Trading assets with the highest risk level

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Top Binary Options Broker 2020!
    Best Choice For Beginners!
    Big Sign-Up Bonus!
    Free Trading Education!
    Free Demo Account!

  • Binomo
    Binomo

    Only For Experienced Traders!

CFA 42: Portfolio Risk & Return I

Термины в модуле (40)

Year Return (%)
2008 14
2009 −10
2020 −2
The fund’s holding period return over the three-year period is closest to:

Year Return (%)
2008 22
2009 −25
2020 11
The hedge fund’s annual geometric mean return is closest to:

Geometric mean return.

Arithmetic mean return.

ETF Time Since Inception Return Since Inception (%)
1 146 days 4.61
2 5 weeks 1.10
3 15 months 14.35
The ETF with the highest annualized rate of return is:

Return on the asset.

Standard deviation of the asset.

Security Security Weight (%) Expected
Standard Deviation (%)
1 30 20
2 70 12
If the correlation of returns between the two securities is 0.40, the expected standard deviation of the portfolio is closest to:

Security Security Weight (%) Expected
Standard Deviation (%)
1 30 20
2 70 12
If the covariance of returns between the two securities is −0.0240, the expected standard deviation of the portfolio is closest to:

Security Security Weight (%) Expected
Standard Deviation (%)
1 30 20
2 70 12
If the standard deviation of the portfolio is 14.40%, the correlation between the two securities is equal to:

Security Security Weight (%) Expected
Standard Deviation (%)
1 30 20
2 70 12

If the standard deviation of the portfolio is 14.40%, the covariance between the two securities is equal to:

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Top Binary Options Broker 2020!
    Best Choice For Beginners!
    Big Sign-Up Bonus!
    Free Trading Education!
    Free Demo Account!

  • Binomo
    Binomo

    Only For Experienced Traders!

Asset Class Geometric Return (%)
Equities 8.0
Corporate Bonds 6.5
Treasury bills 2.5
Inflation 2.1

The real rate of return for equities is closest to:

Asset Class Geometric Return (%)
Equities 8.0
Corporate Bonds 6.5
Treasury bills 2.5
Inflation 2.1

The real rate of return for corporate bonds is closest to:

Asset Class Geometric Return (%)
Equities 8.0
Corporate Bonds 6.5
Treasury bills 2.5
Inflation 2.1

The risk premium for equities is closest to:

Asset Class Geometric Return (%)
Equities 8.0
Corporate Bonds 6.5
Treasury bills 2.5
Inflation 2.1

The risk premium for corporate bonds is closest to:

the same for all individuals.

positive for risk-averse investors.

smallest intercept value.

Investment Expected
Return (%) Expected
Standard Deviation (%)
1 18 2
2 19 8
3 20 15
4 18 30

A risk-neutral investor is most likely to choose:

Investment Expected
Return (%) Expected
Standard Deviation (%)
1 18 2
2 19 8
3 20 15
4 18 30

If an investor’s utility function is expressed as U=E(r)−12Aσ2 and the measure for risk aversion has a value of −2, the risk-seeking investor is most likely to choose:

Investment Expected
Return (%) Expected
Standard Deviation (%)
1 18 2
2 19 8
3 20 15
4 18 30

If an investor’s utility function is expressed as U=E(r)−12Aσ2 and the measure for risk aversion has a value of 2, the risk-averse investor is most likely to choose:

Investment Expected
Return (%) Expected
Standard Deviation (%)
1 18 2
2 19 8
3 20 15
4 18 30

If an investor’s utility function is expressed as U=E(r)−12Aσ2 and the measure for risk aversion has a value of 4, the risk-averse investor is most likely to choose:

below the capital allocation line.

on the capital allocation line.

