7. Risk & Return pt 1 Flashcards
What is the required rate of return on an investment?
It depends on the risk, the greater the risk the greater the required rate of return
At a minimum what must the required rate of return be more than?
The opportunity cost
What are the two components of a return on investments?
The income component - cash flow (dividend or income)
The value component - capital gain or loss (value of the shares or value of the asset)
How do you calculate the return on an investment?
Total dollar return = dividend income + Capital gain or loss
To work out a dividend yield?
Divide the dividend by the price of the share
To work out the Capital gains yield?
Calculated as the change in the price during the year divided by the beginning price
What is nominal returns?
Return on an investment not adjusted for inflation
What is real returns?
Returns adjusted for the effects of inflation
What is the difference between nominal and real returns?
Nominal return on an investment is the percentage change in the number of dollars you have. Real return on an investment is the percentage change in how much you can buy with your dollars, the percentage change in your buying power
What is the fisher effect?
The relationship between nominal returns, real returns and inflation
What are the four types of financial investment?
Ordinary shares
Small shares
Ten-year exchange
Bank bills
What is risk premium?
The excess return required from an investment in a risky asset over a risk free investment
What has a zero risk premium?
The 10 year government bonds. As governments can always pay back debts (raise taxes). All other risk premiums are worked out from this
What is a variance (stocks)?
The average squared deviation between the actual return and the average return
What is standard deviation?
The positive square root of the variance
What is normal distribution?
A symmetric, bell-shaped frequency distribution that can be defined by its mean and standard deviation.
What are the two lessons regarding capital market history?
Risky assets, on average, earn a risk premium
The greater the potential reward, the greater the risk
What is efficient capital market?
Market in which security prices reflect available information, which means based on the available information there is no reason to believe the current price is too high or low
What is EMH?
Efficient market hypothesis. The hypothesis that actual capital markets, such as the NYSE or ASX are efficient
If the market was efficient what would be the implication?
All investments in an efficient market are zero NPV investments
What are the three forms of an efficient market?
Weak
Semi-strong
Strong
What does risk and return focus on?
inflation and returns
average returns
the variability of returns
capital market efficiency.
What is Capital Asset Pricing Model (CAPM)?
a method to evaluate risk and the expected returns.
What is the Capital Market Line? (CML)
the best deals lie along the line that is tangent to the efficient frontier. This line is referred to as the capital market line
