ACTSC 371- Final Exam Guide - Comprehensive Notes for the exam ( 32 pages long!)

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Ieb wireframe: speculation is the undertaking of a risky investment for its risk premium. The risk premium has to be large enough to compensate a risk-averse investor for the risk of the investment: a fair game is a risky prospect that has a zero risk premium. More risk-averse investors will apply greater penalties for risk. We can describe these preferences graphically using indifference curves: the desirability of a risky portfolio to a risk-averse investor may be summarized by the certainty equivalent value of the portfolio. Other methods involve diversi cation of the risky portfolio and hedging. We take up these methods in later chapters: t-bills provide a perfectly risk-free asset in nominal terms only. Money market funds hold, in addition to t-bills, short-term relatively safe obligations such as cp and cds. These entail some default risk, but again, the additional risk is small relative to most other risky assets.

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