Quantitative Investment Concepts

Question 1

Systematic Risk

Answer 1

non-diversifiable, market risk
can’t be avoided
all securities tend to move in same fashion

PRIME
Purchasing Power
Reinvestment Rate Risk
Interest Rate Risk
Market Risk
Exchange Rate Risk

Question 2

Purchasing Power Risk

Answer 2

loss of purchasing power due to inflation

ex rising price of goods and services

Question 3

Reinvestment Risk

Answer 3

proceeds from current investment will be invested at a lower interest rate
short term investments
CD/bond maturing

Question 4

Interest Rate Risk

Answer 4

change in interest rates will cause market value of fixed investments to fall

Question 5

Market Risk

Answer 5

risk of overall market

can’t be avoided

Question 6

Exchange Rate Risk

Answer 6

risk associated with change in value of currencies

foreign stocks and funds

Question 7

Political Risk

Answer 7

Country risk - uncertainty caused by changes in the political or economic environment of a country
National Policy Risk

Question 8

Unsystematic Risk

Answer 8

Non-Systematic Risk
diversifiable
business and financial risk

Question 9

Business Risk/ Financial Risk

Answer 9

Business
nature of the firm’s operation
demand increase and decreases
loss due to bad management

Financial
how business fiances its assets
possible loss due to heavy debt

Question 10

Total Risk

Answer 10

Represented by Standard Deviation

systematic an unsystematic risk

Question 11

Liquidity

Answer 11

speed and stability of price to liquidate
may include cash value life insurance and short term or laddered CD’s

open end MF, closed end funds, ETF, and brokered CD’s not liquid (loss of Principal)

Question 12

Marketability

Answer 12

Speed of a transaction only - no price stability

checking, savings, money markets and MF are redeemable and NOT marketable

bonds, stocks are marketable

Question 13

Mean

Answer 13

middle point between to extremes

Question 14

Normal vs Lognormal Distributions

Answer 14

Normal -Possibility of positive and negative returns over a given time
Return is symmetrical about the mean
(period returns, leveraged money, volatility)

Lognormal - Possibility of positive or 0 over a period of time (can’t lose more than all your money)
Distribution is positively skewed
Mean is to the right of the highest point in the curve
(ending portfolio totals, no margin)

Question 15

Correlation Coefficient

Answer 15

+1 to -1
to determine need covariance and standard deviation

Covariance - measures the extent to which 2 stocks are related to each other

Standard deviation measures variability of returns

COVij = (Pij)(SDi)(SDj) Solve for Pij

+1 = perfect positive correlation - Max risk- standard deviation is = the weighted average of standard deviation of the 2 assets

-1 perfect negative correlation - move exact opposite to one another. Risk is eliminated. Standard deviation is 0.
Risk is less than max risk

Question 16

Coefficient of Variation

Answer 16

measure of relative variability used to compare widely varying rates of returns and standard deviations. RISK PER UNIT OF EXPECTED RETURN

Standard Deviation/Average Mean

Greater coefficient of variation = riskier investment
standard deviation and average mean will be given
-can’t just used standard deviation

Question 17

Standard Deviation

Answer 17

Measures variability of returns in a nondiversifed portfolio- a measure of total risk

Absolute variability around an average or a mean
68% 1 standard deviation
95% 2 standard deviations
99% 3 standard deviations

Calculation = Sigma+
g 0
g .

Question 18

Beta

Answer 18

measures volatility in a diversified portfolio - measure of systematic risk

= correlation coefficient X SD stock
____________________________

              SD of market