Book 3 Pages 52-100 Flashcards
uncertainty of an investment’s realized (actual) rate of return will not equal its expected or forecasted rate of return
investment risk
risk measured by standard deviation
total risk
true or false?
total risk includes both systematic risk and unsystematic risk
true
true or false?
total risk does not include diversifiable risk
false
as more securities are added to the portfolio the level of unsystematic risk ____
decreases
purchasing power risk is a ____ risk
systematic
reinvestment rate risk is a ____ risk
systematic
financial risk is a ____ risk
unsystematic
market risk is a ____ risk
systematic
business risk is a ____ risk
unsystematic
political risk is a ____ risk
unsystematic
tax risk is a ____ risk
unsystematic
interest rate risk is a ____ risk
systematic
exchange rate risk is a ___ risk
systematic
default risk is a ___ risk
unsystematic
investment manager risk is a ____ risk
unsystematic
liquidity risk is a ____ risk
unsystematic
risk that are inherited by investing in the market
systematic risks
the risk the inflation will erode the real value of an investor’s assets
purchasing power risk
the risk that proceeds available for reinvestment must be reinvested at a lower rate of return than that of the investment vehicle that generated the proceeds
reinvestment rate risk
investments with longer terms to maturity have ____ reinvestment rate risk
greater
are zero coupon bonds subject to reinvestment rate risk?
no
are non-dividend paying stocks subject to reinvestment rate risk?
no
the risk that changes in interest rates will affect the value of a security
interest rate risk
as interest rates rise the value of a bond will ___
decrease
true or false?
rising interest rates usually have a positive effect on stocks
false
the risk that a change in the relationship between the value of the dollar and the value of the foreign currency during the period of investment will negatively affect the investor’s return
exchange rate risk
calculate an investors gain in the following scenario:
John invests $1 million in ABC corp which is based in Mexico. The current exchange rate for pesos to dollars is 10 to 1. Jon sells his investment for 15 million pesos but the exchange rate has chanaged to 12 to 1.
John will get 15 million / 12 = $1,250,000 which is a $250,000 gain or 25% gain
what does PRIME stand for in regards to systematic risk?
Purchasing power risk Reinvestment rate risk interest rate risk market risk exchange rate risk
risk that is unique to a single security, business, industry, or country
unsystematic risk
risk associated with the uncertainty of operating income
business risk
the risk that a firm’s financial structure will negatively affect the value of an equity investment
financial risk
true or false?
if two firms have the same net income but one uses more debt than the other, the debt firm will have a higher return on equity
true
the risk that a borrower will be unable to service its debt obligations
default risk
true or false?
default risk is also known as credit risk
true
true or false?
obligations of the US government are considered default risk free
true
the risk that the political or economic climate of a country will negatively affect an investment
political risk
the risk associated with the skills or philosophy of an individual manager of an investment fund or account
investment manager risk
the ability to find a ready market where the investor may sell the investment
marketability
the ability to sell an investment quickly and at a competitive price, with no loss of principal and little price concession
liquidity
real estate is ____ but usually not ____
marketable ; liquid
true or false?
treasury bills are not liquid but they are marketable
false, they are both liquid and marketable
money market accounts are liquid but not ___
marketable
true or false?
cash is the most liquid and marketable asset
true
the risk that taxation of investment gains or losses will negatively affect investment return
tax risk
the sum of observations divided by the number of observations
mean
midpoint of the values after they have been ordered from smallest to largest
median
the observation that appears with the greatest frequency
mode
if the bell curve is skewed to the right (longer right tail) then this is called ______ skewness
positive
which of the three averages (mean, median or mode) is greatest when there is positive skewness?
mean
which of the three averages (mean, median, or mode) is greatest when there is negative skewness?
mode
if the bell curve is skewed to the left (longer left tail) then this is called ____ skewness
negative
measures if a distribution is more or less peaked than a normal distribution
Kurtosis
when a distribution is more peaked than a normal distribution
leptokurtic
when a distribution is less peaked than a normal distribution
playkurtic
when more distributions are cluttered around the mean
leptokurtic
true or false?
investors who want to minimize volatility in their portfolios would prefer leptokurtic distributions
true
when greater than 50% chance that an observation selected at random will fall on the left side of the mean
lognormal probability distribution
lognormal distribution is skewed to the _____
right
used to evaluate the risk associated with a given investment and assesses the impact of different variables on an investment’s returns
sensitivity analysis
what two calculations do investors perform during sensitivity analysis?
