Term
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Definition
| 1. The amount of dividends received per share of stock owned, expressed as a percentage of the value of the investment at the beginning of the period |
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Term
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Definition
| 2. The capital gain or loss based on the change in the value of the investment from the beginning of the year to the end of the year, expressed as a percentage of the value of the investment at the beginning of the perid. |
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| 3. Percentage total return |
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Definition
| 3. The total of the dividend received and the capital gain for the period, expressed as a percentage of the value of the investment at the beginning of the period |
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Definition
| 4. A statistic reflecting the composite value of a selection of securities |
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Term
| 5. Market risk, or Systematic Risk |
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Definition
| 5. Risk that is common to the overall market or a specific market segment and that therefore cannot be eliminated by diversification |
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| 6. Company-specific risk, or unsystematic risk |
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Definition
| 6. Risk that affects a specific company or a small group of companies |
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Term
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Definition
| 7. The risk that a debtor will not repay the amount owed |
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Definition
| 8. The risk that an asset cannot be sold on short notice without incurring a loss. |
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Term
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Definition
| 9. A measure of the deviation from the mean of each variable in a data set |
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Term
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Definition
| 10. The average of the differences (deviations) between the values in a distribution and the expected value (or mean) of that distribution |
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| 11. Coefficient of Variation |
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Definition
| 11. A distribution's standard deviation divided by its mean or expected value |
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Definition
| 12. A measure of potential dollar losses from an unlikely adverse event affecting an investment portfolio in an otherwise normal market environment. |
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| 13. Portfolio optimization |
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Definition
| 13. In the case of stocks, the arrangement of a stock portfolio so that risks are minimized and rates of return are maximized. |
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Term
| 14. Risk-Return Trade Off |
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Definition
| 14. The tendency for the potential return to increase as risk increases. |
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Definition
| 15. In the context of an investment portfolio, the process of reducing a portfolio's company-specific risk by investing in an array of financial assets. |
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Term
| 16. Correlation coefficient |
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Definition
| 16. A statistical measure, ranging from +1 to -1, indicating the degree to which two variables' movements are associated |
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Definition
| 17. A measure of the stock's volatility relative to that of the market. |
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Definition
| 18. The amount of compensaton in excess of the risk free return needed to induce an investor to accept a risk |
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Term
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Definition
| 19. The collection of securities portfolio combinations that generate the hightest expected return for a given level of risk or that have the lowest risk for a given expected return |
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Term
| 20. Capital Asset Pricing Model (CAPM) |
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Definition
| 20. A method of pricing securities based on the relationship between risk and return. |
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Term
| 21. Security market Line (SML) |
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Definition
| 21. The relationship between expected return and beta |
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Term
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Definition
| 22. The process of precisely matching the maturity value of an investmetn with the amount of expected loss payment |
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Definition
| 23. The uncertainty about the rate at which periodic interest paymetns can be reinvested over the life of an investment |
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Term
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Definition
| 24. In the context of bonds, a measure of the number of years required to recover the true cost of a bond, considering the present value of all coupon and principal payments to be received in the future. |
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Term
| 25. Portfolio immunization |
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Definition
| 25. The process of matching investment and liability duration |
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Term
| 1 Id the factors an insurer uses in developing investment portfolio strategies. |
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Definition
1. An insurer uses the following factors an insurer uses in developing investment portfolio strategies:
(a) historical info: Gives investors an idea of the risks and returns thatcertain investments might generate
(b) Financial and risk metrics: Measure the likelihood of not achieving the expected avg rate of return, including variance, standard deviation, coefficient of variation, value at risk, and beta
(c) Various investment and portfolio theories: Considers modern portfolio theory, risk return, trade off, investment diversification, beta and risk premium, equity portfolio risk, capital asset pricing model, investment strategy, and matching investment and liability duration of hond and underwriting portfolios |
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Term
| 2. Describe two ways in which an investor can earn an annual return on an investment in stocks or bonds. |
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Definition
2. The annual return an investor can earn on an investment in stocks or bonds comes from two sources:
(1) periodic pmts in the form of stock dividends or bond interest
(2) a gain or loss based on the change in the value of the investment from the beginning of the year to the end of the year. |
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Term
3. Describe the follwing measures of return for stocks and how each is calculated:
(a) Dividend Yield
(b) Percentage Gain
(c) Percentage total return. |
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Definition
3. The following are measures of return for stocks:
(a) Dividend Yield: The amt of dividends received per share of stock owned, expressed as a percentrage of the value of the investment at the beginning of the period. Calculated as follows:
dividend / share price
(b) Percentage Gain: The capital gain or loss based on the change in the value of the investmetn from the beginning of the period. Calculated as follows: Capital gain/share price at the beginning of the year.
