week 6

Question 1

What does standard deviation (SD) measure in investment risk?

Answer 1

SD measures total volatility of returns, showing how much actual returns vary from the average return.

Question 2

What is the coefficient of variation (CV) and how is it used?

Answer 2

CV = SD ÷ Mean return; it standardizes risk per unit of return to compare investments with different return levels.

Question 3

What does beta measure in relation to stock risk?

Answer 3

Beta measures systematic risk or sensitivity of a stock’s returns to market movements; beta > 1 means more volatile than market.

Question 4

How do standard deviation and beta differ in risk measurement?

Answer 4

SD measures total risk (systematic + unsystematic), beta only measures systematic risk relative to the market.

Question 5

What is the Efficient Frontier in portfolio theory?

Answer 5

A set of portfolios offering the highest expected return for each level of risk, helping investors choose optimal risk-return tradeoffs.

Question 6

What is the Capital Market Line (CML) and how is it different from the Security Market Line (SML)?

Answer 6

CML plots efficient portfolios (risk-return) using total risk (SD); SML plots expected return of individual assets using systematic risk (beta).

Question 7

How do you apply the Capital Asset Pricing Model (CAPM)?

Answer 7

Expected Return = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate), used to estimate cost of equity and required returns.

Question 8

What are the assumptions and limitations of CAPM?

Answer 8

Assumes investors are rational and markets efficient; limitations include unrealistic assumptions about risk-free borrowing and market portfolio.