Finance Risk-Return Relationship Quiz
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Questions and Answers

What is another name for financial return?

Financial return is also known as return.

What is the relationship between the potential for an asset to increase in value and the level of investment risk?

The relationship between the potential for an asset to increase in value and the level of investment risk is directly proportional. This means that as the potential for increase in value goes up, the investment risk goes up as well.

What are two of the most common categories of risk?

The two main categories of risk are systematic risk and unsystematic risk.

Which of the following describes Political / Regulatory Risk?

<p>Impact of political decisions and changes in regulations (B)</p> Signup and view all the answers

Which of the following describes Financial Risk?

<p>Capital structure of a company (F)</p> Signup and view all the answers

Which of the following describes Interest Rate Risk?

<p>Impact of changing interest rates (C)</p> Signup and view all the answers

Which of the following describes Country Risk?

<p>Uncertainties that are specific to a country (B)</p> Signup and view all the answers

Which of the following describes Social Risk?

<p>Uncertainties that are specific to a country (B)</p> Signup and view all the answers

Which of the following describes Environmental Risk?

<p>Impact of Changes in the environment (C)</p> Signup and view all the answers

Which of the following describes Operational Risk?

<p>Decisions of a management team have on company (B)</p> Signup and view all the answers

Which of the following describes Management Risk?

<p>Decisions of a management team have on company (F)</p> Signup and view all the answers

There is a strong positive correlation between time and uncertainty.

<p>True (A)</p> Signup and view all the answers

What are two main strategies for managing risk?

<p>Two of the main strategies for managing risk are diversification and hedging.</p> Signup and view all the answers

What is the primary objective of diversification?

<p>Diversification aims to reduce unsystematic risk, which is specific to individual assets or investments.</p> Signup and view all the answers

How does hedging work in the context of managing risk?

<p>Hedging involves using financial contracts, such as forwards, futures, options, or swaps, to offset potential losses from specific risks.</p> Signup and view all the answers

What is the primary goal of insurance in risk management?

<p>The primary goal of insurance is to protect investors and operators from catastrophic events.</p> Signup and view all the answers

How can deleveraging reduce risk?

<p>Deleveraging reduces risk by lowering a company's debt levels, which provides greater financial flexibility and reduces the risk of bankruptcy or financial distress.</p> Signup and view all the answers

Companies participating in the primary market are selling shares for the first time.

<p>True (A)</p> Signup and view all the answers

What is another name for the primary market?

<p>The primary market is also known as the initial public offering (IPO) market.</p> Signup and view all the answers

What is the purpose of the secondary market?

<p>The secondary market provides a platform for existing shareholders to buy and sell shares of companies that have already gone public.</p> Signup and view all the answers

What are two major benefits of a company going public through an IPO?

<p>Two major benefits of a company going public through an IPO are raising capital and increasing public profile and awareness.</p> Signup and view all the answers

What are two potential dangers that a company should consider before issuing an IPO?

<p>Two potential dangers to consider before issuing an IPO are the potential for increased scrutiny and the possibility of diluting existing ownership stakes.</p> Signup and view all the answers

What are dividends?

<p>Dividends are the regular payments of income that shareholders receive from a company.</p> Signup and view all the answers

Dividends are always paid to shareholders and are a fixed amount

<p>False (B)</p> Signup and view all the answers

Capital gain is the increase in value of a share that an investor has purchased.

<p>True (A)</p> Signup and view all the answers

Shareholders can only get a share of either the gain or the pain.

<p>True (A)</p> Signup and view all the answers

What are two shareholder voting rights?

<p>Two shareholder voting rights are the right to attend company meetings and the right to vote at meetings.</p> Signup and view all the answers

What is the primary purpose of company meetings?

<p>Company meetings provide shareholders with an opportunity to understand the company's performance and make informed decisions on important matters.</p> Signup and view all the answers

What are two of the risks involved with owning shares?

