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RM1 Week 3

The document discusses risk management, focusing on the risk of a single asset and a portfolio. It outlines various risk assessment tools such as scenario analysis, probability distribution, standard deviation, and coefficient of variation. Additionally, it emphasizes the goal of creating an efficient portfolio that maximizes returns for a given risk level through diversification and correlation analysis.

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8 views17 pages

RM1 Week 3

The document discusses risk management, focusing on the risk of a single asset and a portfolio. It outlines various risk assessment tools such as scenario analysis, probability distribution, standard deviation, and coefficient of variation. Additionally, it emphasizes the goal of creating an efficient portfolio that maximizes returns for a given risk level through diversification and correlation analysis.

Uploaded by

uaena
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Risk of a

Single Asset
and Risk of a
Portfolio
RISK MANAGEMENT
WEEK 3 DISCUSSION.
RISK ASSESSMENT TOOLS
RISK ASSESSMENT TOOLS
❖ SCENARIO ANALYSIS PROBABILITY DISTRIBUTION
❖ STANDARD DEVIATION
❖ COEFICIENT OF VARIATION
RISK OF A SINGLE ASSET
SCENARIO ANALYSIS - An approach for assessing risk that uses several
possible alternative outcomes (scenarios) to obtain a sense of the
variability among returns.
VARIABILITY – Is the lack of consistency or pattern; the act of varying or
changing.
Optimistic Scenario – Positive or Best possible result.
Pessimistic – Negative or Worst possible result.
Most Likely – Most probable result.
SCENARIO ANALYSIS
Range - A measure of an
asset’s risk, which is found
by subtracting the return
associated with the
pessimistic (worst) outcome
from the return associated
with the optimistic (best)
outcome.
Probability Distribution
Probability distributions
- provide a more
quantitative insight into
an asset’s risk. It shows
the chance of an
outcome to happen. A
model that relates
probabilities to the
associated outcomes.
Probability Distribution
Continuous probability
distributions - provide a
more quantitative
insight into an asset’s
risk. It shows the
chance of an outcome
to happen. A model
that relates
probabilities to the
associated outcomes.
Risk of a Single Asset
Standard Deviation - The most
common statistical indicator of
an asset’s risk; it measures the
dispersion around the
expected value.
Expected Value of a Return -
The average return that an
investment is expected to
produce over time.
Risk of a Single Asset
Standard Deviation - The most
common statistical indicator of
an asset’s risk; it measures the
dispersion around the
expected value.
Expected Value of a Return -
The average return that an
investment is expected to
produce over time.
Risk of a Single Asset

Coefficient Variation - is a
measure of relative dispersion
that is useful in comparing the
risks of assets with differing
expected returns.
Example 1
Example 2
Risk of a Portfolio

What is the goal of an investor and


investment/ financial managers?
The goal is to create an Efficient
Portfolio, which is a portfolio that
maximizes return for a given risk
level
Risk of a Portfolio

The return on a portfolio is a


weighted average of the returns on
the individual assets from which it
is formed
Example

Assumption:
The portfolio’s
composition is 50%
Asset x and 50%
Asset y
Correlation and Portfolio
Diversification
Correlation is a statistical measure
of the relationship between any two
series of numbers.
❖Positively Correlated.
❖Negatively Correlated.
❖Perfectly Positively Correlated.
❖Perfectly Negatively Correlated.
❖Uncorrelated.
Diversification – combining different
investments in one portfolio
Example
- NEIL ARMSTRONG

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