Ch 11 Flashcards
Risk premium equation?
Risk premium = expected return - risk free rate
Risk premium = E(Ri) - Rf
Expected return
Return on risky asset expected in future
Calculating variance and standard deviation squared?
variance = (Standard deviation)^2
(Standard deviation)^2=
(standard deviation)^2 X (probability) + (standard deviation)^2 X (probability) +…etc
Portfolio
Group of assets such as stocks and bonds held by
An investor
Portfolio watch
Percentage of portfolio’s total value in particular investment
Total return equation?, systematic/unsystematic components?
Total return = expected return + unexpected return
Total return =
expected return + systematic portion + unsystematic portion
Announcement
Announcement = expected part + surprise
Systemic risk AKA Market risk
Risk that influences large number of assets
Unsystematic risk AKA Unique or asset specific risk
Risk that affects at most a small number of assets
Principle of diversification
Spreading an investment across a # of assets will
Eliminate some, but not all of the risk
What is unsystematic risk eliminated by?
Diversification
Total risk equation
Total risk = systematic risk + unsystematic risk
Systematic risk principle
Expected returns on risky asset depends only on that
Asset’s systematic risk
Beta coefficient
Amount of systematic risk present in particular risky
Asset relative to that in an average risky asset
What must be true about the reward to risk ratio?
Be same for all assets in the market
Security market line (SML)
Positively sloped straight line displaying the relationship
Btw/expected return and beta
Market risk premium
Slope of SML, difference btw expected return on market
Portfolio and the risk free rate
Capital asset pricing model (CAPM)
Equation of security market line showing relationship
Btw/ expected return and beta
3 variables the capital asset pricing model (CAPM) depends on?
1 pure time value of money
2 reward for bearing systematic risk
3 amount of systematic risk
Measure for the pure time value of money? Definition of variable?
Risk free rate Rf,
reward for waiting for your money without taking any risk
Variable Reward for bearing systematic risk? Definition?
Measured by market risk premium
Reward market offers for bearing an average amount
Of systemic risk and waiting
Variable for Amount of systematic risk, definition?
Measured by beta
Amount of systemic risk present in a particular asset
Relative to average asset
Reward risk ratio, definition and equation
Ratio of asset’s risk premium to its beta
Reward risk ratio = (E(Ri) - Rf)/beta
Cost of capital
Minimum required return on a new investment
Risk aversion
The greater the risk, the greater the compensation
