Investment Risk Assessment Quiz

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Questions and Answers

What does HPY stand for in the context of investment?

  • Home Price Yield
  • Holding Period Yield (correct)
  • Historical Price Yield
  • High Price Yield

How is the HPY calculated based on the given information?

  • HPY = (Final Value - Initial Value) / Initial Value (correct)
  • HPY = (Initial Value - Final Value) / Initial Value
  • HPY = Selling Price - Purchase Price
  • HPY = Selling Price / Purchase Price

What is the HPY percentage calculated in the example?

  • 50%
  • 75% (correct)
  • 125%
  • 100%

If the initial price was PHP 20, what was the gain per share after three years?

<p>PHP 15 (D)</p> Signup and view all the answers

What is the formula to obtain the Annual HPY from the HPY?

<p>Annual HPY = HPY / Total Years (D)</p> Signup and view all the answers

In the context of this investment scenario, what is the duration of the holding period?

<p>3 years (D)</p> Signup and view all the answers

If the HPY is 75% over three years, what is the total return on an investment of PHP 100?

<p>PHP 175 (B)</p> Signup and view all the answers

What does the range in risk assessment measure?

<p>The difference between optimistic and pessimistic scenarios (A)</p> Signup and view all the answers

Which of the following is a measure of risk?

<p>Coefficient of Variation (CV) (A)</p> Signup and view all the answers

In the standard deviation formula, what does the variable 'k' represent?

<p>A specific outcome in the dataset (C)</p> Signup and view all the answers

What is the purpose of sensitivity analysis in risk assessment?

<p>To assess the impact of changes in input variables (A)</p> Signup and view all the answers

Which formula calculates the standard deviation of a portfolio?

<p>$ rac{1}{n-1} imes ext{Sum of squared differences}$ (B)</p> Signup and view all the answers

What does a higher Coefficient of Variation (CV) indicate?

<p>Higher variability in returns relative to the mean (D)</p> Signup and view all the answers

What is the first step in risk assessment as described?

<p>Conducting sensitivity analysis (C)</p> Signup and view all the answers

What is the relationship between standard deviation and risk?

<p>Higher standard deviation reflects greater risk (B)</p> Signup and view all the answers

What adjustment is made to the Standard Deviation formula according to the provided content?

<p>Use of 'n-1' (B)</p> Signup and view all the answers

In which economic state does Asset 'C' yield its maximum return?

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

What is the range for Asset 'C' calculated from the economic states?

<p>8% (A)</p> Signup and view all the answers

Which asset is considered riskier based on the provided data?

<p>Asset 'C' (C)</p> Signup and view all the answers

What is the expected return for Asset 'D' in a Stable economic state?

<p>5% (C)</p> Signup and view all the answers

What is the purpose of the given formulas and examples?

<p>To compare different asset risks and returns (B)</p> Signup and view all the answers

What is the return for Asset 'C' in the Decline economic state?

<p>2% (D)</p> Signup and view all the answers

What does the abbreviation SD stand for in the context of finance?

<p>Standard Deviation (D)</p> Signup and view all the answers

What does k represent in the context of the assets?

<p>Expected return rate (A)</p> Signup and view all the answers

What does the Capital Asset Pricing Model (CAPM) incorporate that the Markowitz Portfolio Theory (MPT) does not?

<p>Risk-free asset (B)</p> Signup and view all the answers

Which year was the Capital Asset Pricing Model (CAPM) developed?

<p>1965 (A)</p> Signup and view all the answers

Arbitrage Pricing Theory (APT) is best described as a theory that:

<p>Provides a multi-factor approach to asset pricing (B)</p> Signup and view all the answers

Who are the developers associated with the Capital Asset Pricing Model?

<p>Sharpe, Lintner, and Mossin (B)</p> Signup and view all the answers

Which of the following theories primarily focuses on the implications of risk and return?

<p>All of the above (D)</p> Signup and view all the answers

What is the primary objective of the Markowitz Portfolio Theory (MPT)?

<p>Minimize risk while achieving desired returns (C)</p> Signup and view all the answers

In which publication can the discussed theories around portfolio management be found?

<p>Fundamentals of Investment Management (D)</p> Signup and view all the answers

Which of the following statements is accurate regarding the relationship between CAPM and MPT?

<p>CAPM adds complexity to MPT by factoring in the risk-free asset. (A)</p> Signup and view all the answers

Which of the following assumptions of CAPM states that investors can acquire any amount of funds?

<p>Limitless funds may be obtained by investors (A)</p> Signup and view all the answers

What does the assumption that 'all assets are perfectly divisible' imply?

<p>Investors can buy fractional shares of any asset or portfolio (D)</p> Signup and view all the answers

What is indicated by investors using identical time horizons in their investment assessments?

<p>Investors evaluate long-term risks in a similar timeframe (D)</p> Signup and view all the answers

Which assumption suggests that all investors will project the same 'probability distributions for rates of return'?

