Question

Answer each question succinctly yet completely. Be mindful of the multiple parts to each question.

14. Describe the use of scenario analysis in the expected return generation exercise. What is the goal of scenario analysis? State the one word that academics generally use to describe the concept of risk. What metric(s), sometimes referred to as a second moment, is used by econometricians to describe this risk?

Answer 1

Scenario analysis is the process of estimating the expected value of a portfolio after a given period of time, assuming specific changes in the values of the portfolio's securities or key factors take place, such as a change in the interest rate.

As a technique, scenario analysis involves computing different reinvestment rates for expected returns that are reinvested during the investment horizon. Based on mathematical and statistical principles, scenario analysis provides a process to estimate shifts in the value of a portfolio, based on the occurrence of different situations, referred to as scenarios, following the principles of "what if" analysis.

These assessments are used to examine the amount of risk present within a given investment as related to a variety of potential events, ranging from highly probable to highly improbable. Depending on the results of the analysis, an investor can determine if the level of risk present falls within his comfort zone.

Scenario analysis is commonly used to estimate changes to a portfolio's value in response to an unfavorable event, and may be used to examine a theoretical worst-case scenario.

'Uncertainty' is the word used to describe the concept of risk.

Variance is used by econometricians to describe the risk.