Topic 11: Return, Risk and the Security Market line I (Sem 2)

Question 1

Risk Premium

Answer 1

The return on a risky asset less than the return on the risk-free security.

The higher the risk premium, the more risky the investment

Government treasury bills are used as the risk-free asset

Question 2

Expected return

Answer 2

The return on a risky asset expected in the future

CHECK EXAMPLE IN NOTES

Question 3

Quantifying Risk Variance

Answer 3

The average squared difference between the return and the expected return.

Question 4

Standard deviation

Answer 4

The positive square root of the variance

Question 5

Calculating Variance

Answer 5

1) Calculate the squared deviations of the return for each state of the economy using the expected return.

2) Multiply each possible squared deviation by the probability of each state of the economy.

3) Add these up

The result is the variance

CHECK EXAMPLE IN NOTES

Question 6

Portfolio

Answer 6

A group of assets such as equities and bonds held by an investor

Question 7

Portfolio weight

Answer 7

The percentage of a portfolio’s total value that is in a particular asset

CHECK EXAMPLE IN NOTES OF PORTFOLIO EXPECTED RETURNS AND VARIANCE.

Question 8

Diversification

Answer 8

Spreading an investment across a number of assets. Doing this will eliminate some, but not all of the risk.

CHECK EXAMPLE IN NOTES