Understanding Risk and Its Types

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Questions and Answers

What is the new asset value per share after a 20% growth in trust assets?

£1.119

£1.479

£1.839 (correct)

£1.20

What is the impact of increased gearing on asset value fluctuations?

It has no effect on asset values.

It stabilizes asset values.

It amplifies both growth and declines. (correct)

It reduces the overall risk.

What is a common method for investors to manage liquidity in their investments?

Investing solely in shares

Investing via collective funds (correct)

Investing in illiquid assets directly

Avoiding any form of cash reserves

How is volatility in investments typically measured?

By standard deviation from average or benchmark return. (D) Signup and view all the answers

What kind of investments might have a deferred payment period for investors?

Property unit trusts (B) Signup and view all the answers

What is a significant risk for savers in variable-rate accounts?

Interest rates may decrease over time (C) Signup and view all the answers

What would the NAV be if the asset value falls by 20%?

£1.119 per share (A) Signup and view all the answers

What strategy can investors use to combat inflation risk?

Seek investments that provide a real return over time (A) Signup and view all the answers

What would the asset value amount to after a £210,000 interest payment on £21.6m?

£21.39m (A) Signup and view all the answers

What is indicated by higher volatility in an investment?

Higher risk of fluctuating performance. (C) Signup and view all the answers

What may happen to a fixed-rate savings account if interest rates increase?

The account may yield a lower rate relative to the market (B) Signup and view all the answers

If the company had not borrowed, what would the NAV be after a 20% fall in asset value?

£1.20 per share (D) Signup and view all the answers

If an individual saves £1,000 in a non-interest-bearing account for five years with an average inflation rate of 2.1%, what is the future purchasing power?

£902 (D) Signup and view all the answers

What might impose a penalty on accessing funds in certain investments?

Fixed rates that penalize early withdrawals (D) Signup and view all the answers

What does a 24.3% change in NAV signify when assets increase or decrease?

It shows the risk associated with gearing. (C) Signup and view all the answers

What can be impacted by interest risk for retirees relying on their savings?

Lower interest earnings when market rates fall (A) Signup and view all the answers

What does a positive alpha of +1 percent indicate about the share's performance?

The share has outperformed its expected return. (C) Signup and view all the answers

What is the future value of £1 after one year if invested at a rate of 5%?

£1.05 (C) Signup and view all the answers

Why might an individual prefer to receive money now rather than later?

Invested money can generate returns. (A) Signup and view all the answers

If Jon repays his £10,000 interest-free debt now, what does he forgo?

The chance to earn 3% interest on his capital. (B) Signup and view all the answers

What concept explains the ability to convert a lump sum of future payments into an equivalent value today?

Time value of money (B) Signup and view all the answers

If £1.05 is promised to be received in 12 months, what is its present value assuming a 5% return?

£1.00 (D) Signup and view all the answers

When assessing future investment returns, which factor should be considered alongside alpha and beta?

Company or fund strategy changes (A) Signup and view all the answers

What does calculating present and future value help an investor determine?

The feasibility of repaying debt early. (D) Signup and view all the answers

What describes the equity risk premium?

The additional return expected from holding a risky asset over a risk-free asset. (A) Signup and view all the answers

Which risk is Daphne exposed to with her investment in shares and savings in a building society?

Market risk due to concentration in telecom shares. (B) Signup and view all the answers

If Blatant plc shares have an expected return of 12% and a standard deviation of 15%, and Subtle plc shares have an expected return of 8% with a standard deviation of 12%, which share is more volatile?

Blatant plc shares, due to higher standard deviation. (A) Signup and view all the answers

What percentage of data is expected to fall within one standard deviation of the mean in a normal distribution?

68% (A) Signup and view all the answers

What measure indicates whether an investment's risk is justified by its return?

Sharpe Ratio. (C) Signup and view all the answers

If a share has an expected return of 10% and a standard deviation of 15%, what is the range of returns you would expect roughly 95% of the time?

-20% to +40% (D) Signup and view all the answers

Given a fund with a beta of 1.2, short-term interest rates of 3%, and a benchmark rise of 7%, what is the expected return?

10.4% (D) Signup and view all the answers

What does a beta factor of 1 indicate about an investment?

The investment moves in line with the benchmark. (A) Signup and view all the answers

To meet a target of £15,000 in nine years at a 7% growth rate, how much should Harry invest today?

Approximately £9,880. (D) Signup and view all the answers

Which of the following statements is true regarding a beta factor greater than 1?