Security Expected Annual Return (%) Expected Standard Deviation (%)
1 16 20
2 12 20

If the portfolio of the two securities has an expected return of 15%, the proportion invested in Security 1 is:

Security Expected Annual Return (%) Expected Standard Deviation (%)
1 16 20
2 12 20

If the correlation of returns between the two securities is −0.15, the expected standard deviation of an equal-weighted portfolio is closest to:

Security Expected Annual Return (%) Expected Standard Deviation (%)
1 16 20
2 12 20

If the two securities are uncorrelated, the expected standard deviation of an equal-weighted portfolio is closest to:

Average variance of the individual assets.

Standard deviation of the individual assets.

Asset Outcome 1
(%) Outcome 2
(%) Outcome 3
(%) Expected Return
(%)
1 12 0 6 6
2 12 6 0 6
3 0 6 12 6

Which pair of assets is perfectly negatively correlated?

Asset 1 and Asset 2.

Asset 1 and Asset 3.

Asset Outcome 1
(%) Outcome 2
(%) Outcome 3
(%) Expected Return
(%)
1 12 0 6 6
2 12 6 0 6
3 0 6 12 6

If the analyst constructs two-asset portfolios that are equally-weighted, which pair of assets has the lowest expected standard deviation?

Asset 1 and Asset 2.

Asset 1 and Asset 3.

Asset Outcome 1
(%) Outcome 2
(%) Outcome 3
(%) Expected Return
(%)
1 12 0 6 6
2 12 6 0 6
3 0 6 12 6

If the analyst constructs two-asset portfolios that are equally weighted, which pair of assets provides the least amount of risk reduction?

Asset 1 and Asset 2.

Asset 1 and Asset 3.

highest expected return for a given level of risk.

lowest amount of risk for a given level of return.

Trading Assets

What Are Trading Assets?

Trading assets are a collection of securities held by a firm for the purpose of reselling for a profit. They are recorded as a separate account from the investment portfolio and may include U.S. Treasury securities, mortgage-backed securities, foreign exchange rate contracts, and interest rate contracts. Trading assets include those positions acquired by the firm with the purpose of reselling in the near term in order to profit from short-term price movements.

Key Takeaways

  • Trading assets are securities held by a firm for the purpose of reselling to make a profit.
  • Treasuries, mortgage-backed securities, foreign exchange contracts, and other securities can be considered trading assets.
  • The investment portfolio of a firm is kept separate from trading assets.
  • Trading assets are considered current assets as they are intended to be sold quickly.
  • The value of trading assets need to be updated on the balance sheet and recorded as a profit or loss on the income statement.

Understanding Trading Assets

Companies acquire trading assets with the purpose of trading them for a profit. When a company buys and sells a trading asset, it is marked at the fair value of the asset. When trading assets are held by banks for other banks, they are valued at mark-to-market. Certain banks are required to file reports with the government and the Federal Deposit Insurance Corporation (FDIC) when engaging in this activity.

Trading assets are found on the balance sheet and are considered current assets because they are meant to be bought and sold quickly for a profit. While in the firm’s possession, trading assets should be valued at market value and the value should be updated on the balance sheet every reporting period. If the value of trading assets decreases or increases in the market, not only is the value of the assets adjusted on the balance sheet but this loss or gain, even if only on paper, needs to be recorded on the income statement.

For example, if a company purchases shares of ABC company for $2 million, and ABC’s shares drop in value by 30%, the company would adjust the value of the trading assets to $1.4 million on the balance sheet and record a net loss of $600,000 on the income statement.

Bank Trading Assets

Trading assets for all U.S. banks as of Q4 2020 were valued at $659 billion. This was 3.53% of total bank assets. The largest bank holder of trading assets is JPMorgan Chase, holding $263 billion in trading assets, which is 11.26% of its total assets.

Trading Assets vs. the Investment Portfolio

Bank XYZ will likely have an investment portfolio with various bonds, cash instruments, and other securities that contribute to the long-term value of the bank as a business entity. The securities in the investment portfolio might be used to purchase other businesses, assets, or put toward other long-term goals of the bank.

