Question

1. List the five steps in the risk management process (in order) and describe each one in at least one sentence: (5 pts.)

1. ________________________________________________________________________
2. ________________________________________________________________________
3. ________________________________________________________________________
4. ________________________________________________________________________
5. ________________________________________________________________________

2. The following is the probability distribution of rate of return for a particular stock: (5 pts.)

Rate of Return	Probability
20%	0.30
5%	0.40
-10%	0.30

1. What is the expected return of this stock?

2. What is the standard deviation of the expected return?

3. What is the confidence interval of the expected return within one standard deviation? Within two standard deviations?

3. Name three characteristics which distinguish a futures contract from a forward contract:

1. ________________________________________________
2. ________________________________________________
3. ________________________________________________

4. Answer the following questions regarding risk & diversification:
   1. Define “diversification.”

2. What is the benefit of diversification?

3. What is the difference between diversifiable risk and non-diversifiable risk?

4. Give 1-2 examples each of risk factors of diversifiable and non-diversifiable risk.
5. Define the riskless asset.

Answer 1

steps in risk management are:

1) identify: The company should identify potential risk that effect their financials.

2) Analyze: This step should quantify the amount of loss and the reason for occurance.

3) rank: All risks should be ranked accordingly based on the quantum of impact

4)treat: Plans should be formulated and implemented by the respective departments to treat the risk,

5)monitor: Already implemented planes should be reviewed and if any deviation from the desired goals, it should be altered accordingly.

a)(20*0.3)+(5*0.4)+(-10*0.3)=5%(expected returns)

a)standarad deviation is 11.61

1)Futures contracts are traded in stockexchange, on the otherhand forward contracts are privately traded

2)futures contracts are highly standardized, forward contracts are customized

3)The government regulates futures market, whereas the forward market is not regulated

a)Diversification is the process of continuously increasing the range of products or items in a portfolio.

a)With the help of diversification the risk of losing the money will be reduced, while earning maximum returns. It helps in increasing the wealth of an individual.

a)Diversifiable risk is where there the is a chance of reducing the risk. on the contrary, where risk cannot be mitigated is known as non-diversifiable risk.

a)example of diversifiable risk is market risk

a)example od diversifiable risk is increasing the various shares in a portfolio.

b)The asset which is free of risk or having low risk is know as riskless asset. Generally government securities are viewed as riskless assets.