FIN 301 Definitions Exam Questions with Complete Solutions
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Course
FIN301
Institution
FIN301
The uncertainty associated with the expected future returns of an asset.
Risk is the part of an asset's price movement that is caused by an unexpected event.
Risk is measured by the range of possible returns based around an expected return for an investment
Standard deviation is used as a measu...
FIN 301 Definitions Exam Questions with
Complete Solutions
The uncertainty associated with the expected future returns of an asset.
Risk is the part of an asset's price movement that is caused by an unexpected event.
Risk is measured by the range of possible returns based around an expected return for
an investment
Standard deviation is used as a measurement of risk. - Answer-Risk
Risk related to a surprise event that affects a single company (firm-specific risk).
The effects of unsystematic risk can be greatly reduced or eliminated through
diversification.
The stock market does not reward investors for taking on unsystematic risk because it is
risk that can be diversified away. - Answer-Unsystematic Risk
Risk related to a surprise event that affects the entire economy and all assets to some
degree.
Examples of systematic risk are an increase in the interest rate, a terrorist attack, or a
declaration of war.
It is not possible to reduce systematic risk through diversification.
CAPM assumes that the expected return on an asset depends only on systematic risk
because it is possible to eliminate unsystematic risk through diversification. - Answer-
Systematic Risk
Gaines or losses are "realized" when the asset is sold.
Long-term gains are taxed at a lower rate than short-terms. - Answer-Realized Gains or
Losses
Term used for gains or losses when you still own the asset.
If the price of a stock you own falls and you own the stock, the loss is considered and
"unrealized" loss until you sell the stock. - Answer-Unrealized Gains or Losses
The return that an investor receives on a safe asset that is free from credit risk.
In the U.S., investors usually use the rate of return on U.S. Treasury bills as the risk-free
rate because there is an underlying assumption that the U.S. government will always
meets its financial obligations. - Answer-Return on the Risk Free Asset
A measure of an asset's systematic risk.
Indicates how responsive a stock's return is to changes in the expected return on the
market.
The overall stock market is said to have a beta of 1
If an asset has a beta >1, it is riskier than the market
If an asset has a beta<1, it is riskier than the market - Answer-Beta
, [E(Rm)-Rf] The expected return of the stock market minus the risk free rate.
The market risk premium can be thought of as the additional return an investor will
receive if he purchases an average-risk stock (beta=1), as opposed to a treasury bill. -
Answer-Market Risk Premium
Measures the risk of an asset.
Measures how wildly or tightly observed stock returns cluster around the average stock
return. - Answer-Standard Deviation of Return
1) U.S. Treasury bills (least risky)
2) U.S. Government bonds
3) Corporate bonds
4) Large company stocks
5) Small company (most risky) - Answer-Assets Classes in Order of Risk
Nobel prize winning theory used to price risky assets.
Focuses on the tradeoff between the risk of an asset and the expected return
associated with that asset.
CAPM shows the investors will require higher returns as the systematic risk of the
investment increases- beta is the measurement of systematic risk - Answer-CAPM
(Capital Asset Pricing Model)
The specific securities (stocks, bonds, mutual funds) owned by an investor.
Rportfolio= (% of portfolio)(risk)+(% of portfolio)(risk)
Investors who hold large portfolios are not concerned about unsystematic (firm-specific)
risk
Well-diversified portfolios are identical to each other, except for their betas - Answer-
Portfolio
Observed return-expected return
When alpha is positive, the security outperformed the returns expected under the CAPM
benchmark
When alpha is negative, the security underperformed compared to the returns expected
under the CAPM benchmark
*Compare the actual return on the portfolio the expected return on the portfolio -
Answer-Alpha
The current prices of stocks reflect all publicly available information, and stock prices
adjust and react completely, correctly, and almost instantaneously to incorporate new
information
An efficient capital market is a market that can efficiently process information
In an efficient capital market, every investment offers and expected return to match its
level of risk - Answer-Efficient Capital Markets (ECM)
Analysis of past stock prices and trading volume to forecast future prices - Answer-
Technical Analysis
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