FRM- 2.0

Question 1

Not All Investments

Answer 1

1. ) Have Same Return and Risk (Why ?)

2. ) E.g. Small Stocks, S&P 500 and Corporate Bonds have Different Return and Risk

Question 2

Higher Returns are Given

Answer 2

To Compensate for Higher Risks

Question 3

But Not All Risks Have To Be Compensated

Answer 3

Need to Know Which Risk to Compensate

Question 4

Quantifying Relationship Between Risks and Returns

Answer 4

1. ) To Understand Which Risks to Be Compensated

2. ) How Returns Change with Risks

Question 5

Higher Return Order:

Answer 5

1. ) Small Stocks
2. ) S&P 500
3. ) World Portfolio
4. ) Corporate Bonds
5. ) Treasury Bills

Question 6

Higher Volatility in Returns:

Answer 6

1. ) Small Stocks
2. ) S&P 500
3. ) World Portfolio
4. ) Corporate Bonds
5. ) Treasury Bills

Question 7

Measure to Calculate Returns

Answer 7

1. Probabilistic Distribution

2. Historical Annual Average Return

Question 8

Probabilistic Returns

Answer 8

Expected Probability for Different Returns

Question 9

Historical Annual Average Returns

Answer 9

1. ) Realized Returns Based on Dividend- Yield and Capital- Yield
2. ) Annual Realized Returns- Emperical Distribution
3. ) Probability Distribution Remains Same
4. ) Future Mirrors Past

Question 10

Estimation Error

Answer 10

1. ) Expected Return Cannot Be Known
2. ) Assume Expected Return
3. ) Reduces With Increase in Number of Observations (95 % Confidence Interval)
4. ) Limited Due to Change in Market Conditions

Question 11

Variation

Answer 11

1. ) Square Deviation from Mean

2. ) Spread-out of Returns

Question 12

Standard Deviation

Answer 12

Volatility of Returns

Question 13

Variation Based on Historical Returns

Answer 13

1. ) Divide By T-1
2. ) Lost One Observation Due to No Availability of Expected Return
3. ) Making Use of Mean as Expected Return

Question 14

For Small Stocks, S&P 500, Corporate Bonds and Treasury Bills:

Answer 14

Straight Line in Risk- Return Space

Question 15

Individual Stocks

Answer 15

1. ) No Particular Relationship Between Risk and Return
2. ) Small Returns As Compared to Portfolios for Same Risks
3. ) Risk Depends on the Size of the Stocks

Question 16

Common and Independent Risks

Answer 16

1. ) Earthquake

2. ) Theft

Question 17

Independent Risks

Answer 17

1. ) Get Diversified

2. ) Reduces with Increase in Diversification

Question 18

Common Risks

Answer 18

1. ) Remains Same for All Stocks

2. ) Cannot Be Diversified

Question 19

Independent Risks

Answer 19

Firm- Specific Risks; Diversifiable Risk; Idiosyncratic Risks

Question 20

Common Risks

Answer 20

Market Risks; Undiversifiable Risks; Systematic Risk

Question 21

Arbitrage Rule

Answer 21

1. ) Law of One Price

2. ) Risk- Premium for Market Risk Only

Question 22

Law of One Price

Answer 22

1. ) Firm-Specific Risk Can Be Diversified
2. ) Increase in Demand Will Lead to Increase in Price of the Stocks- Lowering the Return
3. ) Finally, Same Return

Question 23

Volatility Cannot Be A Measure of Risk for Portfolio

Answer 23

1. ) Systematic Risk

2. ) Calculated Using Beta

Question 24

Beta

Answer 24

% Change in Return Due to % Change in Market Return