Chapter 5: Risk, Return, And The Historical Record

Question 1

What are the four interest rate determinants?

Answer 1

Supply (savers, primarily households), Demand (businesses), Government’s Net Supply or Demand (expansionary/contractionary), the expected rate of inflation.

Question 2

What are nominal and real interest rates?

Answer 2

• Nominal interest rate - the growth rate of your money
• Real interest rate - growth rate of your purchasing power

Question 3

If interest rates go up what happens to supply of funds? If interest rates go down what happens to demand of funds?

Answer 3

When interest rates go up, supply of funds also increases, and you will get more on investments

When interest rates go down, demand for funds increases, borrowers will have to pay less interest.

Question 4

How does normal distribution relate to investment management?

Answer 4

Is is easier when returns are normally distributed:
- standard deviation is a good measure of risk when returns are symmetric
- If security returns are symmetric, portfolio returns will be as all
-only mean and st develop needed to estimate future scenarios
- pairwise correlation coefficients summarize the dependence of returns across securities

Question 5

What is Value at Risk? (VaR)

Answer 5

Measure of downside risk. The loss that will be incurred in the event of an extreme adverse price change with some given, typically low, probability (VaR 1- q)

Question 6

What is the expected shortfall (ES1-q)

Answer 6

The expected loss on a security, conditional on returns being in the left tail of the probability distribution