Explanation:
D is correct. Out-of-the-money put options provide hedges against volatility risk, since a significant increase in volatility typically corresponds with a decline in the financial markets, therefore increasing the value of out-of-the-money put options.
A is incorrect. Investors in assets exposed to losses during adverse financial market conditions (bad times) are compensated by high risk premiums during stronger market conditions. Conversely, assets that perform well during adverse market conditions have low risk premiums as investors are willing to accept lower returns during normal conditions to obtain the valuable diversification benefits these assets provide during adverse conditions.
B is incorrect. Different investors have different optimal exposures to different sets of risk factors, even if they are invested in the same set of assets.
C is incorrect. Not all assets perform poorly during periods of low or negative economic growth. For example, investment-grade government bonds tend to do well during these conditions.
Ultimate access to all questions.
A
Investors in an asset that is likely to have a high payoff during adverse market conditions usually earn high risk premiums on that asset.
B
Investors who invest in the same assets are exposed to the same set of risk factors and have the same level of optimal exposure.
C
Investors are affected negatively when there is an unexpected decline in economic growth, regardless of the type of their investments.
D
Investors in an asset with a large exposure to volatility risk can hedge against this risk by purchasing out-of-the-money put options.
No comments yet.