10 -- Risk Management and Profitability

10 -- Risk Management and Profitability - CPA BEC - STUDY...

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CPA BEC - STUDY UNIT 10 Risk Management and Profitability: Core Concepts A. Types of Risk 1. Risk is the possibility of an unfavorable event. Investment risk is analyzed in terms of the probability that the actual return will be lower than the expected return. The risk of a security may be considered individually or as part of a portfolio. B. Risk Measurement 1. A probability distribution is the set of all possible outcomes of a decision, with a probability assigned to each outcome. The expected rate of return on an investment is determined using an expected value calculation. The greater the standard deviation of the expected return, the riskier the investment. Investment decisions depend on risk, the risks and returns of alternatives, and the investor’s attitude toward risk. 2. Risk and return should be evaluated for an entire portfolio . Its expected return is the weighted average of the returns on individual securities. The diversification effect is that portfolio risk is less than the average of the standard deviations. The returns are imperfectly correlated. The correlation coefficient (r) has a range from 1.0 to –1.0. It measures the degree to which any two variables, e.g., two stocks in a portfolio, are related. The
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10 -- Risk Management and Profitability - CPA BEC - STUDY...

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