FIN 3331 – Risk and Return Assignment Question
1: According to the video, how do we define risk? Question
According to the video, Brad Simon defines risk as outcomes or returns that may or often differ from what the investors either expect or would like to happen. There exists a positive relationship between risks and returns. For instance, if an investor wants a chance to earn higher returns, he or she is required to take on a higher risk investment. However, safety risks are conducted in banks and treasury bills and not in stocks and bonds.
2: According to the video, how would the risk of a portfolio consisting of stocks from a variety of economic sectors compare to one consisting of stocks from just one sector? What is the technical finance term for this concept? Question
Including more stocks in the portfolio lessens the volatility of returns. The technical finance term for this concept is diversification or diversifying risk. In most circumstances, diversifying risk is mostly done to protect a company’s financial position. This technique applies to the majority of economic sectors in most companies as a mechanism of curbing potential costly consequences. Additionally, diversification gives room to reduce the risk of the company’s portfolio without sacrificing the potential returns. A well-organized collection boasts of the least possible risks for given returns. Some of the positive impacts of diversifying the portfolio involve the ability to build a portfolio whose risk is minor compared to the combined threats of all the individual securities. additionally, having different types of investments in companies getting affected differently by world events and economic factor changes such as exchange rates, inflation rates, and interest rates.
3: According to the video, what is the difference between std. Dev. And beta in terms of measuring risk? Question
Brad Simon asserts that when the standard deviation of the stock itself is higher, the beta also becomes more senior. Furthermore, when the correlation also becomes more significant, the beta becomes more magnificent as well. Both better and standard deviation are common measures of risk. Beta measures the volatility of the stock relative to the whole market while the standard deviation measures individual stock risks. Standard deviation usually indicates the degree of uncertainty of the cash flow and is a precise measure of risk. Higher standard deviations denote generally high levels of risk. Beta measures the risk of the asset of an individual relative to the portfolio of the market.
4: According to the video, what are some caveats associated with CAPM? Question
In the video, Brad Simon asserts that measures of beta for an asset can differ depending on the calculations carried out. The relationship of risk and return rests on the assumption that the stock or asset is valued correctly. This relationship necessitates for the asset markets to get efficient. Furthermore, the given historical events and pieces of evidence allow the room to question how the efficient markets are conducting their pricing of assets at its intrinsic value.
5: According to the video, what is the difference between systematic and unsystematic risk? How is each type of risk impacted by holding a well-diversified portfolio?
Systematic risk is a risk at the market level, while Unsystematic risk involves a firm-specific risk. The well-diversified portfolio makes the risks to be both less risky. Noteworthy, systematic, and unsystematic risk can prove to be challenging to control. For instance, external factors significantly contribute to systematic risks. These factors are most often unavoidable and uncontrollable. Further, they cause adverse effects to the entire market but can get partially constrained through hedging and asset allocation. Unsystematic risk is contributed significantly by internal factors that can easily be controlled or avoided through a great extent through a well-diversified portfolio.