FINANCIAL RISK MANAGEMENT EXAM
1 CORRECT 100%
expected return - ANSWER a weighted average of the possible returns, where the
weight applied to a particular return equals the probability of that return occurring
A: the CV reflects the effects of both RISK & RETURN - ANSWER Q: Why's the
coefficient of variation (CV) a better measure of stand-alone risk that the standard
deviation of an asset?
A: One that MINIMIZES risk & MAXIMIZES expected returns - ANSWER Q: What's an
"optimal" portfolio?
A: add additional securities to our portfolio that will move us further in a NORTHWEST
direction - ANSWER Q: How can we form an optimal portfolio?
Efficient frontier - ANSWER --the limit of how far we can move in a northwest direction
--represents all risk-return combo's that can be created by combining RISKY assets
Southeast - ANSWER Where are individual stocks plotted with respect to the efficient
frontier?
Diversification - ANSWER __________ allows us to create risk-return combo's that are
superior to a single stock
return for a given level of risk
(risk for a given level of return) - ANSWER the efficient frontier is superior because it
represents portfolios that provide the greatest ___________ for a given level of
__________ (or the least amount of __________ for a given level of _________).
efficient - ANSWER Portfolios that provide the greatest return for a given level of risk
are said to be ___________
new efficient frontier - ANSWER the capital market line (CML) is also known as
_______
market portfolio (M) - ANSWER the tangency point on the CML that indicates the
portfolio of risky assets that's best to combine with the risk-free asset is known as ____
market portfolio (M) - ANSWER on the CML, the ___________ is the optimal portfolio of
risky assets for all investors
risk-free (F) & risky (M) - ANSWER on the CML: since all investors differ in their
tolerance to risk, they will allocate different amounts to the _______ & ________ assets
, more
less - ANSWER As an investor's risk aversion increases, he will allocate _______ to F
and _________ to M
Borrowing @ the risk-free rate and investing his original funds and the borrowed funds
exclusively in M - ANSWER On the CML: An investor can achieve points above M on
the CML by doing what?
same portfolio
apetite for risk - ANSWER CML: all investors should choose the ________ __________
of risky assets (M) and reflect their _______ _____ _______ by combining this risk
investment with borrowing or lending the risk-free asset
Nonsystematic risk - ANSWER --the portion of a stock's risk that is attributable to factors
specific to that one stock
--thus, this risk can be offset by investing in stocks that don't share that factor
--aka company-unique risk, diversifiable risk
--ex) lawsuit outcomes, regulatory rulings, issues with management team, new product
launches
systematic risk - ANSWER --refers to the portion of a stock's risk that's attributable to
factors that affect all stocks to some degree
--this risk is inherent to the entire economic system, and thus CANNOT be reduced by
diversification
--ex) economic news, catastrophes, oil prices or interest rates changing unexpectedly,
Warren Buffet saying "SELL EVERYTHING!"
--aka market risk, nondiversifiable risk
Capital asset pricing model (CAPM) - ANSWER equation that equates the expected
return on a stock to the risk-free rate plus a risk premium due to the stock's systematic
risk
Beta of security i - ANSWER ______ tells us how many times the market risk premium
is deserved as a risk premium for security i.
equal to the risk-free rate - ANSWER What's the expected return of a stock with a Beta
of 0?
equal to the Market Portfolio - ANSWER What's the E(R) for a security with a Beta of 1?
Security Market Line (SML) - ANSWER The _________ is a graphical representation of
the CAPM equation that represents the E(R) for a level of Beta.
underpriced
1 CORRECT 100%
expected return - ANSWER a weighted average of the possible returns, where the
weight applied to a particular return equals the probability of that return occurring
A: the CV reflects the effects of both RISK & RETURN - ANSWER Q: Why's the
coefficient of variation (CV) a better measure of stand-alone risk that the standard
deviation of an asset?
A: One that MINIMIZES risk & MAXIMIZES expected returns - ANSWER Q: What's an
"optimal" portfolio?
A: add additional securities to our portfolio that will move us further in a NORTHWEST
direction - ANSWER Q: How can we form an optimal portfolio?
Efficient frontier - ANSWER --the limit of how far we can move in a northwest direction
--represents all risk-return combo's that can be created by combining RISKY assets
Southeast - ANSWER Where are individual stocks plotted with respect to the efficient
frontier?
Diversification - ANSWER __________ allows us to create risk-return combo's that are
superior to a single stock
return for a given level of risk
(risk for a given level of return) - ANSWER the efficient frontier is superior because it
represents portfolios that provide the greatest ___________ for a given level of
__________ (or the least amount of __________ for a given level of _________).
efficient - ANSWER Portfolios that provide the greatest return for a given level of risk
are said to be ___________
new efficient frontier - ANSWER the capital market line (CML) is also known as
_______
market portfolio (M) - ANSWER the tangency point on the CML that indicates the
portfolio of risky assets that's best to combine with the risk-free asset is known as ____
market portfolio (M) - ANSWER on the CML, the ___________ is the optimal portfolio of
risky assets for all investors
risk-free (F) & risky (M) - ANSWER on the CML: since all investors differ in their
tolerance to risk, they will allocate different amounts to the _______ & ________ assets
, more
less - ANSWER As an investor's risk aversion increases, he will allocate _______ to F
and _________ to M
Borrowing @ the risk-free rate and investing his original funds and the borrowed funds
exclusively in M - ANSWER On the CML: An investor can achieve points above M on
the CML by doing what?
same portfolio
apetite for risk - ANSWER CML: all investors should choose the ________ __________
of risky assets (M) and reflect their _______ _____ _______ by combining this risk
investment with borrowing or lending the risk-free asset
Nonsystematic risk - ANSWER --the portion of a stock's risk that is attributable to factors
specific to that one stock
--thus, this risk can be offset by investing in stocks that don't share that factor
--aka company-unique risk, diversifiable risk
--ex) lawsuit outcomes, regulatory rulings, issues with management team, new product
launches
systematic risk - ANSWER --refers to the portion of a stock's risk that's attributable to
factors that affect all stocks to some degree
--this risk is inherent to the entire economic system, and thus CANNOT be reduced by
diversification
--ex) economic news, catastrophes, oil prices or interest rates changing unexpectedly,
Warren Buffet saying "SELL EVERYTHING!"
--aka market risk, nondiversifiable risk
Capital asset pricing model (CAPM) - ANSWER equation that equates the expected
return on a stock to the risk-free rate plus a risk premium due to the stock's systematic
risk
Beta of security i - ANSWER ______ tells us how many times the market risk premium
is deserved as a risk premium for security i.
equal to the risk-free rate - ANSWER What's the expected return of a stock with a Beta
of 0?
equal to the Market Portfolio - ANSWER What's the E(R) for a security with a Beta of 1?
Security Market Line (SML) - ANSWER The _________ is a graphical representation of
the CAPM equation that represents the E(R) for a level of Beta.
underpriced