NPV and IRR
diversification and unsystematic risk have a ____ relationship
inverse (as diversification increases, unsystematic risk decreases
term used to describe how adding an additional stock to a portfolio with only five stock will have a greater impact on the level of diversification than adding an additional stock to a portfolio of 30 stocks
law of diminishing returns
measures the extent to which two variables move together
covariance
how to calculate covariance
covariance = correlation x standard deviation of A x standard deviation of B
calculate the correlation of the following assets:
covariance = 0.0096
standard deviation of A = 20%
standard deviation B = 12%
correlation = .40
measures the extent to which the returns on any two securities are related
correlation (R or p)
true or false?
correlation has a range of -1 to +1
true
what does a correlation of -1 mean?
securities move in opposite directions
what does a correlation +1 mean?
securities move in same direction
what does a correlation of 0 mean?
securities are not related
describes the percentage of variability of the dependent variable this is explained by changes in the independent variable
coefficient of determination (R squared)
how do you calculate the coefficient of determination?
just square the correlation
if the coefficient of determination = 1 then the portfolio has no _____ risk
unsytematic
a relative measure of systematic risk
beta
the beta of the market is equal to ___
1
if a security has a beta of 1.25 then the security is 25% ____ volatile than the market
more
securities with a beta greater than 1 are known as a(n) ____ asset where as securities with a beta less than 1 are known as a(n) _____ assets
aggressive ; defensive
formula for beta
covariance between investment and the market / standard deviation of the market squared
or
correlation between investment and market x standard deviation of investment / standard deviation market
John’s investment had a return of 7.5% where as the market had a 9% return. The standard deviation of the investment and the market are 12% and 10% respectively. With a correlation of .65 between the investment and the market what is the beta?
.78
a measure of risk or dispersion of outcomes around the mean or expected return
standard deviation
approximately ____% of outcomes fall within 1 standard deviation of the mean
68%
approximately ____% of outcomes fall within 2 standard deviation of the mean
95%
approximately ___% of outcomes fall within 3 standard deviation of the mean
99%
measures the number of standard deviations a data value is from the mean
z score
how to find z score?
(data point - mean) / standard deviation
if the data value is higher than the mean then the z score will be ____
postive
what does a z score of 1.46 indicate
it means the data is 1.46 standard deviations above the mean
if the data value is smaller than the mean then the z score will be___
negative
true or false?
standard deviation is a measure of total risk, systematic and unsystematic
true
how to calculate variance
standard deviation squared
calculate the standard deviation of the following portfolio:
mean return = 12% security returns: 13.5% 12% 5% -2% 7% 23% 6% 10% 45% 10% .5% 14%
standard deviation = 12.29%
true or false?
if the securities standard deviation is greater than the market standard deviation the the security is more risky than the market
true
calculate the expected rate of return for the following security:
bull market = 30% probability with return of 50%
slow growth = 45% probability with return of 10%
bear market = 25% probability with return of -15%
= (.30 x .50) + (.45 x .10) + (.25 x -.15)
= 15.75%
only considers the downside volatility of an investment
semivariance
money earned by investing a sum of money for a specific period
simple interest
how to calculate simple interest
principal x interest rate x time
calculate simple interest on the following:
Johny borrows $1,000 for 2 years at 8%
1,000 x .08 x 2 = $160 (this is the interest only)
calculate the compound interest on the following:
johny invests $1,000 for 2 years at 8%
$1,000 x 1.08 x 1.08 = $1,166.40
or use
pv = -$1,000
n = 2
i = 8
how to calculate holding period return
(ending value - beginning value +/- cash flows) / beginning value
calculate the holding period return on following:
Bob purchases 100 shares of stock at $40
two years late he sells 100 shares at $52
in addition he received a dividends of $5 over the two years
42.5%
calculate the holding period return on the following:
Jim owns an investment with the following returns over the past 5 year period: 12% -9% 3% 5% -7%
(1+12%) x (1-9%) x (1+3%) x (1+5%) x (1-7%) - 1
= 2.51%
the average compounded return or the IRR
geometric mean
calculate the geometric mean of the following:
returns:
- 2%
- 1%
- 5%
- 3%
- 8%
square root of the following:
pv = -1 fv= 1.152 x 1.091 x 1.065 x 1.183 x 1.168 n = 5 pmt = 0
13.09%
how to calculate the real rate of return
1 + nominal rate / 1 + inflation
minus 1
x 100
calculate the real rate of return of the following:
nominal return = 10%
infaltion = 4%
5.77%
if a lender advertises a 1.25% monthly rate what is the APR?
