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?

<p>To reduce overall portfolio risk (C)</p> Signup and view all the answers

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

<p>The stock is riskier than the average stock (D)</p> Signup and view all the answers

What does the risk premium represent?

<p>The compensation for the risk taken on an investment (C)</p> Signup and view all the answers

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

<p>$ rac{amount eceived - amount isk}{amount isk}$ (C)</p> Signup and view all the answers

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

<p>The risk of a single asset in isolation (B)</p> Signup and view all the answers

Which statement is true regarding investor preferences toward risk?

<p>Investors generally favor returns over risks (C)</p> Signup and view all the answers

How is the expected rate of return determined?

<p>As a weighted average of estimated returns based on their probabilities (C)</p> Signup and view all the answers

What is the defining characteristic of mutually exclusive projects?

<p>They require a choice, as there are not enough resources to do both. (C)</p> Signup and view all the answers

What does a normal cash flow represent?

<p>A single change in sign, starting negative then positive cash flows. (B)</p> Signup and view all the answers

Which of the following accurately describes the discounted payback method?

<p>Present values of cash flows are utilized. (D)</p> Signup and view all the answers

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

<p>To sum all cash inflows and outflows at present value. (C)</p> Signup and view all the answers

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

<p>IRR is a metric that can conflict with net present value. (D)</p> Signup and view all the answers

What is a disadvantage of the payback method?

<p>It ignores cash flows that occur after the payback period. (B)</p> Signup and view all the answers

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

<p>Both methods provide a simple calculation framework. (C)</p> Signup and view all the answers

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

<p>By finding the discount rate that results in an NPV of zero. (D)</p> Signup and view all the answers

Flashcards

Standard Deviation

A measure of how spread out numbers are from their average.

Coefficient of Variation

A measure of relative variability calculated as the ratio of Standard Deviation to Mean.

Sharpe Ratio

Measures risk-adjusted return. Higher is better, more return per unit of risk.

Portfolio Beta

A weighted average of the betas of individual stocks in the portfolio.

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Portfolio Risk

Risk associated with a portfolio of investments. It can be reduced by diversification.

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Mutually Exclusive Projects

Projects where choosing one prevents choosing the other. This is because there aren't enough resources to do both at the same time, but not necessarily because they are related.

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Independent Projects

Projects that can be undertaken simultaneously because they don't compete for resources or are unrelated to each other.

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Normal Cash Flow

A cash flow pattern with one sign change, usually starting with an initial cost (negative) and following with positive cash flows.

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Non-Normal Cash Flow

A cash flow pattern with more than one sign change, often involving an initial cost, then positive cash flow, and then a negative cash flow.

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Payback Period

The time it takes for a project's cumulative cash inflows to equal the initial investment.

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Discounted Payback Period

The time it takes for a project's cumulative present value of cash inflows to equal the initial investment.

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Net Present Value (NPV)

The sum of the present values of all cash inflows and outflows of a project, taking into account the time value of money.

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Internal Rate of Return (IRR)

The discount rate that makes the net present value (NPV) of all cash flows from a project equal to zero.

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Risk Aversion

Investors generally prefer higher returns with lower risk. They are willing to accept higher returns only if the risk is also higher.

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Risk Premium

The extra return investors demand for taking on the risk of investing in a risky asset compared to a risk-free asset.

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Stand Alone Risk

The risk of an individual asset when considered in isolation, without considering its impact on a portfolio.

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Investment Risk

The probability of earning a return lower than expected, or losing money on an investment.

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Expected Rate of Return

The average return an investor expects to earn on an investment, calculated as a weighted average of potential returns, considering their probabilities.

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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

  • rp = 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.

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