The investment fluctuates more widely, indicating higher risk. (B) Signup and view all the answers

What is the expected range of returns for Blatant plc shares 68% of the time, given an expected return of 12% and standard deviation of 15%?

Between -3% and 27%. (D) Signup and view all the answers

For regular investments of £600 every year for 10 years at a growth rate of 6%, which of the following is a correct calculation of the future value?

Approximately £10,450. (A) Signup and view all the answers

What is the primary purpose of calculating the alpha of an investment?

To compare the level of return relative to the risk taken. (C) Signup and view all the answers

How is beta significant to investors considering volatility?

It helps assess how much an investment's price will move compared to the market. (C) Signup and view all the answers

If an investment has a beta close to 0, what does this imply?

The investment has minimal connection to market fluctuations. (C) Signup and view all the answers

What should investors consider when determining the level of risk to take?

The potential total return including capital gains and dividends. (B) Signup and view all the answers

What is one of the main risks associated with investing in building society accounts?

The risk of missing out on higher potential returns from other investments. (A) Signup and view all the answers

What does the text suggest about the time frame of investment and its impact on risk?

The risk of investing in stocks is higher over shorter periods than longer periods. (D) Signup and view all the answers

What is an 'equity risk premium' (ERP)?

The higher return expected for taking on the risk of investing in equities compared to bonds. (A) Signup and view all the answers

Based on the provided text, what is a key consideration when recommending an investment to a client?

The client's investment objectives and time horizon for the investment. (C) Signup and view all the answers

Which of the following is NOT a valid reason why asset-backed investments may be more suitable for long-term investments?

Asset-backed investments are generally more liquid than deposit-based investments. (A) Signup and view all the answers

What is an example of an asset-backed investment as mentioned in the text?

Shares (stocks) (C) Signup and view all the answers

What is the main reason why building societies are considered generally safe investments?

They protect the capital invested and add interest to it. (B) Signup and view all the answers

Which of the following best describes the relationship between the risk and the time horizon of an investment?

The shorter the time horizon, the higher the potential for return, but also for loss. (A) Signup and view all the answers

Study Notes

Risk

Risk is the possibility of something harmful or damaging occurring, leading to loss.
Risk is associated with the probability of an adverse event occurring.
Risk is defined as the possible variation in an outcome from what is expected.
Risk involves uncertainty about future events.
Risk is about variability because future events cannot be predicted with certainty.
Risk relates to expectations of what will happen.
Risk arises because actual events might differ from intended or expected results.
Risk can never be eliminated, it can only be reduced.

Types of Risk

Investment risk: probability of achieving or failing to achieve expected return
Operational risk: losses due to inadequate processes, systems, or external factors
Business risk/reputational risk: company’s exposure to factors affecting profit
Capital risk: risk of losing the original investment.
Income risk: reduction in investment income (e.g., declining interest rates, reduced dividends).
Shortfall risk: investment failing to meet expectations.
Liquidity and access risk: inability to convert investment into cash quickly.
Interest risk: impact of interest rate fluctuations on investment value.
Inflation risk: reduction in purchasing power of cash or investments due to inflation.
Currency risk: fluctuations in exchange rates impacting investment value.
Systemic risk: risk that failures in one part of a system can affect other parts.
Non-systematic risk: risk particular to a specific business or sector.
Gearing: using borrowed funds for investment, amplifying both returns and losses.

Volatility

Volatility measures how a share or fund's value fluctuates against previous performance, sector averages or benchmarks.
Standard deviation is a method measuring how much a set of values differ from the average.
Lower volatility = lower risk.
High volatility = higher risk.

Beta and Alpha

Beta: measures how a share or fund's value fluctuates compared to the overall market (or benchmark).
- Beta of 1: moves in line with the benchmark
- Beta greater than 1: more volatile than the benchmark
- Beta less than 1: less volatile than the benchmark
Alpha: measures an investment's return compared to its risk-adjusted expected return.
- Positive alpha: investment performs better than expected, given the risk.
- Negative alpha: investment performs worse than expected.

Time Value of Money

Money available today is worth more than the same amount in the future due to potential earning capacity.
Compounding is the process of calculating future values.
Discounting is the opposite of compounding, calculating present values of future sums.

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Description

This quiz explores the concept of risk, its definition, and the various types associated with it, including investment risk, operational risk, and more. Understand how risk relates to uncertainty and expectations in different contexts. Test your knowledge on managing and mitigating risks in various scenarios.