Investment Risk and Return Analysis

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Questions and Answers

What does the standard deviation measure in a dataset?

The range of data points

The percentage of outliers

Tightness of distribution or variability (correct)

Average value of the dataset

Which formula correctly represents the Coefficient of Variation (CV)?

$CV = rac{ar{r}}{ ext{Standard deviation}}$

$CV = rac{ar{r}}{rac{ ext{sum}(r_{i})}{n}}$

$CV = rac{ar{r}}{rac{ ho}{n}}$

$CV = rac{ ext{Standard deviation}}{ar{r}}$ (correct)

What does a Sharpe Ratio greater than 1 indicate?

The investment is not worth the risk taken

The investment is providing a good return per unit of risk (correct)

The investment has a higher risk with a lower return

The investment return is less than the risk-free rate

What is the primary benefit of diversifying a portfolio?

To reduce overall portfolio risk Signup and view all the answers

What does a beta ($β_{i}$) greater than 1 indicate about a stock?

The stock is riskier than the average stock Signup and view all the answers

What does the risk premium represent?

The compensation for the risk taken on an investment Signup and view all the answers

Which of the following formulas correctly calculates the percentage return on an investment?

$rac{amount eceived - amount isk}{amount isk}$ Signup and view all the answers

What does the term 'stand-alone risk' refer to?

The risk of a single asset in isolation Signup and view all the answers

Which statement is true regarding investor preferences toward risk?

Investors generally favor returns over risks Signup and view all the answers

How is the expected rate of return determined?

As a weighted average of estimated returns based on their probabilities Signup and view all the answers

What is the defining characteristic of mutually exclusive projects?

They require a choice, as there are not enough resources to do both. Signup and view all the answers

What does a normal cash flow represent?

A single change in sign, starting negative then positive cash flows. Signup and view all the answers

Which of the following accurately describes the discounted payback method?

Present values of cash flows are utilized. Signup and view all the answers

What is the purpose of calculating net present value (NPV)?

To sum all cash inflows and outflows at present value. Signup and view all the answers

Which statement about the internal rate of return (IRR) method is correct?

IRR is a metric that can conflict with net present value. Signup and view all the answers

What is a disadvantage of the payback method?

It ignores cash flows that occur after the payback period. Signup and view all the answers

Which characteristic is NOT shared by both the discounted payback method and NPV?

Both methods provide a simple calculation framework. Signup and view all the answers

How is the internal rate of return (IRR) calculated?

By finding the discount rate that results in an NPV of zero. Signup and view all the answers

Study Notes

Standard Deviation

Measures tightness of distribution / variability
Formula: σ = √[(Σ(x-µ)²)/n]

Coefficient of Variation

CV = σ/µ
Alternative measure of stand-alone risk
Higher = better

Sharpe Ratio

Alternative measure of stand-alone risk
Formula: (r-rf)/σ
Higher = better

Expected Return on Portfolio

r_p = w₁r₁ + w₂r₂...
Weight-average expected return on all assets in the portfolio

Portfolio Risk

Reduces risk by diversifying
Diversifiable risk = risk associated with individual assets (e.g. market risk would be diversifiable)
Stand-alone risk = risk of 1 asset

Beta (β)

Slope / Stock moving up/down
Measures market risk (relevant risk)
Volatility relative to market or average stock

Beta Measure

β₁ = 1 → average
β > 1 → riskier
β < 1 → less risky

Portfolio Beta

Weighted average of stock betas
(weighted avg. * beta)

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Description

This quiz covers key concepts related to investment risk and return, including standard deviation, coefficient of variation, and Sharpe ratio. Additionally, it explores expected return calculations and the significance of portfolio beta in assessing market risk. Test your understanding of these financial metrics and their implications for investment strategies.