return of a given level of risk

Answer 20

efficient portfolio

Question 21

it is a weighted average of the returns on the individual assets from which it is formed

Answer 21

return on a portfolio

Question 22

a statistical measure of the relationship between any two series of numbers

Answer 22

correlation

Question 23

describes two series that move in the same direction

Answer 23

positively correlated

Question 24

describes two series that move in opposite directions

Answer 24

negatively correlated

Question 25

measure of the degree of correlation between two series

Answer 25

correlation coefficient

Question 26

describes two positively correlated series that have a correlation coefficient of +1

Answer 26

perfectly positively correlated

Question 27

describes two negatively correlated series that have a correlation coefficient of -1

Answer 27

perfectly negatively correlated

Question 28

describes two series that lack any interaction and therefore have a correlation coefficient close to zero

Answer 28

uncorrelated

Question 29

it is the basic theory that links risk and return for all assets, quantifies the relationship between risk and return, it measures how much additional return an investor should expect from taking a little extra risk

Answer 29

capital asset pricing model

Question 30

portion of an asset’s risk that is attributable to firm-specific, random causes; can be eliminated through diversification

Answer 30

Diversifiable (Unsystematic) Risk

Question 31

relevant portion of an asset’s risk attributable to market factors that affect all firms; cannot be eliminated through diversification

Answer 31

Nondiversifiable (Systematic) Risk

Question 32

results from uncontrollable or random events that are

firm-specific (e.g. labor strikes, lawsuits, unsuccessful acquisitions).

Answer 32

diversifiable risk

Question 33

attributable to forces that affect all similar

investments (e.g. war, inflation, political events).

Answer 33

nondiversifiable risk

Question 34

the combination of a security’s nondiversifiable risk and diversifiable risk

Answer 34

total risk

Question 35

a relative measure of nondiversifiable risk. an index of the degree of movement of an asset’s return in response to a change in the market return

Answer 35

beta coefficient

Question 36

is the return on the market portfolio of all traded securities

Answer 36

market return

Question 37

the CAPM (Capital Asset Pricing Model) can be divided into two parts:

Answer 37

1. the risk-free rate of return

2. risk premium

Question 38

represents the premium the investor must receive for taking the average amount of risk associated with holding the market portfolio of assets

Answer 38

risk premium

Question 39

other things being equal: the higher the beta, the ___ the required return
the lower the beta, the ___ the required return

Answer 39

higher, lower