Bank XYZ would hold its trading assets in an account separate from the long-term investment portfolio, hold them for a short period of time, and trade them as appropriate in the marketplace to make a profit for the bank. The key point to note is that trading assets are for the short term where the investment portfolio is typically geared toward the long term.

Trading assets with the highest risk level

Risk is defined in financial terms as the chance that an outcome or investment’s actual gains will differ from an expected outcome or return. Risk includes the possibility of losing some or all of an original investment.

Quantifiably, risk is usually assessed by considering historical behaviors and outcomes. In finance, standard deviation is a common metric associated with risk. Standard deviation provides a measure of the volatility of asset prices in comparison to their historical averages in a given time frame.

Overall, it is possible and prudent to manage investing risks by understanding the basics of risk and how it is measured. Learning the risks that can apply to different scenarios and some of the ways to manage them holistically will help all types of investors and business managers to avoid unnecessary and costly losses.

Understanding Risk And Time Horizon

The Basics of Risk

Everyone is exposed to some type of risk every day – whether it’s from driving, walking down the street, investing, capital planning, or something else. An investor’s personality, lifestyle, and age are some of the top factors to consider for individual investment management and risk purposes. Each investor has a unique risk profile that determines their willingness and ability to withstand risk. In general, as investment risks rise, investors expect higher returns to compensate for taking those risks.

A fundamental idea in finance is the relationship between risk and return. The greater the amount of risk an investor is willing to take, the greater the potential return. Risks can come in various ways and investors need to be compensated for taking on additional risk. For example, a U.S. Treasury bond is considered one of the safest investments and when compared to a corporate bond, provides a lower rate of return. A corporation is much more likely to go bankrupt than the U.S. government. Because the default risk of investing in a corporate bond is higher, investors are offered a higher rate of return.

Quantifiably, risk is usually assessed by considering historical behaviors and outcomes. In finance, standard deviation is a common metric associated with risk. Standard deviation provides a measure of the volatility of a value in comparison to its historical average. A high standard deviation indicates a lot of value volatility and therefore a high degree of risk.

Individuals, financial advisors, and companies can all develop risk management strategies to help manage risks associated with their investments and business activities. Academically, there are several theories, metrics, and strategies that have been identified to measure, analyze, and manage risks. Some of these include: standard deviation, beta, Value at Risk (VaR), and the Capital Asset Pricing Model (CAPM). Measuring and quantifying risk often allows investors, traders, and business managers to hedge some risks away by using various strategies including diversification and derivative positions.

Key Takeaways

  • Risk takes on many forms but is broadly categorized as the chance an outcome or investment’s actual gain will differ from the expected outcome or return.
  • Risk includes the possibility of losing some or all of an investment.
  • There are several types of risk and several ways to quantify risk for analytical assessments.
  • Risk can be reduced using diversification and hedging strategies.

Riskless Securities

While it is true that no investment is fully free of all possible risks, certain securities have so little practical risk that they are considered risk-free or riskless.

Riskless securities often form a baseline for analyzing and measuring risk. These types of investments offer an expected rate of return with very little or no risk. Oftentimes, all types of investors will look to these securities for preserving emergency savings or for holding assets that need to be immediately accessible.

Examples of riskless investments and securities include certificates of deposits (CDs), money market accounts, U.S. Treasuries, and municipal securities. U.S. Treasuries are backed by the full faith and credit of the U.S. government. Investors can place money in multiple U.S. Treasury securities with different maturity options across the Treasury yield curve.

Risk and Time Horizons

Time horizon and liquidity of investments is often a key factor influencing risk assessment and risk management. If an investor needs funds to be immediately accessible, they are less likely to invest in high risk investments or investments that cannot be immediately liquidated and more likely to place their money in riskless securities.

Time horizons will also be an important factor for individual investment portfolios. Younger investors with longer time horizons to retirement may be willing to invest in higher risk investments with higher potential returns. Older investors would have a different risk tolerance since they will need funds to be more readily available.