(c) Percentage total return: The total of the dividend received and the capital gain for the period, expressed as a percentage of the value of the investment at the beginning of the period. Calculated as follows:
(capital gain + dividend) / share price at the beginning of the year |
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Term
| 4. Explain why the effect of inflation should be considered when evaluating the return on an investment |
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Definition
| 4. The effect of inflation should be considered when evaluating the return on investment to determine the purchasing power of the return |
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Term
| 5. Describe how an investor might use a market index. |
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Definition
5. An investor might use a market index for the following reasons:
(1) to measure the return on the particular mkt or sector represented by the index
(2) To serve as a benchmark against which portfolio, financial, or economic performance is measured
(3) To reflect the returns for a given mkt or industry |
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Term
| 6. Id the indexes commonly used for bonds. |
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Definition
6. The following indexes are commonly used for bonds:
(1) Lehman Brothers Aggregate Bond Index: Consists of price appreciatino or depreciation plus income, expressed as a percentage of the original investment
(2) Ten Year U.S. Treasury Bond: Backed by the U.S. Govt; often considered the standard for long-term bond investments |
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Term
7. Describe the following stock market indexes:
(a) Dow Jones Industrial Avg (DIJA)
(b) S&P 500
(c) Nasdaqq Composite Index
(d) Russell 2000 Index
(e) Morgan Stanley Capital Int'l Incs MSCI EAFE Index |
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Definition
7. The following are widely used stock market indexes:
(a) Dow Jones Industrial Average (DIJA): Consists of the stocks of thirty large U.S. Companies
(b) S&P 500 Index: A mkt weighted index that tracks 500 co's in leading industries
(c) Nasdaq Composite Index: Measures all common stocks, domestic and international, listed on the Nat'l Association of Securities Dealers Automated Quotation System (Nasdaq) stock market
(d) Russell 2000 Index: Measures the overall performance of the small to mid-size market capitalization stocks
(e) Morgan Stanley Capital Int'l, Incs. MSCI EAFE Index: Free-float adjusted mkt capitalization index designed to measure developed mkt equity performance, excluding that of the U.S. and Canada. |
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Term
8. Describe how the following measures of past rates of return can be used to set expected returns:
(a) Arithmetic average of past returns
(b) Geometric average total rate of return. |
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Definition
8. The following measures of past rates of return can be used to set expected returns, as shown below:
(a) The arithmetic avg of past returns is calculated as follows:
Sum of annual returns / Number of years.
(b) The geometric avg total rate of return measures the compound annual avg rate at which the asset's value has grown during the period under observation. It is calculated as follows: [(1 + Return 1) x (1 + Return 2) x ... x (1 + Return n)] x (1/n) - 1.0 |
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Term
| 9. Describe the circumstances in wich the geometric avg return of a prodcuct would be the appropriate method of caclulating the expected return |
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Definition
| 9. The geometric avg return of a product would be the appropriate method of calcuating expected return if several differing rates of return (such as interest rates) contribute to a products return. |
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Term
| 10. Explain why it is important to use indicators in addition to hsitorical mkt returns to assess the effect of certain risks on an investment security. |
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Definition
| 10. It is important to use indicators in addition to historical mkt returns to assess the effect of certain risks on an investment security because historical mkt returns do not show the types of risk that are involved. Investors need to understand which risks commonly affect the securities in which they are considering investing and how those risks can affect returns. |
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Term
| 11. Describe the common investment-related risks. |
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Definition
11. The following are common investment-related risks:
(a) risks that are common to the overall mkt or a specific market segment.
