The Investment Advisor Body of Knowledge + Test Bank

CHAPTER 7 Risk Measurements

Measuring risk effectively should include both qualitative as well as quantitative analysis. This chapter focuses on fundamental quantitative metrics used to define and measure risk.

There is wide debate over the reliability of the various measures of investment risk. While each metric provides meaningful data, the interpretation of each varies greatly among investment professionals. Investment advisors and consultants should however be familiar with each measurement, how it is calculated, how each is different from the others, and how one may interpret the results of each. Understanding these measurements and their application help form a critical foundation for analyzing uncertainty, managing risk effectively, and communicating with clients appropriately.

Perhaps the most common way to measure investment risk today is by looking at asset or portfolio volatility. The industry's preferred method for calculating this uncertainty and dispersion from the average is to measure an investment's standard deviation. This chapter demonstrates how to calculate standard deviation (and variance) mathematically and discusses how to analyze and interpret the results.

Both readings introduce the concept of distribution as it relates to measuring the returns and volatility of investments and markets. The first reading discusses tracking error variance, probability shortfall, expected shortfall, and finally lower partial moments and semivariance. The second reading ...