Morningstar Risk Ratings

Morningstar is one of the premier objective agencies that affixes risk ratings to mutual funds and exchange-traded funds (ETF). An investor can match a portfolio’s risk profile with their own appetite for risk.

Types of Financial Risk

Every saving and investment action involves different risks and returns. In general, financial theory classifies investment risks affecting asset values into two categories: systematic risk and unsystematic risk. Broadly speaking, investors are exposed to both systematic and unsystematic risks.

Systematic risks, also known as market risks, are risks that can affect an entire economic market overall or a large percentage of the total market. Market risk is the risk of losing investments due to factors, such as political risk and macroeconomic risk, that affect the performance of the overall market. Market risk cannot be easily mitigated through portfolio diversification. Other common types of systematic risk can include interest rate risk, inflation risk, currency risk, liquidity risk, country risk, and sociopolitical risk.

Unsystematic risk, also known as specific risk or idiosyncratic risk, is a category of risk that only affects an industry or a particular company. Unsystematic risk is the risk of losing an investment due to company or industry-specific hazard. Examples include a change in management, a product recall, a regulatory change that could drive down company sales, and a new competitor in the marketplace with the potential to take away market share from a company. Investors often use diversification to manage unsystematic risk by investing in a variety of assets.

In addition to the broad systematic and unsystematic risks, there are several specific types of risk, including:

Business Risk

Business risk refers to the basic viability of a business—the question of whether a company will be able to make sufficient sales and generate sufficient revenues to cover its operational expenses and turn a profit. While financial risk is concerned with the costs of financing, business risk is concerned with all the other expenses a business must cover to remain operational and functioning. These expenses include salaries, production costs, facility rent, office, and administrative expenses. The level of a company’s business risk is influenced by factors such as the cost of goods, profit margins, competition, and the overall level of demand for the products or services that it sells.

Credit or Default Risk

Credit risk is the risk that a borrower will be unable to pay the contractual interest or principal on its debt obligations. This type of risk is particularly concerning to investors who hold bonds in their portfolios. Government bonds, especially those issued by the federal government, have the least amount of default risk and, as such, the lowest returns. Corporate bonds, on the other hand, tend to have the highest amount of default risk, but also higher interest rates. Bonds with a lower chance of default are considered investment grade, while bonds with higher chances are considered high yield or junk bonds. Investors can use bond rating agencies—such as Standard and Poor’s, Fitch and Moody’s—to determine which bonds are investment-grade and which are junk.

Country Risk

Country risk refers to the risk that a country won’t be able to honor its financial commitments. When a country defaults on its obligations, it can harm the performance of all other financial instruments in that country – as well as other countries it has relations with. Country risk applies to stocks, bonds, mutual funds, options, and futures that are issued within a particular country. This type of risk is most often seen in emerging markets or countries that have a severe deficit.

Foreign-Exchange Risk

When investing in foreign countries, it’s important to consider the fact that currency exchange rates can change the price of the asset as well. Foreign exchange risk (or exchange rate risk) applies to all financial instruments that are in a currency other than your domestic currency. As an example, if you live in the U.S. and invest in a Canadian stock in Canadian dollars, even if the share value appreciates, you may lose money if the Canadian dollar depreciates in relation to the U.S. dollar.

Interest Rate Risk

Interest rate risk is the risk that an investment’s value will change due to a change in the absolute level of interest rates, the spread between two rates, in the shape of the yield curve, or in any other interest rate relationship. This type of risk affects the value of bonds more directly than stocks and is a significant risk to all bondholders. As interest rates rise, bond prices in the secondary market fall—and vice versa.

Political Risk

Political risk is the risk an investment’s returns could suffer because of political instability or changes in a country. This type of risk can stem from a change in government, legislative bodies, other foreign policy makers, or military control. Also known as geopolitical risk, the risk becomes more of a factor as an investment’s time horizon gets longer.

