Chapter 8, Problem 1QTD

a)

Summary Introduction

To define: Risk

Explanation of Solution

Risk is nothing but the probability of any adverse occurrence of an event. In finance, risk is the probability that an investment will yield real returns or cash flows less than expected.

b)

Summary Introduction

To define: Probability distribution.

Explanation of Solution

Probability distribution describes the approximate probability of each of one or more possible outcomes.

c)

Summary Introduction

To define: Standard deviation.

Explanation of Solution

Standard deviation is a statistical measure of a variable’s dispersion over mean. It is an absolute risk metric, which is defined as the square root of the weighted average square deviations from the mean of individual observations.

d)

Summary Introduction

To define: Required rate of return.

Explanation of Solution

Required rate of return of an investment is the level of demand for return investors, despite the investment risk.

e)

Summary Introduction

To define: Coefficient of variation.

Explanation of Solution

Coefficient of variance is a measure of the inherent risk. It is defined as the ratio of any variable’s standard deviation to the mean.

f)

Summary Introduction

To define: Efficient portfolio.

Explanation of Solution

 A portfolio is efficient if there is no other portfolio with a greater expected return for a given standard deviation, or if there is no other portfolio with a smaller deviation for a given expected return.

g)

Summary Introduction

To define: Efficient frontier.

Explanation of Solution

Efficient frontier consists of an optimal portfolio collection.

h)

Summary Introduction

To define: Capital market line.

Explanation of Solution

Capital market line is a line which joins the risk-free rate and the portfolio of stocks. This shows the probability and projected returns that can be obtained by investing in probability-free investment and the stock portfolio of risky assets in different proportions of one’s wealth.

i)

Summary Introduction

To define: Beta coefficient.

Explanation of Solution

Beta is one indicator of an asset or security’s systematic risk. It is nothing but the ratio of the return covariance for any asset or security j and the market portfolio m to the return variance in the market portfolio.

j)

Summary Introduction

To define: CAPM

Explanation of Solution

CAPM is the Capital Asset Pricing Model, a principle that defines the risk and required return on securities and other assets.

k)

Summary Introduction

To define: Correlation coefficient.

Explanation of Solution

Correlation coefficient is a general statistical measure of the degree to which two sets of numbers appear to shift or differ together, such as the returns from two securities.

l)

Summary Introduction

To define: Portfolio.

Explanation of Solution

Portfolio is nothing but a series of two or more securities or assets.

m)

Summary Introduction

To define: Characteristic line.

Explanation of Solution

Characteristic line is a line of regression that compares the periodic returns on holding periods on a given security to the periodic returns on the stock portfolio.

n)

Summary Introduction

To define: Security market line.

Explanation of Solution

Security market line describes the relationship between systematic risk and the returns expected for individual securities.

o)

Summary Introduction

To define: Covariance.

Explanation of Solution

Covariance is an absolute statistical measure of the degree to which two series of numbers appear to travel together or differ.

p)

Summary Introduction

To define: Systematic risk.

Explanation of Solution

Systematic risk is the portion of the volatility in the return of a security that is caused by conditions that influence the entire market. It is also called as non-diversifiable risk.

q)

Summary Introduction

To define: Unsystematic risk.

Explanation of Solution

Unsystematic risks are the threats specific to an organization. These risks are also called as diversifiable risks.