Ch 13? Flashcards
(30 cards)
What is risk in the context of investments?
Risk is the uncertainty or variability of future returns or cash flows from an investment.
How does uncertainty affect cash flow projections?
The greater the uncertainty in cash flows, the higher the risk associated with the investment.
What does it mean for an investor to be risk-averse?
A risk-averse investor prefers investments with lower risk for a given level of return.
Why are investors risk-averse?
nvestors prefer to avoid uncertainty and minimize potential losses, even if it means accepting a lower return.
What is the standard deviation in finance?
Standard deviation measures the total variability of returns. A higher standard deviation indicates more risk.
What is the Coefficient of Variation (CV)?
he Coefficient of Variation is the ratio of the standard deviation to the mean return. It normalizes risk across different investments.
What does a beta of 1 indicate?
A beta of 1 indicates that the asset’s returns move in line with the market.
What does a beta greater than 1 indicate?
A beta greater than 1 indicates that the asset is more volatile than the overall market.
What is a risk-adjusted discount rate (RADR)?
RADR is a discount rate adjusted for the riskiness of future cash flows in a project or investment.
Why do we adjust discount rates for risk?
To properly account for the uncertainty of future cash flows, ensuring that riskier investments are discounted more heavily.
What are certainty equivalents?
Certainty equivalents adjust uncertain future cash flows into certain amounts that an investor would accept.
How do simulation models help assess risk?
Simulation models use computer-generated scenarios to predict different outcomes and assess potential risks.
What is sensitivity analysis?
Sensitivity analysis examines how changes in input variables (e.g., sales, costs) affect a project’s financial outcomes.
What is a decision tree in finance?
A decision tree is a graphical tool used to analyze different decision paths and their potential outcomes under uncertainty.
What is the key benefit of diversification in a portfolio?
Diversification reduces unsystematic risk by combining assets that are not perfectly correlated.
What is systematic risk?
Systematic risk is the market-wide risk that cannot be eliminated through diversification, such as economic or political events.
What is unsystematic risk?
Unsystematic risk is specific to an individual asset or company and can be reduced through diversification.
What does a negative correlation between two investments imply?
A negative correlation means the investments tend to move in opposite directions, reducing overall portfolio risk.
What does the Efficient Frontier represent?
he Efficient Frontier shows the optimal combinations of risk and return, providing the best risk-return trade-off for an investor.
What is the goal of portfolio management in terms of risk and return?
The goal is to maximize return for a given level of risk or minimize risk for a given level of return.
What happens to risk when investments are perfectly correlated?
When investments are perfectly correlated, risk in the portfolio is the same as the risk of the individual assets.
What is the primary objective when choosing a point on the Efficient Frontier?
The primary objective is to balance the investor’s risk tolerance with the expected return, choosing the optimal risk-return combination.
What is the relationship between risk and return?
There is a positive relationship: higher risk is typically associated with higher potential return.
Why do firms analyze the wishes and demands of shareholders regarding risk?
Because shareholders are often risk-averse and fluctuations in stock prices impact their perceptions of value and security.