Counterparty Risk

Counterparty risk is the likelihood or probability that one of those involved in a transaction might default on its contractual obligation. Counterparty risk can exist in credit, investment, and trading transactions, especially for those occurring in over-the-counter (OTC) markets. Financial investment products such as stocks, options, bonds, and derivatives carry counterparty risk.

Liquidity Risk

Liquidity risk is associated with an investor’s ability to transact their investment for cash. Typically, investors will require some premium for illiquid assets which compensates them for holding securities over time that cannot be easily liquidated.

Risk vs. Reward

The risk-return tradeoff is the balance between the desire for the lowest possible risk and the highest possible returns. In general, low levels of risk are associated with low potential returns and high levels of risk are associated with high potential returns. Each investor must decide how much risk they’re willing and able to accept for a desired return. This will be based on factors such as age, income, investment goals, liquidity needs, time horizon, and personality.

The following chart shows a visual representation of the risk/return tradeoff for investing, where a higher standard deviation means a higher level or risk—as well as a higher potential return.

It’s important to keep in mind that higher risk doesn’t automatically equate to higher returns. The risk-return tradeoff only indicates that higher risk investments have the possibility of higher returns—but there are no guarantees. On the lower-risk side of the spectrum is the risk-free rate of return—the theoretical rate of return of an investment with zero risk. It represents the interest you would expect from an absolutely risk-free investment over a specific period of time. In theory, the risk-free rate of return is the minimum return you would expect for any investment because you wouldn’t accept additional risk unless the potential rate of return is greater than the risk-free rate.

Risk and Diversification

The most basic – and effective – strategy for minimizing risk is diversification. Diversification is based heavily on the concepts of correlation and risk. A well-diversified portfolio will consist of different types of securities from diverse industries that have varying degrees of risk and correlation with each other’s returns.

While most investment professionals agree that diversification can’t guarantee against a loss, it is the most important component to helping an investor reach long-range financial goals, while minimizing risk.

There are several ways to plan for and ensure adequate diversification including:

  1. Spread your portfolio among many different investment vehicles – including cash, stocks, bonds, mutual funds, ETFs and other funds. Look for assets whose returns haven’t historically moved in the same direction and to the same degree. That way, if part of your portfolio is declining, the rest may still be growing.
  2. Stay diversified within each type of investment. Include securities that vary by sector, industry, region, and market capitalization. It’s also a good idea to mix styles too, such as growth, income, and value. The same goes for bonds: consider varying maturities and credit qualities.
  3. Include securities that vary in risk. You’re not restricted to picking only blue-chip stocks. In fact, the opposite is true. Picking different investments with different rates of return will ensure that large gains offset losses in other areas.

Keep in mind that portfolio diversification is not a one-time task. Investors and businesses perform regular “check-ups” or rebalancing to make sure their portfolios have a risk level that’s consistent with their financial strategy and goals.

The Bottom Line

We all face risks every day—whether we’re driving to work, surfing a 60-foot wave, investing, or managing a business. In the financial world, risk refers to the chance that an investment’s actual return will differ from what is expected – the possibility that an investment won’t do as well as you’d like, or that you’ll end up losing money.

The most effective way to manage investing risk is through regular risk assessment and diversification. Although diversification won’t ensure gains or guarantee against losses, it does provide the potential to improve returns based on your goals and target level of risk. Finding the right balance between risk and return helps investors and business managers achieve their financial goals through investments that they can be most comfortable with.

Best Binary Options Brokers 2020:
  • Binarium
    Binarium

    Top Binary Options Broker 2020!
    Best Choice For Beginners!
    Big Sign-Up Bonus!
    Free Trading Education!
    Free Demo Account!

  • Binomo
    Binomo

    Only For Experienced Traders!

Like this post? Please share to your friends:
Binary Options Trading Secrets
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: