Lesson #2 Quiz :Financial Markets (Financial Markets) answer 2025

Question 1

A stress test: (Select all that apply)

❌ Aims to test the behavior of historical returns and their fluctuations during all sorts of potential financial crises.
❌ Tries to incorporate all the interconnections between financial institutions.
❌ Tries to incorporate all potential economic and financial crises, such as recessions, appreciation and depreciation of currency, liquidity crisis, etc.
✅ Does not look at historical returns, and looks at all the details of the portfolios and their vulnerabilities during all sorts of potential financial crises.

Explanation:
Stress tests are forward-looking and scenario-based. They focus on portfolio structure and vulnerabilities under hypothetical extreme conditions rather than relying purely on historical returns.

Question 2

A 5% 3-month Value At Risk (VaR) of $1 million represents:

❌ A 5% decline in the value of the asset after 3 months, per each $1 million of notional.
✅ A 5% chance of the asset declining in value by $1 million during the 3-month time frame.
❌ A 5% chance of the asset increasing in value by $1 million during the 3-month time frame.
❌ The likelihood of a 5% of $1 million decline in the asset over the next 3-month.

Explanation:
VaR answers: “What is the maximum expected loss over a given time horizon at a given confidence level?”
Here, there is a 5% probability of losing $1 million or more in 3 months.

Question 3

In the Capital Asset Pricing Model (CAPM), a measure of systematic risk is captured by:

❌ The standard deviation of returns.
❌ The variance of returns.
✅ The Beta.
❌ The Alpha.

Explanation:
Beta measures how sensitive an asset is to movements in the overall market, which represents systematic (market) risk.

Question 4

Market (or systematic) risk ___________ whereas idiosyncratic risk __________.

✅ Is the risk for an asset to experience losses due to factors that affect the entire stock market
✅ Is the risk which is endemic to a specific asset and therefore not the market as a whole

❌ Other options

Explanation:
Systematic risk affects all assets (e.g., recessions), while idiosyncratic risk is asset-specific and can be diversified away.

Question 5

Why might an investor not normally invest large sums of money into Walmart or Apple stock?

❌ The stock prices are very stable, making it difficult to gain large sums of money
❌ Both companies have received extensive media coverage
❌ Their stock prices are highly volatile, and thus carry a lot of risk
✅ Their stock prices closely track the S&P 500

Explanation:
Large, mature companies like Walmart and Apple tend to track the overall market, limiting opportunities for outsized abnormal returns.

Question 6

Why is the normal distribution not a good model of some financial data?

❌ The standard deviation is too high
❌ It does not have many outliers
✅ Extreme events occur in it too often
❌ The standard deviation is too low

Explanation:
Financial returns exhibit fat tails, meaning extreme events happen more frequently than predicted by a normal distribution.

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