1. Understand that risk represents the variability of possible future returns from an investment. Risk tends to increase as one looks further into the future
2.Understand that a probability distribution indicates the percentage chance of occurrence of each of the possible outcomes
a. The expected value is a measure of mean or average value of the possible outcomes, each having an associated probability of occurrence
b. The standard deviation is an important measure of the total risk or variability of possible outcomes, each having an associated probability of occurrence
c. The coefficient of variation is a useful total risk measure when comparing two investments with different expected returns
3. Understand that the required rate of return on an investment—financial asset (security) or physical asset—is equal to the risk-free rate of return plus a risk premium. The risk premium is positively related to the risk that the investor faces
a. The risk-free rate of return refers to the return available on a short-term investment with no risk of default
b. The risk premium is a function of maturity risk, default risk, seniority risk, and marketability risk
4. Understand three theories about the term structure of interest rates and their impact on the yield curve
a. According to the expectations theory, long-term interest rates are a function of expected future short-term rates
b. According to the maturity risk premium theory, required returns on long-term securities tend to be greater the longer the term to maturity
c. According to the market segmentation theory, the securities markets are segmented by maturity because various participants match the maturity structure of liabilities with the maturity structure of assets
5. Understand that portfolios are composed of two or more assets
a. The risk of a portfolio of assets depends on the risk of the individual assets in the portfolio and the correlation of returns between the pairs of assets in the portfolio
b. By combining assets that are less than perfectly positively correlated, portfolio risk can be
