PROP 1020 / CHAPTER 10 Flashcards
__________ may be defined as the admission of total ignorance about the possible outcomes.
Uncertainty may be defined as the admission of total ignorance about the possible outcomes.
_________ implies an awareness of the range of possible outcomes, or a degree of variability based on our experience.
Risk or riskiness implies an awareness of the range of possible outcomes, or a degree of variability based on our experience.
NOTE ONLY / RISK
The riskiness of a real estate investment (e.g., property acquisition, property development) is a function of the probable variability of the future cash flows associated with the investment; the more variable the periodic cash flows, the “riskier” the investment.
NOTE ONLY / RISK
The riskiness of a real estate investment (e.g., property acquisition, property development) is a function of the probable variability of the future cash flows associated with the investment; the more variable the periodic cash flows, the “riskier” the investment.
This is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs.
ANSWER: Operating Leverage
NOTE ONLY
Business decisions are rarely made on the basis of precise estimates. A prudent investor will qualify his or her forecasts. A common practice is to develop pessimistic and optimistic forecasts so that the range of probable outcomes is established based on the best information available.
We use the term probable to imply that the range of forecasts are based on our experience and a series of facts and variables. We refer to this distribution of possible outcomes as a probability distribution.
There is a distinct probability associated with each possible outcome. In its simplest form, the probability distribution illustrates the possible states of the world associated with a few possible outcomes.
NOTE ONLY
Business decisions are rarely made on the basis of precise estimates. A prudent investor will qualify his or her forecasts. A common practice is to develop pessimistic and optimistic forecasts so that the range of probable outcomes is established based on the best information available.
We use the term probable to imply that the range of forecasts are based on our experience and a series of facts and variables. We refer to this distribution of possible outcomes as a probability distribution.
There is a distinct probability associated with each possible outcome. In its simplest form, the probability distribution illustrates the possible states of the world associated with a few possible outcomes.
We may compare forecasts by constructing a single measure of different forecasts: the average of possible returns weighted by their respective probabilities of occurrence. Such a weighted average is called the ________ of an outcome. The use of one “summary number” such as the expected value makes it easier to incorporate the ideas into the rest of the analysis.
We may compare forecasts by constructing a single measure of different forecasts: the average of possible returns weighted by their respective probabilities of occurrence. Such a weighted average is called the expected value of an outcome. The use of one “summary number” such as the expected value makes it easier to incorporate the ideas into the rest of the analysis.
The standard deviation is often used by investors to measure the risk of an investment. The basic idea is that the standard deviation is a measure of volatility: the more an investment’s returns vary from the average return, the more volatile the investment.
The standard deviation is often used by investors to measure the risk of an investment. The basic idea is that the standard deviation is a measure of volatility: the more an investment’s returns vary from the average return, the more volatile the investment.
With _____________, the question “what if” is used directly and addressed to one or more variables. Investors and analysts will commonly use ____________ to probe the potential impacts of changes in key investment variables, such as the rate of financing, construction costs, or expected commercial rents or condominium sales.
In SENSITIVITY ANALYSIS, the question “what if” is used directly and addressed to one or more variables. Investors and analysts will commonly use SENSITIVITY ANALYSIS to probe the potential impacts of changes in key investment variables, such as the rate of financing, construction costs, or expected commercial rents or condominium sales.
NOTE / STANDARD DEVIATION & RISK
In many sectors of the finance industry, risk measurement is a primary focus. While it can play a role in economics and accounting, the impact of accurate or faulty risk measurement is most clearly illustrated in the investment sector. Whether investing in stocks, options or mutual funds, knowing the probability that a security moves in an unexpected way can be the difference between a well-placed trade and bankruptcy. Traders and analysts use a number of metrics to assess the volatility and relative risk of potential investments, but the most common metric is standard deviation.