<p>Investors have access to complete information (B)</p> Signup and view all the answers

What does it mean when it is stated that investments are free from taxes and transaction costs?

<p>Investors do not need to consider the cost of trading or taxes when making decisions (B)</p> Signup and view all the answers

Which of the following best describes market efficiency in the context of CAPM?

<p>Asset prices reflect all available information at any given time (A)</p> Signup and view all the answers

How do investors assess investment opportunities according to CAPM assumptions?

<p>Using the expected value &amp; standard deviations of portfolio returns (A)</p> Signup and view all the answers

What does the assumption about 'identical time horizons' imply for investors?

<p>Overall market behavior can be predicted based on average investor actions (D)</p> Signup and view all the answers

What does a change in inflation indicate in the context of finance?

<p>It leads to a new required return. (D)</p> Signup and view all the answers

Which factor is affected by risk aversion according to CAPM principles?

<p>The required return on assets. (C)</p> Signup and view all the answers

In CAPM, what happens when risk aversion increases?

<p>The required return increases. (B)</p> Signup and view all the answers

What is one key assumption of the Capital Asset Pricing Model (CAPM)?

<p>All investors have the same expectations. (C)</p> Signup and view all the answers

How does CAPM relate to the required return on an asset?

<p>It connects the required return to the asset's risk level. (B)</p> Signup and view all the answers

What can be concluded about investor behavior in response to rising inflation?

<p>Investors may seek riskier assets to maintain returns. (B)</p> Signup and view all the answers

What is the impact of an increase in required return on investment decisions?

<p>It discourages potential investment opportunities. (A)</p> Signup and view all the answers

According to CAPM, what directly influences an investor's required return?

<p>Expected inflation rates. (D)</p> Signup and view all the answers

Flashcards

Holding Period Yield (HPY)

The total return on an investment over a specific period, expressed as a percentage.

Annual HPY

The holding period yield (HPY) expressed on an annual basis.

Initial Investment Price

The price paid for a share or investment at the beginning.

Selling Price

The price at which an investment is sold.

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HPY Calculation

Calculated using the formula: (Selling Price - Initial Investment Price) / Initial Investment Price.

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Investment Return

The profit or loss generated from an investment.

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Investment Period

The length of time an investment is held before being sold.

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Investment Appreciation

An increase in investment value over time.

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Risk Assessment

Evaluating potential risks and their impact on a project or investment.

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Sensitivity Analysis

A technique to determine the range of possible outcomes based on varying inputs.

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Probability Distribution

A model showing the likelihood of different outcomes occurring.

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Risk Measurement: Standard Deviation (SD)

A statistical measure of the dispersion (spread) of potential returns of an investment.

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Risk Measurement: Coefficient of Variation (CV)

A relative measure of risk, calculated by dividing the standard deviation by the expected return.

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Portfolio Standard Deviation

Standard deviation calculated for investment portfolios (combining different assets).

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Standard Deviation Formula

A formula to calculate how spread out the values are from the average in a dataset.

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Coefficient of Variation Formula

Calculates the risk relative to the return using a formula.

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Range calculation

The difference between the maximum and minimum values in a dataset.

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Standard Deviation (SD)

A measure of the dispersion of a dataset around its mean.

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Coefficient of Variation (CV)

A standardized measure of risk, calculated as the ratio of standard deviation to the mean.

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Asset 'C' Range

The difference between the maximum and minimum expected returns for Asset C.

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Asset 'D' Range

The difference between the maximum and minimum expected returns for Asset D.

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Asset Risk

The possibility that an investment's actual return will differ from its expected return.

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Economic State and Probability

Describes the economic situation and its associated probability (e.g., Decline 0.3, Stable 0.6, Upturn 0.1).

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Asset Return 'C'(kC)

The expected return for Asset C in each economic state.

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Asset Return 'D'(kD)

The expected return for Asset D in each economic state.

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Riskier Asset

An asset with a greater variability in possible returns, thus a higher risk.

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Portfolio Theory

A framework for understanding and managing investments, considering risk and return.

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Markowitz Portfolio Theory (MPT)

A mathematical approach to portfolio optimization, aiming to find the best combination of assets for a given level of risk.

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Capital Asset Pricing Model (CAPM)

A model that describes the relationship between risk and return for individual assets within a portfolio.

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Arbitrage Pricing Theory (APT)

A model that extends CAPM to include factors beyond market risk, such as inflation and economic growth.

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Risk-Free Asset

An investment that guarantees a certain return with no risk of loss.

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Sharpe (1964), Lintner (1965), and Mossin (1966)

These economists played crucial roles in developing the Capital Asset Pricing Model (CAPM).

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What is the relationship between MPT and CAPM?

The CAPM builds upon the MPT by incorporating the concept of a risk-free asset. While MPT provides a framework for optimal portfolio construction, CAPM adds a way to measure and adjust for risk based on market trends.

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What is the importance of understanding portfolio theory?

