The Investment Advisor Body of Knowledge + Test Bank

CHAPTER 6 Attributes of Risk

The concept of “risk” is defined in many different ways, is feared by most investors, and is often misunderstood. At a most basic level, risk can be described as the possibility of loss or that something unpleasant or bad will happen. Risk can also be described as the possibility that an expected outcome will not be achieved. Mathematically risk can be expressed as the “probability of loss” multiplied by “the expected loss,” but investors often see risk simply as the chance that they will lose money. The concept and applications of risk are actually much more involved and complex, as one will see in this chapter.

It is the presence of risk that actually provides the potential or opportunity to gain in the financial markets. In a capitalistic or free-marketplace, risk is an essential component of growth, gain, and return. Without taking risk, investors should not experience the potential to gain anything other than some form of risk-free rate in a marketplace that is properly functioning. When looking at risk in this way, investors should see the positive side of risk (i.e., taking risk provides opportunity). Thus a critical responsibility of the investment advisor or consultant is to help clients understand, assess, and manage risk effectively.

The readings found in this chapter review the more common forms of risk. The authors also look at theoretical studies in risk, particularly as they pertain to financial markets and investments. The second ...