Nicki Tobin, CFA candidate, has just started studying portfolio management. She notes the following similarities between the graphical representations of the fundamental and systematic views of risk. Which one of her observations is INCORRECT? For both views of risk:
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A. B. C. D.Explanation
The systematic view of risk is that the security's required risk premium is a function of its systematic, or non diversifiable risk, while the fundamental view of risk is that the security's risk premium is a function of its total risk. However, the market's risk premium is not on either axis for either view. The fundamental view plots total risk versus expected return, and the systematic view plots beta (systematic risk) versus expected return. Although both views use the concept of a risk premium over the risk-free rate, the calculation differs. The risk premiumFundamental view= total risk = business risk + financial risk + liquidity risk + exchange rate risk + country risk. The risk premiumsystematic view= Expected ReturnMarket"" Nominal ReturnRisk-Free. The equation for the stock's risk premium is:
[Expected ReturnMarket"" Nominal ReturnRisk-Free] * Beta.