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FNCE317 > Ch 13- Return Risk and Security > Flashcards

Ch 13- Return Risk and Security Flashcards

1
Q

in the assignment, it is very likely that even if you choose one individual stocks, you will moer likely get higher reward if you BLEND stocks

instead of pickoing one best stock you will be better off picking a blend

A
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2
Q

what is the measure of systematic risk

A

BETA

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3
Q

What are expected returns

A

the sum of the probabilities of an outcome

ex:
if you get 100 on tails or -100 on heads
you do it like this

100(0.5)+(-100)(0.5)=0

EXPECTED VALUE IS 0

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4
Q

What does state of nature mean

A

the different outcomes that you can have!! (all must sum to 1)

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5
Q

Ri , Pi, piRi meaning, E(R)

WHAT IS THE GOAL

A

Ri = return of i
Pi = probability of i
piRi= probability of getting return (multiply)

E(R): Expected return- sum all of probability of getting returns

HIGHEST EXPECTED RETURN

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6
Q

What is the variance and standard deviation

A

measurnig the volatility of returns

YOu can use unequal prob for the entire range of possibilites

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7
Q

Formula for variance

A

Sum of all probabilitites(return-expected return))^2

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8
Q

How do you calcc expected returns and variances in your calculator

A
  1. stat, L1 , put in your probabilitis as % (30%=0.3)
  2. stat, L2, put in your returmss as % (2%=0.02)
  3. stat, calc,1- var stats, list=l2, freqlist=l1
  4. you will get sigmax (square it to get var) [DO NOT USE THE Sx IT WILL BE 0!!!!!!! we want SIGMAx because it is the population deviation
    ]
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9
Q

What is a portfolio

A

collection of assets

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10
Q

how do you measure the risk return tradeoff for a protfolio

A

EXPECTED RETURN!!! AND STANDARD DEVIATION (just like w individual assets)

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11
Q

How do you figure out the expected return of a portfolio

A
  1. Get the weighted amounts for each portfolio
  2. Multiply weight OF EACH PORTFOLIO * return IN STATE OF NATURE i and sum all of them
  3. You will get expected return of the portfolio

E(Rp) = Sum(Wi)(ri)

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12
Q

How to do portfolio variance questions that are really complicated

A
  1. Note the states of nature (and what are the probabilites associated with them)
  2. declare the stocks and their porbabilities in each state of nature
  3. declare the % invested in each stock
  4. for portfolio return

(state of naturei)(Stock1 return)+(State of naturei)(stock 2 return)

DO THIS FOR ALL STATES OF NATURE

  1. Get the weighted average of the returns (State of nature i )(portfolio return) + (State of nature ii )(Portfolio return)
  2. To get variance
    (State of nature)(Portfolio return - weighted avergage)^2

DO THIS FOR ALL STATES OF NATURE

  1. Sum all the individual variances you got together!!!
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13
Q

Alternative way to calculatee proftolio variance

A

(Weight of A)^2 x (Variance of A) + (Weight of b)^2 x (Variance of b) + (2WaWb x Corr AB)

CorrAB is the correlation coefficient

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14
Q

what does perfect correlation (1) mean

A

when we can tell where one is by looking at where the other is (THIS IS WHEN THEY MOVE IN THE SAME DIRECITON)

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15
Q

what is the goal in investing

A

getting negative correlation (of a return with no risk attached!!!)

Does not have to be a lot of return but it can just be a loop

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16
Q

What is a feasible set?

A

this is the curve that shows all possible portfolio combos (we can go from U to L in class notes)

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17
Q

What is the efficient set?

A

the portion of the feasible set that has only the portfoflios w max return for an x amount of risk OR when minimum risk is accepted for given level of return

Basically if there is a curved point (or a point on the graph that does not point the vertical line test) choose the one with either max return or min reward

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18
Q

what is the MVP

A

the portfolio with the least variance (lowest possible risk FORGET RETURNS)

19
Q

Realized returns are not always equal to expected returns

A

!!

20
Q

When we see a round cloud between realized and expected what oes it mean

A

0 correlation

21
Q

What are efficient markets the result of?

A

investors trading on unexpected portion of announcements

22
Q

In efficient markets

A

you want to be able to trade instantaneously!!!! reactions will happen really quickly

23
Q

Systematic risk

A

affect lots of assets

SYNONYM: NON-DIVERSIFIABLE RISK, MARKET RISK

EX: LIKE COVID, GDP, INFLATION, INTEREST RATES (cost of monye)

24
Q

unsystematic risk

A

affects a limited number of assets, affects a single industry

“Unique risk” or “Asset-specific risk”

25
Q

total return

A

expected return + unexpected return

or

[[[[[[[[[[[[[ expected return + systematic return + unsystematic return ]]]]]]]]]]]]]]]

EXPECTED RETURN= What we THOUGHT we were getting going in
SYSTEMATIC RETURN= unexpected return due to the market (nothing to do with the company)
UNSYSTEMATIC RETURNS= good or bad due to the company or the company or industry (door blwoing off a boeing)

26
Q

formual for unexpected return

A

systematic return + unssystematic return

27
Q

basiacally diversifiable risk is risk we can mitigate by owning shares in different companies/ indsutries

A
28
Q

As you buy more stocks you reduce the standard deviation

A

!!

29
Q

Is diversifiable risk necesary?

A

no!

30
Q

What is total risk = ?

A

systematic risk + unsystematic risk

(the dtandard deviation of returns is a measure of total risk)

31
Q

What is the systematic risk principle

A

there is a reward for systematic risk, there is no reward for bearing risk uncessarily (unsystematic risk)

32
Q

How do you measure systematic risk

A

we use the beta coefficient to measure!!

-a beta of 1 implies a asset haas the same systematic irks as the overall market
-low beta stocks still dont move around with the overall market

33
Q

Id there are two stocks C & K

if C has a higher beta and K has a higher SD what does it mean?

what has more total risk, what has more systemeaitc risk, what are we paid more for owning?

A

C does really wel when the market is doing well, but when the market is dropping it is extremely bad

K does its own thing not associated with the market, it is driven by its own up and down not linked to the market as C is

K has more total risk, C has higher systematic risk, we get paid more for owning K

34
Q

Formula for portfolio beta:

A

weighted avf of component betas (weight)(beta)+(weight2)(beta2)

35
Q

When computing the expected return on a portfolio of stocks the portfolio weights are based on the:

A

market value of shares

36
Q

if assets are above the risk reard line= buy them

A

if assets are below the risk reqrd line=sell them

37
Q

if the market is efficient, all assets should be on the green line (risk reward line)

A

these assets have the same reqard to risk ratio

38
Q

WHat is the SML

A

security maket line represents market equilibrium

39
Q

the slope of the SML is the reward to risk ratio

A

(E(Rm)-Rf)/BetaM (MARKET RISK PREMIUM)

40
Q

What defines the raltionship between risk and return

A

capital assset pricing model (CAPM)

E(Ra)= Rf + BetaA(E(Rm)-Rf)
exp return on asset= risk free rate + beta of asset(exp return on market)- Risk free rate)

41
Q

What are factors affecting expected return

A
  1. pure time value of money- measured by the risk free rate
  2. reward for bearing systematic risk
42
Q

what is another name for the time value of money

A

risk free rate

43
Q

If the risk free rate is 4.5% and the market risk premium is 8.5% what is the expecterd rm

A

13%

44
Q
A

FNCE317 (21 decks)

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