Week 7: Risk, Uncertainty and portfolio theory Flashcards
What is risk?
When there is a variability of return, if we are certain of the return there is no risk!
What are the three attitudes towards risk?
1) Risk loving
2) Risk neutral
3) Risk averse
What is the relationship. between risk and return?
Higher the risk, the higher the return.
What does standard deviation show about risk?
The higher the standard deviation, the more riskier.
Why do investors choose different investments which offer different combination of risk and return?
I. If two investments have same expected return and one has higher risk then investor
will prefer the project with lower risk.
II.For same level of risk a project with higher expected rate of return will be preferred
What does variance and standard deviation measure?
measure the variability of individual stocks.
What does covariance and correlation measure?
measure how two random variables are related.
How does diversifying reduce firm-specific risk?
1) Each investment is a much smaller percentage of the portfolio, muting the effect (positive or negative) on the overall portfolio.
2) Firm-specific actions can be either positive or negative. In a large portfolio, it is argued, these effects will average out to zero.
Where must organisation aim to move on the efficient frontier?
The goal is to move left and up.
what does sharpe ratio show?
compares the return of an investment with its risk.
The higher the ratio, the better.
