Unit 7 - Financial Risk Management

Question 1

The coefficient of correlation that indicates the weakest linear association between two variables…

Answer 1

• Coefficient of correlation can vary from -1 to +1.
• A negative - 1 coefficient indicates a perfect negative correlation
• A positive + 1 coefficient indicates a perfect positive correlation
• While a zero 0 - indicates no linear association between the variables

So the coefficient that is nearest to the zero indicates the weakest linear association.

Eg. -0.73 vs. -0.11 -

The correlation coefficient that is nearest to zero —-> -0.11

Question 2

What is the high-low method used to generate a regression line?

Answer 2

It’s based on the equation on only the HIGHEST and LOWEST series of observations.

Question 3

In the standard regression equation

y = a + bx

What does each letter represent?

Answer 3

y = dependent variable
a = the y intercept
b = the slope of the regression line
x = the independent variable

Question 4

The expected return can be calculated from the CAPM model formula which is

Answer 4

The effect of an individual security on the volatility of a portfolio is measured by its sensitivity to movements by the overall market. This sensitivity is stated in terms of a stock’s beta coefficient.

Expected return = RF + β(RM – RF)

(RM - RF ) = Risk premium

RF = Risk-free rate

RM = Market return

When β = 1, expected return is equal to the market return.