Concept explainers
To explain: Examples of risk-increasing and risk-reducing options techniques to scale up or reduce overall portfolio risk.
Introduction: Options are used to supervise the portfolio risk. They can boost the risk as well as diminish it. There are two categories of options one is risk increase and the second is a risk decrease option.
Answer to Problem 1PS
The optional example of a risk-increasing option is at the money option while the protective put strategy is an example of a risk-reducing option technique.
Explanation of Solution
Given Information: Here a statement is provided that options are used to raise and reduce the portfolio risk.
Risk-increasing options- This technique boots up the level of portfolio risk while investing in particular folio, for example, at the money option. In this option the value of expiration will be null, hence it equates the asset price with an exercise price. These options are very risky but profitable also.
Risk-reducing options- This option reduces the risk with protection, for example, a protective put strategy. Investors invested in this option in the long run because the strike price is either lower than the market price or higher. The risk is reduced with full security of value in a particular portfolio.
Want to see more full solutions like this?
Chapter 20 Solutions
EBK INVESTMENTS
- a)explain the concept of the delta normal method for calculating VAR when options are present in the portfolio. b)explain the basic concepts of the historical method and the Monte Carlo simulation method of calculating VARs. c)discuss the benefits and limitations of VAR. d)define credit risk (default risk). e)explain how option pricing theory can be used in valuing default risk.arrow_forwardGive a definition of a "return". Why do we need to incorporate risk into return (discount rate)?arrow_forwardAn efficient portfolio is one that: Select one: a. maximises return for a given level of risk. b. maximises risk for a given level of return. c. minimises risk for a given rate of return. d. Both A and C. are efficient portfolios.arrow_forward
- Which of the following statements is correct? A delta-neutral portfolio is protected against large changes in the underlying asset price. The delta hedging error increases as gamma decreases. To change the vega of a portfolio, we need to trade the portfolio’s underlying asset. A delta-neutral portfolio needs to be rebalanced more frequently as the gamma increases to maintain delta-neutrality. Please explain and justify your choice using your own words.arrow_forwardWhat is Sharpe ratio? Show the link between Sharpe ratio and best efficient portfolio.arrow_forwardThe optimal proportion of the risky asset in the complete portfolio is given by the equation below y*= E(Rp− Rf) A0² For each of the variables on the right side of the equation, discuss the impact of the variable's effect on y* and why the nature of the relationship makes sense intuitively. Assume the investor is risk aversearrow_forward
- Which one of the following statements is correct? Group of answer choices The lower the average return, the greater the risk premium. The greater the volatility of returns, the greater the risk premium. The lower the volatility of returns, the greater the risk premium. The risk premium is not affected by the volatility of returns. The risk premium is unrelated to the average rate of return.arrow_forwardThe following figures show the optimal portfolio choice for two investors with different levels of risk-aversion graphically. Which statement is correct? E[R] 0.3 0.25 0.2 0.15 0.1 0.05 0 0 0.05 0.1 0.15 Figure 1 0.2 0.25 0.3 0.35 o(R) 0.4 0.45 [H]Z 0.3 0.25 0.2 0.15 0.1 0.05 0 0 0.05 0.1 Figure (2) shows an investor that borrows in risk-free rate and invests in the risky asset. Figure (1) shows an investor with a conservative investment behavior. In the optimal point of both figures, the highest indifference curve is tangent to the efficient frontier. In Figure (1), more aggressive investment decision led to a higher Sharpe ratio. 0.15 Figure 2 0.2 0.25 o (R) 0.3 0.35 0.4 0.45arrow_forwardMarket's Risk premium measures Select one: a. The market return plus the risk free rate. b. The risk free rate and market portfolio rate of return c. The risk free rate plus the risk premium d. The change in the risk free rate and the market return e. The difference between return on market portfolio and risk-free ratearrow_forward
- Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning