Ch 13 Flashcards
Unsystematic risk
a risk that affects at most a small number of assets. also called unique or asset specific risks or diversifiable risk
Example: oil strike
Systematic risk
A risk that influences a large number of assets. also called market risk or nondiversifiable risk
Example: interest rates and inflation Rates
Systematic risk principle
Principle stating that the expected return on a risky assets depends only on that asset’s systematic risk
Reward for bearing risk depends on systematic risk
No reward for bearing unsystematic risk because it can be eliminated by diversification
Beta coefficient
Amount of systematic risk present in a particular asset relative to an average asset
The larger the beta, the higher the systematic risk
The beta is a measure of systematic risk and is equal to the slope of the line of best fit (regression analysis) called the characteristic line
To find beta: slope of return of a stock and total market return
Security market line (SML)
Positively sloped straight line displaying the relationship between expected return and beta
It tells us the reward offered for bearing risk
slope: E(Rm) - Rf also called market risk premium
Capital Asset Pricing Model (CAPM)
CAPM shows the expected return for an asset depends on:
1) The pure time value of money
2) The reward for bearing systematic risk
3) The amount of systematic risk
COVariance
Measures the strength of correlation (the degree to which 2 variables move together)
If positive, moves in the same direction
If negative, opposite direction
Correlation coefficient
A positive covariance results in a positive correlation coefficient and a negative covariance results in a negative correlation coefficient
Efficient set
The set of all pairs from the opportunity set that have the highest expect a return for any given level of risk
Positive slope (like supply curve)
Arbitrage Pricing Theory
The unexpected return is related to several factors such as inflation, GNP, And interest rates
Can handle multiple factors that CAPM ignores
