Investment Risk and Return Concepts

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Questions and Answers

Which of the following terms defines the average annual return on an investment over a specified time period?

CAGR (correct)

Beta

Expected return

Standard deviation

What is a measure of a stock's volatility in relation to the overall market?

Standard deviation

Variance

Sharpe ratio

Beta (correct)

Which type of risk can be reduced through diversification?

Systematic risk

Interest rate risk

Market risk

Diversifiable risk (correct)

Which measure assesses the spread of returns around the expected return of an investment?

Variance Signup and view all the answers

Which investment typically has the least variability in returns over a one-year period?

Treasury bills Signup and view all the answers

What is the most common method for calculating the expected return of a stock?

Applying the Capital Asset Pricing Model (CAPM) Signup and view all the answers

Which of the following measures of risk addresses only the downside of potential returns?

Semivariance Signup and view all the answers

Which statement correctly describes the relationship between variance and standard deviation?

Standard deviation is the square root of variance. Signup and view all the answers

What does the Compound Annual Growth Rate (CAGR) measure?

The rate of return of an investment over a period as if it grew at a steady rate Signup and view all the answers

What type of risk can be eliminated through diversification?

Specific risk Signup and view all the answers

Beta is a measure of which type of risk?

Systematic risk Signup and view all the answers

Which scenario implies a higher risk based on volatility?

Higher standard deviation Signup and view all the answers

What is the relationship between risk and return according to historical data?

Higher risk typically leads to higher returns Signup and view all the answers

What does the variance of a financial return distribution measure?

The magnitude of deviations from the mean return Signup and view all the answers

Which formula correctly represents the calculation of standard deviation from variance?

SD(R) = √Var(R) Signup and view all the answers

If a stock has a variance of 0, what can be inferred about its return?

The return is risk-free and constant Signup and view all the answers

How is standard deviation often interpreted in financial contexts?

As the risk associated with an investment Signup and view all the answers

Systematic risk is defined as risk that:

Affects all securities in the market Signup and view all the answers

What distinguishes standardized returns from expected returns?

Standardized returns show past performance while expected returns predict future returns Signup and view all the answers

Study Notes

Risk and return are closely connected concepts in investment opportunities.
Investors only require a risk premium for non-eliminable market risk, not for risk that may be diversified away.
The Capital Asset Pricing Model (CAPM) relates risk and return.
Investors' optimal portfolio choices are quantified.
Estimating the cost of capital for individual projects and firms is also crucial.
Investor behavior and capital market efficiency are explored.
Historical investment data illustrates the effects of risk on returns.
The Law of One Price applies when comparing investment opportunities with equal risk.
The performance of different investment options varies significantly.
Examples include Procter & Gamble (PG), Advanced Micro Devices (AMD), and U.S. Treasury bills.

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Description

This quiz explores the critical relationship between risk and return in investment strategies. It covers key concepts such as the Capital Asset Pricing Model (CAPM), the importance of a risk premium, and how investor behavior impacts capital market efficiency. Understanding historical data and the Law of One Price is also essential for making informed investment decisions.