Please answer the following two questions. (a) Explain the problem of unknown risks for financial instruments in furthering the 2007-2009 financial crisis. [10 marks] (b) Stocks offer an expected return of 20%, with a standard deviation 22%. Silver offers an expected return of 12% with a standard deviation of 30%. In light of the apparent inferiority of silver with respect to both mean return and volatility, why would anyone hold silver? [10 marks]

The problem with unkown risk is that the inestor doesnot know where it actually comes from and how much its intensity is, which was the case in the 2008 crisis.

For instance cds was one of financial instrument which caused risk to increase.

b)

Yes, Silver is inferior in both terms mean return and volatality but it still can be preferred because of many reasons:

Its covariance or correlation can be negative with other stocks which may make the stock more useful over the other stock

Even its standard deviation is high, its beta may be low which may be useful for some investors.