Created by Marinda Steenkamp
about 8 years ago


Question  Answer 
Define 'Risk'  Risk relates to the chance of loss; to the variability of returns associated with a given asset. The more certain the return, the less variability and the less risk. 
Give an example of a riskfree asset  Government Bonds 
Define 'Return'  It is the total gain or loss experienced on an investment over a given period of time. 
How is 'return' calculated?  the asset's cash distributions during the period + change in value / its beginningofperiod investment value 
Provide the formula for calculating the rate of return earned on any assets over a period of time  rt = Ct + Pt  Pt1 / Pt1 rt actual, expected or required rate of return Ct  cash flows received from the investment Pt  price (value) of asset at time t Pt1  price (value) of asset at time t1 
Explain the difference between a realised and unrealised return.  Realised return  asset is purchased and sold during the time measured. Unrealised return  return that could have been realised if an asset had been purchased and sold during the period measured. 
What does CAPM stand for?  Capital Asset Pricing Model 
Explain the a 'riskaverse' financial manager, which most managers are.  The increase in possible return does not justify the higher risk because these managers shy away from risk and seek stability. 
Explain the a 'riskindifferent' financial manager.  They require no change in return for an increase in risk. 
Explain the 'rational investor' type of financial manager  The required return increases for an increase in risk. These mangers require higher expected returns to compensate them for taking greater risk. 
How do we assess risks?  By looking at expectedreturns, as well as scenario analysis and probability distribution 
How do we measure risk quantitatively?  Using statistical formulas such as the standard deviation the coefficient of variation it measures the variability of assets return. 
Explain scenario analysis  it throws several scenarios at the risk to determine its worst, expected and best outcomes and returns. 
How is an asset's risk measured through the use of 'the range'?  You would take the optimistic outcome and subtract the pessimistic outcome. The higher the range, he riskier the investment 
Explain probability distributions  It indicate the probability/chance that an outcome could occur. It gives a more quantitative insight into an asset's risk. 
Explain the statistical indicator, Standard Deviation (σr) Formula included  it measures the dispersion around the expected value the higher the standard deviation, the greater the risk 
Explain the expected value of return. Formula included  It is the most likely return on an asset. 
Explain Coefficient of variation. Formula included  It is a measure of relative dispersion that is useful in comparing the risks of assets with differing expected returns the higher the CV, the greater the risk, the greater the expected return. 
Explain the financial manager's goal with regards to creating an efficient portfolio.  He needs to create a portfolio that maximises return for a given level of risk or minimises risk for a given level of return. 
Explain the return on a portfolio. formula included  It is a weighted average of the returns on the individual assets from which it is formed. 
Explain Standard Deviation of a portfolio's returns. Formula included  You apply the normal formula for a single asset when probabilities are known. The following formula is used when the outcomes are known and their related probabilities are assumed to be equal. 
Provide the definition of correlation  it is a statistical measure of the relationship between any two series of numbers representing data of any kind. 
Explain positive correlation  It describes two series that move in the same direction. 
Explain negative correlation  Describes two series that move in the opposite directions. 
Explain Correlation Coefficient.  A measure of the degree of correlation between two series. +1 = perfectly positively correlated 1 = perfectly negatively correlated 
What is the purpose of Diversification?  It assist in reducing the risk in the portfolio. "Not having all your eggs in one basket scenario" 
Explain Capital Asset Pricing Model (CAPM)  It is the basic theory that links risk and return for all assets. 
Explain the difference between 'diversifiable risk' and 'nondiversifiable risk'  Diversifiable risk  Strikes, litigation, loss of key contracts, etc Nondiversifiable risk  Ware, inflation, political events, etc 
Explain Beta or Beta Coefficient (b)  It measures nondiversifiable risk. It is and index of the degree of movement of an asset's return in response to a change in the market return. 
The equation for the CAPM is 
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