Measurement of Investment Risk
KNOWLEDGE EXPECTED OF: Both CFP® Professionals and QAFPTM Professionals
- Explain the relationship between expected return and risk.
- Explain types of risks that may affect an investment, such as:
- Systematic risk
- Non-systematic risk
- Inflation rate risk
- Political risk
- Sovereign risk
- Liquidity risk
- Marketability risk
- Interest rate risk
- Reinvestment risk
- Foreign exchange risk
- Default risk
- Credit risk
- Timing or call risk
- Volatility risk
- Event risk
- Counterparty risk
- Define volatility.
- Explain how the types of risk may affect volatility.
- Explain possible approaches to reducing the types of risk.
- Define measures of investment risk, such as:
- Standard Deviation
- Identify that given two investments with the same level of risk, an investor will choose the investment with the higher return; identify that given two investments with the same level of return, an investor will choose the investment with the lower risk.
- Explain how the measures of investment risk may be used to measure the sensitivity of an investment to changes in the market.
- Interpret the calculation of standard deviation for an investment.
- Interpret the calculation of Beta for an investment.
- Define other measures of investment risk,†such as:
- Range of returns
- Best and worst periods
- Number of periods of negative returns
- Average drop in value between peak and valley of returns
- Largest drop in value between peak and valley of returns
- Average length of time between subsequent peaks of returns
- Maximum length of time between subsequent peaks of returns
† Measurements can be over any time period that is appropriate. One such time period may equate to the expected time horizon over which the investment will be held.
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