<p>Two risks involved with owning shares are low profits and no dividends.</p> Signup and view all the answers

What are two other risks of owning shares?

<p>Two other risks of owning shares are price risk and liquidity risk.</p> Signup and view all the answers

What is issuer risk?

<p>Issuer risk refers to the possibility that the company issuing the shares may face financial difficulties or even go bankrupt.</p> Signup and view all the answers

What is the bond market?

<p>The bond market is a financial market where investors buy and sell debt securities, known as bonds, issued by governments, corporations, and other entities.</p> Signup and view all the answers

What are some of the parties involved in the bond market?

<p>Some of the parties involved in the bond market include issuers who create and sell bonds, investment banks or underwriters who facilitate the issuance, and purchasers or investors who acquire the bonds.</p> Signup and view all the answers

What is the maturity date of a bond?

<p>The maturity date of a bond is the date when the principal amount of the bond, along with any accumulated interest, is repaid to the investor by the issuer.</p> Signup and view all the answers

A bond is a form of debt financing.

<p>True (A)</p> Signup and view all the answers

Foreign exchange risk applies only to bonds.

<p>False (B)</p> Signup and view all the answers

Flashcards

Investment Risk

The possibility that an investment's value may decrease or result in negative returns.

Risk

The variability of an asset's future returns, reflecting the chance of unfavorable events.

Return

The money earned or lost on an investment over a specific period.

Risk-Return Relationship

The relationship between investment risk and potential return, where higher risk is usually associated with the possibility of higher returns.

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Systematic Risk (Market Risk)

External factors impacting all or many companies in an industry or group, beyond their control.

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Unsystematic Risk (Asset-Specific Risk)

Factors specific to an asset or company that can affect its performance, potentially controllable by the organization.

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Political/Regulatory Risk

The impact of political decisions and regulatory changes on investments.

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Financial Risk

The risk associated with a company's financial structure, particularly the level of debt it has.

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Interest Rate Risk

The impact of fluctuations in interest rates on investments.

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Country Risk

Uncertainties specific to a particular country that can impact investments.

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Social Risk

The risk of changes in social norms, movements, and unrest impacting investments.

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Environmental Risk

The risk associated with environmental liabilities or the impact of changes in the environment on investments.

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Operational Risk

Risk related to a company's operations, including efficiency, processes, and potential disruptions.

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Management Risk

The risk associated with the decisions made by a company's management team, and their impact on performance.

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Time vs. Risk

The longer the time period involved in an investment, the greater the uncertainty about future returns.

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Diversification

A strategy to reduce unsystematic risk by investing in a variety of assets.

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Hedging

A technique for eliminating uncertainty by entering into agreements with counterparties, such as derivatives, to manage market risk or lock in costs.

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Insurance

Protection against catastrophic events through contracts with insurance companies.

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Deleveraging

A strategy to reduce financial risk by decreasing the amount of debt a company has, increasing flexibility and reducing bankruptcy risk.

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Initial Public Offering (IPO)

The initial sale of shares by a company to the public, allowing it to raise capital and become publicly traded.

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Primary Market

A market where newly issued securities are sold to investors for the first time, allowing companies to raise capital.

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Secondary Market

A market where previously issued securities are traded between investors after their initial sale in the primary market.

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Dividends

Regular income paid to shareholders by a company, determined by profitability and expectations.

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Capital Gain

The increase in value of an investment over time, realized when the investment is sold.

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Shareholder Voting Rights

The right of shareholders to attend company meetings and vote on important decisions.

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Company Meetings

Meetings held by companies to update shareholders on performance, make decisions, and allow for shareholder questions.

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Low Profit Risk

The risk that a company may not be profitable, resulting in no capital gain for shareholders or even bankruptcy.

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No Dividend Risk

The risk that a company may not pay dividends to shareholders, depriving them of income.

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Price Risk

The risk that the price of shares may decrease, resulting in a loss for investors.