1.25% x 12 = 15%
provides the annual rate of interest of an investment or debt when compounding occurs more than once per year
effective annual rate
how to calculate effective annual rate
EAR = [1 + (i / n)] ^n - 1
calculate the EAR on the following:
Johnny carries a balance on his credit card. The nominal APR is 9.99% compounded daily
[1+ (.0999 / 365)] ^365 - 1
10.5%
the earnings rate at which the present value of a series of cash flows will equal its cost
IRR
the geometric annual rate of return measured on the basis of the current year value of the asset
time weighted return
measures the rate of return without considering an investor’s size or timing of funds
time weighted return
the compounded annual rate of return (IRR) that discounts a portfolio’s future value and cash flows to a present value
dollar weighted return
what is the preferred method for analyzing the performance of a portfolio manager?
time weighted return
how do you calculate the tax-adjusted rate of return?
rate of return x (1 - tax rate)
represents the return for a set of securities, such as a portfolio, where each return is weighted by the proportion of the security to the entire group or portfolio
weighted average return
refers to changing the mix of investment classes based on changing market conditions
tactical asset allocation
true or false?
when using a tactical asset allocation there is a greater chance to experience high transaction costs
true
true or false?
tactical asset allocation is also known as market timing
true
an investment strategy investing in both broad market indexes and higher-risk alternatives
core and satellite
a portfolio that has the highest amount of return for a given level of risk
efficient portfolio
who is said to have come up with Modern Portfolio Theory
Harry Markowitz
what does the efficient frontier highlight?
the efficient frontier shows the portfolios that provide the highest rate of return for a given risk or the portfolios with the lowest risk for a given rate of return
what is the indifference curve?
graph used to measure the risk reward trade offs an investor is willing to make
the portfolio that lies at the ____ of the indifference curve and the efficient frontier is the optimum portfolio for the investor
tangent
true or false?
Portfolios above the efficient frontier are attainable
false
the x axis of the efficient frontier measures ___
risk
the y axis of the efficient frontier measures ___
expected portfolio return
who developed the CAPM?
William Sharpe
how to calculate CAPM?
rf + beta (market return - rf) = expected rate of return
what does CAPM calculate?
expected rate of return
appears in the capital asset pricing model to depict the rates of return for efficient portfolios subject to the risk level (standard deviation) for a market portfolio and the risk-free rate of return.
capital market line
represents some portion of the portfolio is invested in the market portfolio and the remainder is invested in risk free government securities
the lending portfolio
the lending portfolio is located to the ___ of the market portfolio on the CML
left
represents in investor putting 100% of investment assets in the market portfolio and has borrowed funds at the risk free rate to invest in the market portfolio
borrowing portfolio
the borrowing portfolio is located to the _____ of the market portfolio on the CML
right
how to calculate the CML
portfolio expected return = rf + standard deviation of the portfolio x [ return of market - rf / standard deviation of market]
true or false?
the CML uses standard deviation as a risk measure
true
true or false?
the SML uses beta as a measure of risk
true
how to calculate SML
same way as CAPM
true or false?
CAPM explains the returns on stock as a result of one factor
true
attempts to explain the portfolio return in terms of multiple factors
arbitrage pricing theory
this theory suggests that investors are unable to outperform the market on a consistent basis without accepting additional risk
efficient market hypothesis
states that the current stock prices reflect all available information for a company and that the prices rapidly adjust to reflect any new information
efficient market hypothesis
true or false?
the efficient market hypothesis and technical analysis directly contradict each other
true
holds that the current stock prices have already incorporated all historical data, such as prices, trading volume, and published financial info
efficient market hypothesis weak form
holds that the current stock prices not only reflect all past historical data but also data from analyzing current financial statements, industry and economic outlooks
efficient market hypothesis semi-strong form
holds that stock prices reflect all public info and most private (insider) info
efficient market hypothesis strong form
what type of info is reflected in weak form of EMH?
technical analysis
what type of info is reflected in semi-strong form of EMH?
technical and fundamental analysis
what type of info is reflected in strong form of EMH?
technical analysis, fundamental analysis, and insider info
suggests that higher returns are attainable with portfolios consisting of securities with low P/E ratios
P/E effect
states that stocks have a tendency to decline in value during the month of December and to move up in January
January effect
states that with fewer analysts following a stock there could be stocks that are over/under valued
small firm effect
give an example of using a collar in terms of options
writing a call option in order to generate premium to pay for a put option
allows an un-diversified portfolio to be exchanged for interest in a diversified portfolio
exchange fund (not an ETF)
