MCQs- CHAPTER 11: FUNDAMENTALS OF RISK AND RETURN

Country risk refers to the risk related to a country as a whole, where the country may not be able to honor its financial commitments. When a country defaults on its obligations, it can affect the performance of all other securities issued in that country as well as other countries with relations to it. Country risk applies to all types of securities issued in that country.

Dividend is indeed a small component of the total returns from equity.

Reinvestment risk increases when interest rates fall because the reinvestment of periodic cash flows at lower rates will result in lower returns.

Projection bias refers to projecting recent past experiences or events into the distant future, ignoring the distant past. It involves giving more weight to recent events and not considering historical patterns or trends.

Stock turnover ratio is calculated by dividing the number of shares traded during a given period by the number of outstanding free float shares.

Inflation risk represents the risk that the money received on an investment may be worth less when adjusted for inflation. It arises from the decline in the value of security's cash flows due to the falling purchasing power of money. It is highest in fixed return instruments such as bonds, fixed deposits, and debentures, where investors are paid a fixed periodic interest and returned the principal amount at maturity. Inflation risk is relatively less for equity shares.

Liquidity risk refers to the absence of liquidity in an investment. It implies that the investor may not be able to sell their investment when desired, or they may have to sell it below its intrinsic value, or incur high costs to carry out transactions. Investments in assets such as corporate bonds, property, and art are subject to liquidity risk, as finding a buyer and determining the price can be a lengthy process in the absence of an active market.

Business risk is indeed also known as operating risk, as it is caused by factors that affect the company's operations.

Sharpe Ratio factors in the difference in risk by measuring the risk premium earned per unit of standard deviation.

Herd Mentality bias can prevent investors from benefiting from market corrections.

Ownership bias, also known as the endowment effect, reflects the tendency to place a higher value on a position than others woul

The winner's curse refers to the tendency to ensure winning a competitive bid even after overpaying for the asset. While it may be a behavioral win, financially it may result in a loss.

Anchoring bias is a cognitive bias where individuals rely too heavily on the first piece of information offered when making decisions. Investors may hold on to outdated information, ignoring new information that is available. This bias can impact decision-making, such as holding on to losing stocks in expectation of a price rebound based on past prices, rather than considering current information.

Confirmation bias, also called my side bias, is the tendency to search for, interpret, or prioritize information in a way that confirms one's beliefs or hypotheses.

The investor expects both to preserve the capital invested and earn a return from the investment.

Annualized return converts the return to a uniform period, enabling comparison between investments with different holding periods.

Reinvestment risk arises from the probability that income flows received from an investment may not be able to earn the same interest as the original interest rate. It occurs when intermediate cash flows may be reinvested at a lower return compared to the original investment. Reinvestment rates can be high or low depending on the levels of interest rates at the time when the coupon income is receive

Interest rates and bond prices have an inverse relationship. When interest rates fall, or are expected to fall, bond prices go up. Conversely, when interest rates rise, or are expected to rise, bond prices decline. This relationship exists because investors demand a higher return for taking on the risk of holding a bond when interest rates are higher, and vice vers

CAGR (Compounded Annual Growth Rate) is the accepted standard measure of return in financial markets.

Market risk refers to the risk of the loss of value in an investment due to adverse price movements in the market. The price of an asset responds to information that impacts its intrinsic value. For example, changes in interest rates or currency exchange rates can affect the market price of bonds or stocks. Market risk primarily affects investments in marketable securities such as equity, bonds, gold, real estate, et

Jensen's Alpha refers to the excess return earned on investment compared to its benchmark.

Loss-aversion bias refers to an investor's tendency to strongly prefer avoiding losses to acquiring gains, and the fear of loss leads to inaction.

CAGR is computed using the formula: (End Value / Beginning Value)^(1/n) - 1, where n is the holding period in years.

The Sharpe Ratio measures the risk premium earned per unit of standard deviation.

Confirmation bias leads to searching, interpreting, or prioritizing information that confirms one's beliefs or hypotheses.

ROI numbers should be used with caution for investments with unknown future returns and for equity and mutual funds.

The main objective of stock exchanges is to provide liquidity, which refers to the ease of buying and selling shares in the market.

Call risk refers to the possibility that a debt security will be called prior to its maturity. It is most prevalent when interest rates are falling, as companies trying to save money will usually redeem bond issues with higher coupons and replace them with issues with lower interest rates. Call risk usually goes hand in hand with reinvestment risk.

Stock turnover ratio is calculated using the number of shares traded divided by the number of outstanding free float shares.

Compounded return (CAGR) takes into consideration the time value of money and assumes reinvestment of periodic returns.

The main measure of liquidity in the traded value turnover ratio is the traded value of the shares.

ROI for a single period is calculated as net profit divided by the investment, multiplied by 100.

Business risk, also known as operating risk, is the risk inherent in the operations of a company. It is caused by factors that affect the company's operations, such as the cost of raw materials, employee costs, introduction and position of competing products, marketing and distribution costs, et Holding a diversified portfolio is an efficient way to diversify this risk.

Unsystematic risk, also known as diversifiable risk, refers to risks that are specific to individual securities or

Systematic risk, also known as undiversifiable risk, refers to risks that impact multiple investment categories and cannot be eliminated through diversification. It is caused by factors that affect the economy or markets as a whole, such as changes in government policy, external factors, wars, or natural calamities. Inflation risk, exchange rate risk, interest rate risk, and reinvestment risk are examples of systematic risks.

The calling feature in bonds is most prevalent when interest rates are expected to fall.

Credit risk, also known as default risk, refers to the possibility that a bond issuer will not be able to make expected interest rate payments and/or principal repayment. Debt instruments are subject to credit risk as they have pre-committed payouts. The credit rating provided by credit rating agencies is used to measure the credit risk in an instrument. A lower credit rating represents a higher credit risk, resulting in higher interest rate expectations by investors.

A higher Jensen's Alpha indicates superior performance.

The Treynor Ratio measures the risk premium earned per unit of Bet

The Treynor Ratio calculates the risk premium per Bet

Herd mentality is a bias where investors follow the investment choices made by others, often due to a belief that others may have better information. This behavior can lead to bubbles and crashes in the market.

Political risk refers to the risk associated with unfavorable government actions such as nationalization, changes in tax structures, or licensing regulations. Businesses and securities are exposed to political risk because governments have the power to change laws that affect them. Political risk can have a significant impact on the performance of businesses and securities.

The time frame typically used for calculating the stock turnover ratio is one year.

The gambler's fallacy is the mistaken belief that if something happens more frequently than normal during some period, then it will happen less frequently in the future, or vice versa, based on past events.

Traded value turnover ratio measures the liquidity of a stock by dividing the traded value of the shares by the market capitalisation of the company.