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Liquidity Risk

The risk that shares may be difficult to sell quickly at a desirable price, potentially leading to losses.

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Issuer Risk

The risk that the issuing company may collapse, potentially making the shares worthless.

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Foreign Exchange Risk

The risk of fluctuations in currency exchange rates affecting the value of investments in foreign markets.

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Bond Market

A market where debt securities, such as bonds, are issued and traded.

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Maturity Date

The final date for repayment of a debt instrument, including principal and interest.

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Study Notes

Risk

  • Risk is the variability of future returns on an asset.
  • It represents the chance of an unfavorable event occurring.
  • Uncertainty about future outcomes creates risk.
  • Higher variability means higher risk.

Return

  • Return, also known as financial return, is the profit or loss from an investment over a period.
  • Return can be expressed as a percentage or nominally as the change in peso value.

Risk-Return Relationship

  • Investment risk is the likelihood of a negative asset value change.
  • Higher potential asset value increase leads to higher risk.
  • Investments with higher long-term returns usually have higher risk.
  • Diversification can reduce overall risk exposure.

Two Main Risk Categories

Systematic Risk (Market Risk)

  • External factors affecting many companies within an industry.
  • Uncontrollable by a single organization.

Unsystematic Risk (Asset-Specific Risk)

  • Asset-specific uncertainties affecting investment performance.
  • Potentially controllable by an organization.

Types of Risks

  • Political/Regulatory Risk: Impact of political decisions.
  • Financial Risk: Capital structure of a company.
  • Interest Rate Risk: Impact of changing interest rates.
  • Country Risk: Risks specific to a country.
  • Social Risk: Changes in social norms.
  • Environmental Risk: Environmental liabilities or changes.
  • Operational Risk: Uncertainty about company operations.
  • Management Risk: Impact of management decisions.

Risk Management Strategies

Diversification

  • Reducing unsystematic risk by investing in various assets.
  • Balances out underperformance in one investment by other investments.

Hedging

  • Eliminating uncertainty by agreement with a counterparty.
  • Strategies include forwards, options, futures, swaps.
  • Used by investors for market risk reduction and business revenue management.

Insurance

  • Protecting investors and operators from catastrophic events.

Leveraging

  • Companies can lower uncertainty by reducing debt.
  • Lower leverage leads to flexibility and lower risk.

Primary and Secondary Market

Primary Market

  • Company sells shares to investors for the first time.
  • Also known as becoming listed, floating on the market, or IPO.

Secondary Market

  • Existing listed companies' shares are traded.
  • Investors can buy or sell existing shares.

IPO (Initial Public Offering)

  • First time shares of a business are offered to the public.
  • Offering shares to unrelated third parties.
  • Company's shares start trading on a stock exchange.

Return on Shares

Dividends

  • Regular income for shareholders.
  • Determined by profit and expectations.
  • Often expressed as a percentage (dividend yield).
  • Not always paid.

Capital Gains

  • Increase in share value.
  • Realized when shares are sold.
  • Unrealized when shares are not sold.

Shareholder Rights

  • Right to attend company meetings.
  • Right to vote at meetings
  • Receive dividends, or share of company's gain or loss.

Risks Involved in Owning Shares

  • Low profits
  • No dividends
  • Bankruptcy risk
  • Price risk
  • Liquidity risk
  • Issuer risk
  • Exchange rate risk

Bond Markets

  • Bonds are debt securities.
  • Investors loan money to a borrower.
  • Bonds describe agreement with interest rate.
  • Bond issuers are corporations, municipalities, states, and sovereign governments

Parties involved in a Bond Market

  • Issuer (companies, governments)
  • Investment bank/underwriter (help sell bonds)
  • Purchaser/investor (buy the bonds being issued)

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Risk and Return PDF

Description

Test your understanding of the concepts of risk and return in finance. This quiz covers the variability of future returns, the risk-return relationship, and the different categories of risk. Dive into key financial principles and enhance your proficiency in investment analysis.

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