Standard deviation is a basic mathematical concept that carries a lot of weight. Simply put, standard deviation measures the average amount by which individual data points differ from the mean. It is calculated by first subtracting the mean from each value, and then squaring, summing and averaging the differences to produce the variance. While variance itself is a useful indicator of range and volatility, the squaring of the individual differences means they are no longer reported in the same unit of measurement as the original data set. In the case of stock prices, the original data is in dollars and variance is in dollars squared, which is not a useful unit of measure. Standard deviation is simply the square root of the variance, bringing it back to the original unit of measure and making it much simpler to use and interpret.
In investing, standard deviation is used as an indicator of market volatility and therefore of risk. The more unpredictable the price action and the wider the range, the greater the risk. Range-bound securities, or those that do not stray far from their means, are not considered a great risk because it can be assumed with relative certainty that they continue to behave in the same way. A security that has a very large trading range and tends to spike, reverse suddenly or gap, is much riskier. However, risk is not necessarily bad. The riskier the security, the greater potential for payout as well as loss.
NOTE / STANDARD DEVIATION & RISK
In many sectors of the finance industry, risk measurement is a primary focus. While it can play a role in economics and accounting, the impact of accurate or faulty risk measurement is most clearly illustrated in the investment sector. Whether investing in stocks, options or mutual funds, knowing the probability that a security moves in an unexpected way can be the difference between a well-placed trade and bankruptcy. Traders and analysts use a number of metrics to assess the volatility and relative risk of potential investments, but the most common metric is standard deviation.
Standard deviation is a basic mathematical concept that carries a lot of weight. Simply put, standard deviation measures the average amount by which individual data points differ from the mean. It is calculated by first subtracting the mean from each value, and then squaring, summing and averaging the differences to produce the variance. While variance itself is a useful indicator of range and volatility, the squaring of the individual differences means they are no longer reported in the same unit of measurement as the original data set. In the case of stock prices, the original data is in dollars and variance is in dollars squared, which is not a useful unit of measure. Standard deviation is simply the square root of the variance, bringing it back to the original unit of measure and making it much simpler to use and interpret.
In investing, standard deviation is used as an indicator of market volatility and therefore of risk. The more unpredictable the price action and the wider the range, the greater the risk. Range-bound securities, or those that do not stray far from their means, are not considered a great risk because it can be assumed with relative certainty that they continue to behave in the same way. A security that has a very large trading range and tends to spike, reverse suddenly or gap, is much riskier. However, risk is not necessarily bad. The riskier the security, the greater potential for payout as well as loss.
TRUE OR FALSE?
Since all investments are, to a certain extent, dependent on the vagaries of the economy, one cannot escape the general risks through diversification.
ANSWER:
TRUE
_________ are external to the specific investment. They result from the operation of the whole market and/or the whole economy. They may also be called _________ OR ___________
General risks are external to the specific investment. They result from the operation of the whole market and/or the whole economy. They may also be called market risks or systematic risks.
______________ is a method for isolating how change in one or more variable may affect investment risk.
ANSWER: SENSITIVITY ANALYSIS
NOTE ONLY / OPERATING LEVERAGE
The higher the degree of operating leverage, the greater the potential danger from forecasting risk.
That is, if a relatively small error is made in forecasting sales, it can be magnified into large errors in cash flow projections.
The opposite is true for businesses that are less leveraged.
A business that sells millions of products a year, with each contributing slightly to paying for fixed costs, is not as dependent on each individual sale.
For example, convenience stores are significantly less leveraged than high-end car dealerships.
NOTE ONLY / OPERATING LEVERAGE
The higher the degree of operating leverage, the greater the potential danger from forecasting risk.
That is, if a relatively small error is made in forecasting sales, it can be magnified into large errors in cash flow projections.
The opposite is true for businesses that are less leveraged.
A business that sells millions of products a year, with each contributing slightly to paying for fixed costs, is not as dependent on each individual sale.
For example, convenience stores are significantly less leveraged than high-end car dealerships.
______ risks are unique to a particular investment or class of assets: they result from the idiosyncrasy of a given investment.
Specific risks are unique to a particular investment or class of assets: they result from the idiosyncrasy of a given investment.
