Chapter 8

Question 0

How is the variance calculated?

Answer 0

Add the squared difference between each period’s return and the mean return

Divide by (n-1)

Question 1

Measures deviation of actual return from average return over a specific period.

Answer 1

Variance

Question 2

What is a downside to using the variance to measure deviation of actual return?

Answer 2

May be difficult to interpret due to squaring

Question 3

How is the standard deviation calculated.

Answer 3

Square root of the variance

Question 4

Why is standard deviation a good way to measure deviation of actual return from the average return?

Answer 4

In the same units

Same number of days points as variance

Question 5

What is a drawback to using standard deviation?

Answer 5

The larger the values in the data set the larger the standard deviation

Question 6

How is the coefficient of variation calculated?

Answer 6

Standard deviation / expected (or mean) return

Question 7

What does the coefficient of variation measure?

Answer 7

Risk per unit of return

Question 8

This provides an indication of the dollar amount involved in a risk being assessed; items not provided by standard deviation or coefficient of variation

Answer 8

Value at risk

Question 9

What is this an example of? An investment portfolio might have a 6% one-day, _____ of $400,000

Answer 9

Value at risk

Question 10

What are the advantages of VaR?

Answer 10

Expresses the loss in monetary terms that are easy to understand

Quantities in numerical terms the potential loss associated with a decision

Requires only two inputs

Question 11

What is the disadvantage of VaR?

Answer 11

The extent to which a loss exceeds the VaR threshold is not accurately measured.

Question 12

What does beta represent?

Answer 12

An assets market risk; the extent to which a change in the overall marketplace can affect a particular asset.

Question 13

What is the beta of the market?

Answer 13

1.0

Question 14

What does a beta of 1.1 mean?

Answer 14

Asset is more volatile than the market

Question 15

This theory indicates that asset allocation can optimize risk and return

Answer 15

Modern portfolio theory

Question 16

What type of risk cannot be diversified away?

Answer 16

Market risk/systematic risk

Question 17

What type of risk can be diversified away?

Answer 17

Company-Specific (business risk, default risk)

Question 18

What is a major benefit of investing internationally?

Answer 18

Diversification

Question 19

This can allow an investor to achieve higher return for a given risk level than can be achieved with a single asset

Answer 19

Diversification

Question 20

Does another investment need to have a negative correlation to reduce risk through diversification?

Answer 20

No. Just cannot be perfectly correlated.

Question 21

Is there a limit to the benefit of diversification?

Answer 21

Yes. There is an optimum mix

Question 22

What is efficient frontier?

Answer 22

Portfolio with the highest return for a given level of risk

Question 23

What is the most important objective of an insurance company when investing in long-term bonds?

Answer 23

To match timing of investment cash inflows with expected cash outflows of the company

Question 24

What are the three risks bonds have?

Answer 24

Credit risk (can eliminate through diversification)
Interest rate risk (cannot eliminate)
Reinvestment rate risk

Question 25

What type of risk does cash matching eliminate?

Answer 25

Interest rate risk

Question 26

What is cash matching?

Answer 26

Matching the maturity of bonds with the expected time losses must be paid

Question 27

What are the limitations of cash matching?

Answer 27

Insurer must purchase correct amount of bonds to offset loss payments

Insurer must find zero-coupon bonds that mature at the exact time losses are paid.

Question 28

What types of bonds expose an insurer to reinvestment rate risk?

Answer 28

Coupon rate bonds

Question 29

What does duration of a bond represent?

Answer 29

Amount of time required to recover the true cost.

Question 30

What is the duration of a zero coupon bond?

Answer 30

Maturity

Question 31

What are the uses of bond duration?

Answer 31

Compare volatility of bonds

Estimate price changes when YTM changes

Immunize a portfolio

Question 32

Who regulates insurer investments?

Answer 32

The state

Question 33

What types of assets are permitted on a balance sheet?

Answer 33

Money market investments 
Treasury bills and commercial paper 
High quality bonds 
Common and preferred stock 
Real estate and mortgages

Question 34

What is the primary goal of state regulators?

Answer 34

Ensuring solvency and liquidity of an insurer

Question 35

What types of restrictions are placed in insurers with regard to investments.

Answer 35

Can’t put too many eggs in one type of basket

Can’t put too many eggs in one basket

Cannot own too much stock in another company

Question 36

What do investment restrictions usually lead insurers to invest in?

Answer 36

High quality bonds