Risk and Reward Flashcards
What factors influence returns? (3)
How the economy performs
What events are taking place in the investment’s geographical location
how the sector in which the company operates behaves
How is overall ER calculated?
Expected returns = probability x scenario return and summing the results
What is variance?
Variance is the extent to which returns vary from the average or expected return
What is standard deviation?
The square root of variance which is used as a statistical measure of risk to depict likely variance from ER
Types of risk at macro level (2)
Market crashes
Terrorism that cause markets to plunge
Types of risk at micro level (2)
Creditworthiness or company invested in
Internal events of company invested in
General types of risk (8)
Market risk
Political and legal risk
Reinvestment risk
Inflation risk
Interest rate risk
Exchange rate risk
Liquidity risk
Default risk
Ways of quantifying risk (2)
Forward looking where forecasts and probabilities assess likelihood of possible states of the world and predict each possible outcome
Backward looking where analysis on historically observed returns and associated frequencies on the basis that past data is representative of future data
Levels of risk attached to types of equity (2)
Medium levels of risk are attached to larger, well-established company shares
High levels of risk are attached to startup company shares
What is an equity premium?
A higher rate of return offered to entice investors to take on the risk of owning shares or equity
What makes an Equity investment more risky? (2)
Non secured asset
Company can suffer from adverse business conditions even bankruptcy
What is the risk-free rate?
The rate on gvt bonds and short term debts because of low chance of default
Risks associated with money market instruments (2)
Prices can fluctuate
If investors want to swap with more secure issuers such as T-bills, discount priced instruments will yield negative returns
What factors are a trade off in money market instruments?
There is trade-off and calculation between the value of a long term income stream from money market instruments vs. greater volatility of longer dated paper
What makes bonds over equities attractive to investors? (3)
Offer fixed income
Regular, predetermined coupon
Certainty of principal being repaid at end of term