(b) Risk that a debtor will not repay the amt owed, which is called credit risk.
(c) Uncertainty about the future value of an investment because of changes in the general level of interest rates, which is called interest rate risk.
(d) The risk that an asset cannon be sold on short notice without incurring a loss, which is called liquidity risk. |
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Term
| 12. Explain the effectiveness of diversification regarding market risk and company-specific risk. |
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Definition
| 12. Diversification is not an effective way to eliminate mkt risk because the prices of individual securities tend to follow broad mkt swings, independent of an individual co's performance. Company specific risk affects a specific co or small group of co's so diversification is an effective way to eliminate this type of risk. |
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Term
13. Describe how the following risk metrics are used to measure the likelihood of not achieving the expected avg rate of return on an investment:
(a) Variance
(b) Standard Deviation
(c) Coefficient of variation
(d) Value at Risk
(e) Beta |
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Definition
13. The following risk metrics are used to measure the likelihood of not achieving the expected avg rate of return on an investment:
(a) Variance: Used to quantify investment risk by measuring the deviation of the values of an investment from the avg of the investment's values during a specific period. The larger the variance, the more often the actual returns will differ from the avg returns and the wider those differences may be. The varianc eis calculated by dividing the sum of the squared deviations by the number of elements included in the data set less one:
sum of squared deviations / (n-1)
(b) Standard Deviation: Measure of the variability between each value in a data set and the data set's mean. The larger the standard deviation, the more volatile the returns of the stock. The standard deviation is the square rood of the variance.
(c) Coefficient of variation: Facilitates the comparison of two data sets with substantially different means. The variation of actual values can be compared with teh variation of expected values. The coefficient of variation is calculated by dividing the standard deviation by the mean or expected value:
Standard deviation / mean or expected value
(d) Value at Risk: Measure of potential dollar losses from an unlikely adverse event affecting an investment portfolio in an otherwise normal mkt environment. It is expressed as a dollar amt.
(e) Beta: Measures the movement of an indivudual stock's return in relation to the mkt. |
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Term
| 14. Id one drawback of using the standard deviation as a measure of risk |
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Definition
| 14. One drawback of the standard deviation as a masure of risk is that the larger the actual values in a data set, the larger its standard deviation will typically be. COmparing the standard deviation of two or more data sets in which elements are of different magnituded can be misleading. |
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Term
| 15. Id situations in which the coefficient of variation is not useful as a measure of risk. |
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Definition
| 15. The coefficient of variation is not useful as a measure of risk when the mean approaches zero or is zero |
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Term
| 16. Describe methods that may be used to estimate the value at risk for any given small probability of loss |
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Definition
16. The following are methods that may be used to estimate the value at risk for any given small probability of loss:
(1) parametric statistical methods: mathematical procedures that assume that the occurrence of the vaiables being assessed belongs to a known probability distribution
(2) Simulation techniques: Models that create an artifical environment designed to mirror the actual environment. |
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Term
| 17. Id the considerations included in a comprehensive investment portfolio mgmt program |
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Definition
17. The following considerations are included in a comprehensive investment portfolio mgmt program:
(a) modern risk portfolio theory
(b) Risk return trade off
(c) investment diversification
(d) beta and risk premium
(e) equity portfolio risk
(f) capital asset pricing model
(g) investment strategy
(h) matching investment and liability duration |
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Term
| 18. Describe the four steps in the decision process associated with the modern portfolio theory |
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Definition
18. The following four steps are part of the decision process associated with the modern portfolio theory:
(1) security valuation: Assess securities in terms of expected return and expected risk to compare the relative attractiveness of the investments.
