tailieunhanh - Lecture Money, banking, and financial markets: Chapter 5 - Stephen G. Cecchetti, Kermit L. Schoenholtz

Chapter 5 - Understanding risk. In this chapter we will: Learn to measure risk and assess whether it will increase or decrease, understand why changes in risk lead to changes in the demand for a particular financial instrument, understand why change in risk lead to corresponding changes in the price of those instruments. | Chapter Five 5- Introduction Risk cannot be avoided. Everyday decisions involve financial and economic risk. How much car insurance should I buy? Should I refinance my mortgage now or later? We must have the capacity to measure risk to calculate a fair price for transferring risk. 5- Outline In this chapter we will: Learn to measure risk and assess whether it will increase or decrease. Understand why changes in risk lead to changes in the demand for a particular financial instrument. Understand why change in risk lead to corresponding changes in the price of those instruments. 5- Defining Risk According to the dictionary, risk is “the possibility of loss or injury.” For outcomes of financial and economic decisions, we need a different definition. Risk is a measure of uncertainty about the future payoff to an investment, measured over some time horizon and relative to a benchmark. 5- Defining Risk Risk is a measure that can be quantified. The riskier the | Chapter Five 5- Introduction Risk cannot be avoided. Everyday decisions involve financial and economic risk. How much car insurance should I buy? Should I refinance my mortgage now or later? We must have the capacity to measure risk to calculate a fair price for transferring risk. 5- Outline In this chapter we will: Learn to measure risk and assess whether it will increase or decrease. Understand why changes in risk lead to changes in the demand for a particular financial instrument. Understand why change in risk lead to corresponding changes in the price of those instruments. 5- Defining Risk According to the dictionary, risk is “the possibility of loss or injury.” For outcomes of financial and economic decisions, we need a different definition. Risk is a measure of uncertainty about the future payoff to an investment, measured over some time horizon and relative to a benchmark. 5- Defining Risk Risk is a measure that can be quantified. The riskier the investment, the less desirable and the lower the price. Risk arises from uncertainty about the future. We do not know which of many possible outcomes will follow in the future. Risk has to do with the future payoff of an investment. We must imagine all the possible payoffs and the likelihood of each. 5- Defining Risk Definition of risk refers to an investment or group of investments. Investment described very broadly. Risk must be measured over some time horizon. In general, risk over shorter periods is lower. Risk must be measured relative to some benchmark - not in isolation. A good benchmark is the performance of a group of experienced investment advisors or money managers. 5- Measuring Risk We must become familiar with the mathematical concepts useful in thinking about random events. In determining expected inflation or expected return, we need to understand expected value. The investments return out of all possible values. 5- Probability theory states that .