Prolessor fsadore (Lmy) Invest-a-Lot retired two years ago from Except.docx

Prolessor fsadore (Lmy) Invest-a-Lot retired two years ago from Except.docx

• 1.
  Prolessor fsadore (Lmy)Invest-a-Lot retired two years ago from Exceptional College, a small bberal arts college in Louisiana after teaching corporate finance and imvestment theory for 35 years. Yesterday, laxy appeat on EC LIVE, a television show produced for the students, faculty and staff on the EU campurs and the local communities. Samantha Salvertongue is the host of EC UVVE, and one of Professor Iry's former students. The following is a transcript of the interview. Unfortunately the software that transcribes the interview into written form failed to understand several words and phrases used in the interview. To complete the transcript and demonstrate your knowledge of the risks and returns of investing. please select the best answer from each dropdown menu. SAMANTHA: Good morning, Professor Imvest-a-Lot. I'd Like to welcome you to EC LIVE, and thank you for coming in today to offer us insights into the basics of investing. I remember your course well, and while my grades didn't always reflect great success, I was always very interested in the material and the possibility of using the concepts and technques when the opportunities arose. 1ZYt Good morning, Samantha, and please call me, Irry. Thank you for the invitation to discuss one of the important fundamentals to sound imvesting: an apprecation of the relationship between the objective or outcome of your investment, that is its and the likehiood of receiving it, or the investment's. SAMANIHA: Let's begin with a generalization regarding the financial markets. Hew are people buying and selling investments in the financial markets generally assumed to react to risk? And, how do the markets define "risk"? IZYr Rusk is best thought of as the potential for variability in the investment's outcomes. This means that if an investment has the potential to provide only one possible outcome or return, then it is while if there is more than one possible return or result, then the asset should be considered This is why securities sold by the U.S. Treasury have historically been considered to be the securities in the world; because except in the event of the failure of the U.S. government, any investor holding a Treasury security would receive the security's face volue upon its maturity. Most investors have an expected outcome associated with an investment, and risk refers to the potential for receiving an outcome or return that is greater of less than his or her expected return. It is not surprising that investors receiving investment returns that exceed their expected return, but they tend to respond differently if the imvestment can generate a lower return. This potential for outcome is the risk on which most irvestors focus. In general, the majority of investors, or those buying and selling secunities, are assumed to be This does not mean that they won't purchase or sell risky securibes or projects, it simply means that they be compensated with a risk premuium or additional return for taking on projects or secunties exhibiting additional risk. SAMANIHA: So investors require a given amount of retum for imvesting in a risk-free investment, and then require an additional risk premium if they invest in projects or secunties that exhibit risk? Is that correct? RXY. That's absolutely correctl And the magnitude of the risk premium will as the amount of risk exhibited by the investment increases. So the riskiest investments require the risk premiums, and investments exhibiting relatively little risk require risk premiums. AMANTHA: OK, that makes sense, but how do you know how risky an investment is? 2.Y: It depends on how many imvestments you hold. If you hold only one investment-not just one type, such as one house, one car, one savings account, but one of all possible investments-then you can measure the riskiness of that investment by calculating the of the investment's possible returns. If you're holding a portfolio of assets, on the other hand, then the risk that is of greater interest is the riskiness, and how the addition of a new security or asset would affect the overall riskiness of the portfolio. This brings us to a related concept: the advantages and disadvantages of SAMANTHA: This is related to the notion of not putting all of your eggs in one basket; isn't it? Doesn't it mean just bolding a bunch of securities rather than
• 2.
  only one ortwo? That way if the value of one stock goes down, its loss will be offset by the gains exhibited by the other securities in the portfolio. Right? IPFY: Not exactly. Effective diversification requires knowledge of the extent to which the returns of an asset exhibit the same changes, increases or decreases over tame, as the retums of another asset or group of assets. Notice that it is not the magnitude of return that is important in this case, but the degree to which their movements are synchronized over time. This tendency to move together is measared by the asset's and assets that are generate returns that exhibit the identical pattern over time. In contrast, assers that are generate returns that exhibit the exactly opposite pottern. Another way of thinking about the risk-reduction benefits of diversification is to focus on the standard deviations of the assets. If the standard deviation of the returns of an asset being added to a portfolio is than the standard deviation of the portfolio's return, then the riskiness of the portfolio will increase, rather than decrease, which is contrary to the goal of diversification. It should be noted, however, that during the period of 1968 to 1998 , the correlation coefficient for most pairs of randomly selected U.S. companies was 0.28 . This means that the addition of a randomiy selected U.S. company to a portfolio of other U.S. corporations should the riskaness of the portfolio. SAMANTHA: Izry, this is fascinating stuff. Unfortunately our time is up, but l'd like very much for you to come back next week to continue our descussion. Would that fit into your schedule? IZZY: Of course, and I'll look forward to it! However, before I leave, I'd like to ask you and the audience to take a pop quiz, It addresses the material discussed today and is intended to reinforce some of the important concepts. Have fun, and I'll see you next weekl The use of a security's historical prices and returns to predict its estimated future return is theoretically sound. The fact that an investment generates a negotive return implies that the investor has badly selected or managed their investments. An imvestment exhibiting a greater amount of risk will always return a higher actual return. The use of a security's historical standard deviation to estimate its future riskiness is a theoretically sound financial practice. 2. According to research in the area of behavioral finance, the average risk averse investor perceives his or her gains and losses differently; that is, the utulity derived from a $1 , 000 gain is not equal to the disutility associated with a $1 , 000 loss. According to this research, risk averse investors dislike or fear losses more than they enjoy gains. False True 3. Two securities, A and B , are expected to be worth $100.00 in one year. Because A is riskier than B , the current price of A should be the current price of B .