(2) Asset allocation: Determine the proportion of assets to be allocated to each security category
(3) Portfolio optimization: arrange a stock portfolio so that risks are minimized and rates of return are maximized.
(4) Performance Measurement: Monitor the earnings, dividends, and price of the stock over time . |
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Term
| 19. Id the economic and financial theory assumption concerning risk that is made about investors and mgrs who are choosing investments. |
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Definition
| 19. The economic and financial theory assumption concerning risk is that investors and mgrs are risk averse and will generally choose investments with the least risk. |
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Term
| 20. Describe the significance of a correlation coefficient between two variables of +1, -1, and zero |
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Definition
20. Correlation coefficients ahve the following significance between two variables:
(1) Correlation coefficient of +1: Perfectly positively correlated, and price changes always move in the same direction.
(2) Correlation coefficient of -1: Perfectly negatively correlated, and price changes always move in the opposite direction
(3) Correlation coefficient of zero: Uncorrelated, and price movements are totally unrelated. |
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Term
| 21. Id the advantages of using the beta as a measure of risk when assessing the volatility of a stock. |
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Definition
21. Advantages of using the beta as a measure of risk when assessing stock volatility include:
(1) Interpreting its value is reasonably straightforward
(2) The beta can also be used asn an indication of the volatility of an entire portfolio |
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Term
| 22. Describe the indications of beta values regarding stock volatility |
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Definition
22. Beta values indicate the following:
(1) Beta of 1: The stock has the same risk as the mkt as a whole; indicates avg risk
(2) Beta greater than 1: The stock has greater price volatility thatn the overall mkt and can be considered riskier.
(3) Beta less than 1: The stock has less price volatility thatn the overall mkt and could be considered less risky |
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Term
| 23. Explain why a co strives to develop the efficient frontier regarding investment portfolios. |
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Definition
| 23. A co strives to develop the efficient frontier regarding investment portfolios so the portfolio combinations best best meet its needs. Typically, investors combine securities to generate the highest expected return for a given level of risk or choose securities that have the lowest risk for a given expected return. |
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Term
| 24. Describe the three elements used in the capital asset pricing model (CAPM) |
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Definition
24. The following threee elements are used in the capital asset pricing model (CAPM):
(1) Risk Free Returns: The reutrn on a risk free investment establishes a baseline against which teh returns of all other securities can be compared.
(2) Market risk premiums: The difference between the expected return on the market portfolio (rm) and the risk free rate of return (rf) |
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Term
| 25. Explain why integrating invesment strategy with other functional areas of the co is important for insurers. |
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Definition
| 25. Integrating investment strategy with other functionaal areas of the co is important for insurers because invested assets are a primary source of funds available to pay losses. The investment strategy and portfolio mgmt must recognize the relationship between the investment portfolio and the co's underwriting decisions. |
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Term
| 26. Id the most important objective of bond portfolio mgmt |
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Definition
| 26. The most important objective of bond portfolio mgmt is to structure the portfolio so that the amt and timing of the investment cash flows correspond to the firm's expected cash flows. |
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Term
| 27. Id additional sources of risk to which an investor is exposed when investing in bonds. |
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Definition
27. An investor is exposed to the following additional sources of risk when investing in bonds:
(1) credit risk: uncertainty about an issuers ability to make the required principal and interest pmts as they come due.
(2) Interest rate risk: Uncertainty about an assets value associated with changes in market determined interest rates. |
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Term
| 28. List two important characteristics of bond duration. |
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Definition
28. two important characteristics of bond duration are:
(1) The duration of a zero coupon bond is always equal to its time to maturity.
(2) The duration of a bond that pays interest over its life will always be less than its time to maturity |
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