Portfolio theories provide frameworks for investors to make informed decisions about asset allocation, risk management, and maximizing returns. They help in understanding the dynamics of markets and the relationship between risk and reward.

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CAPM Assumptions

Assumptions used in the Capital Asset Pricing Model (CAPM) to simplify the analysis of investment risk and return.

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Limitless Funds

The assumption that investors can obtain unlimited funds to invest, without any financial constraints.

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Perfectly Divisible Assets

Assumption that assets can be bought and sold in any desired fraction, allowing investors to create diversified portfolios.

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Identical Time Horizons

Investors have the same time horizon for holding investments, simplifying the analysis of portfolio returns.

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Risk Assessment with Expected Value & Standard Deviation

Investors assess investment opportunities based on the expected return and standard deviation (risk) of a portfolio.

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Tax & Transaction Costs

The assumption that investments in a portfolio are not affected by taxes or transaction costs, simplifying the analysis.

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Same Probability Distributions

Investors project the same probability distributions for rates of return on different assets.

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Market Efficiency

The market is efficient, meaning all publicly available information is reflected in asset prices, making it impossible to consistently outperform the market.

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CAPM

The Capital Asset Pricing Model (CAPM) is a financial model that determines the expected rate of return for an asset based on its systematic risk (beta) relative to the overall market.

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Risk-Free Rate

The risk-free rate of return is the theoretical rate of return on an investment with zero risk, often represented by the return on government bonds.

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Beta

Beta represents the volatility of a specific asset compared to the overall market. A beta of 1 means the asset's price moves with the market, while a beta greater than 1 implies higher volatility and a beta less than 1 indicates less volatility.

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Market Risk Premium

The market risk premium is the additional return investors expect for investing in the stock market compared to a risk-free investment.

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Inflation

Inflation is the rate of increase in prices of goods and services over a period of time. It erodes the purchasing power of money.

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Risk-Aversion

Risk-aversion refers to the degree to which investors are willing to accept risk for potential reward. Investors with higher risk-aversion require higher returns for taking on the same level of risk.

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Required Return

The required return is the minimum rate of return an investor expects to receive for investing in a particular asset, considering its risk level and other factors.

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Study Notes

Return

  • Return is the total gain or loss on an investment over a given period.
  • Formula for Holding Period Return (HPR): (Ending Value + Cash Flows) / Beginning Value
  • Formula for Holding Period Yield (HPY): HPR - 1
  • Annual HPY = (Annual HPR)^ (1/n) - 1, where n is the investment period in years

Risk

  • Risk refers to the uncertainty that an investment will earn its expected rate of return.

Risk Assessment: Range

  • Formula: Range = |Optimistic Case – Pessimistic Case|

Risk Measurement: Standard Deviation (SD)

  • Formula: σ = √Σ [(kj - kÌ„)² * Pr(kj)] or σ = √Σ [( kj – kÌ„)² / (n – 1)]
  • Note: Values may be adjusted to determine portfolio SD

Risk Measurement: Coefficient of Variation (CV)

  • Formula: CV = σ / kÌ„
  • Note: Formulae may be adapted to determine the portfolio SD. kÌ„ and kp are used in calculation.*

Integrated Example: An Asset's Risk

  • Examples given to determine range, SD, & CV of assets (C and D). Data for each asset was provided.
  • Asset C's riskier than Asset D based on the computed risk measures.

Integrated Example: A Portfolio's Risk

  • Examples given to calculate portfolio's standard deviation (SD)
  • Diversification reduces risk.

Correlation Coefficient

  • Formula: r = COV(káµ¢, kâ±¼) / (σᵢ * σⱼ)
  • Note:* cov= Σ(káµ¢-kÌ„áµ¢)(kâ±¼-kÌ„â±¼)Pᵢⱼ
  • Examples given to illustrate how the correlation coefficient is calculated. Data for each asset was provided.

CAPM

  • Developed by Sharpe, Lintner, and Mossin.
  • Accounts for risk-free asset (RF).
  • Ties systematic risk and return of assets. Uses past data. Assumes efficient markets.
  • Attributes of an efficient market:
  • numerous investors
  • identical information, & assumptions about securities.
  • No limitations (taxes, transaction costs)
  • Sensible investors
  • Kinds of Risk:
  • Nondiversifiable (systematic risk): Beta Coefficient
  • Diversifiable (unsystematic risk)

CAPM Formula

  • Formula: káµ¢ = RF + [βᵢ * (kₘ - RF)]
  • where: RF = risk-free rate
  • káµ¢ = required return
  • βᵢ = beta coefficient
  • kₘ = market return

CAPM Example

  • Examples are given in the slides to show how to calculate required return

CAPM Critiques

  • Unclear proxy for risk-free rate (RF)
  • Unclear market return (km)
  • Changes in beta of assets over time.

Addressing CAPM Critiques

  • Use portfolio beta (βp) instead of individual security beta (βi)
  • Formula: kâ‚š= RF + [βₚ * (Km - RF)]

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