Financial Risk Management – Exam 1, 2026 – Study Material
and Practice Questions
expected return - ANS✔✔ 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 - ANS✔✔ 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 - ANS✔✔ Q: What's an "optimal"
portfolio?
A: add additional securities to our portfolio that will move us further in a NORTHWEST direction
- ANS✔✔ Q: How can we form an optimal portfolio?
Efficient frontier - ANS✔✔ --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 - ANS✔✔ Where are individual stocks plotted with respect to the efficient frontier?
Diversification - ANS✔✔ __________ 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) - ANS✔✔ 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 - ANS✔✔ Portfolios that provide the greatest return for a given level of risk are said to
be ___________
new efficient frontier - ANS✔✔ the capital market line (CML) is also known as _______
market portfolio (M) - ANS✔✔ 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) - ANS✔✔ on the CML, the ___________ is the optimal portfolio of risky
assets for all investors
risk-free (F) & risky (M) - ANS✔✔ on the CML: since all investors differ in their tolerance to risk,
they will allocate different amounts to the _______ & ________ assets
more
less - ANS✔✔ 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 - ANS✔✔ On the CML: An investor can achieve points above M on the CML by
doing what?
same portfolio
apetite for risk - ANS✔✔ 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 - ANS✔✔ --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 - ANS✔✔ --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) - ANS✔✔ 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 - ANS✔✔ ______ tells us how many times the market risk premium is
deserved as a risk premium for security i.
equal to the risk-free rate - ANS✔✔ What's the expected return of a stock with a Beta of 0?
equal to the Market Portfolio - ANS✔✔ What's the E(R) for a security with a Beta of 1?
Security Market Line (SML) - ANS✔✔ The _________ is a graphical representation of the CAPM
equation that represents the E(R) for a level of Beta.
underpriced
buy it! - ANS✔✔ If an asset's actual return is above its E(R) (above the SML), it's ____________.
and Practice Questions
expected return - ANS✔✔ 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 - ANS✔✔ 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 - ANS✔✔ Q: What's an "optimal"
portfolio?
A: add additional securities to our portfolio that will move us further in a NORTHWEST direction
- ANS✔✔ Q: How can we form an optimal portfolio?
Efficient frontier - ANS✔✔ --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 - ANS✔✔ Where are individual stocks plotted with respect to the efficient frontier?
Diversification - ANS✔✔ __________ 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) - ANS✔✔ 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 - ANS✔✔ Portfolios that provide the greatest return for a given level of risk are said to
be ___________
new efficient frontier - ANS✔✔ the capital market line (CML) is also known as _______
market portfolio (M) - ANS✔✔ 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) - ANS✔✔ on the CML, the ___________ is the optimal portfolio of risky
assets for all investors
risk-free (F) & risky (M) - ANS✔✔ on the CML: since all investors differ in their tolerance to risk,
they will allocate different amounts to the _______ & ________ assets
more
less - ANS✔✔ 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 - ANS✔✔ On the CML: An investor can achieve points above M on the CML by
doing what?
same portfolio
apetite for risk - ANS✔✔ 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 - ANS✔✔ --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 - ANS✔✔ --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) - ANS✔✔ 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 - ANS✔✔ ______ tells us how many times the market risk premium is
deserved as a risk premium for security i.
equal to the risk-free rate - ANS✔✔ What's the expected return of a stock with a Beta of 0?
equal to the Market Portfolio - ANS✔✔ What's the E(R) for a security with a Beta of 1?
Security Market Line (SML) - ANS✔✔ The _________ is a graphical representation of the CAPM
equation that represents the E(R) for a level of Beta.
underpriced
buy it! - ANS✔✔ If an asset's actual return is above its E(R) (above the SML), it's ____________.
