CH 7 Flashcards
Define ‘multifactor models’.
Models of security markets which propose that returns respond t several systematic factors.
In a two-factor economy, what three values when summed is the expected rate of return on a security?
1) the risk-free rate of return
2) the security’s sensitivity to the market index (ie its market beta) times the risk premium of the index [E(rm) - rf]
3) the security’s sensitivity to interest rate risk (ie its T-bond beta) times the risk premium of the T-bond portfolio, [E(rTB) - rf].
Define ‘value stocks’.
More mature firms that derive a larger share of their market value from assets already in place, high Book to market ratio, and not from growth opportunities.
Define ‘growth firms’.
Potentially smaller firms, low- Book to market ratios, whose market value derive from anticipated growth in future cash flows, rather than assets already in place.
What does the acronym ‘SMB’ mean? And what does it show?
Small minus big
*Low cap firms versus high cap firms.
It shows the size factor.
What does the acronym ‘HML’ mean? and what does it show?
High minus low
*high versus low ratios of Book- to-market value.
It shows the ‘value-versus-growth’ factor.
What does the ‘SMB Return’ equal?
It equals the return from a long position in small stocks, financed with a short position in the large stocks.
What is ‘alpha’?
Alpha is the excess return of a security above a certain benchmark
For example a security which has an alpha of 1.5% using the SNP500 as a benchmark, has outperformed the SNP500 by 1.5%
What is ‘beta’?
Beta measures the broad market overall volatility or risk, known as systematic market risk.
Define the ’arbitrage pricing theory (APT)’.
A theory of risk-return relationship derived from no-arbitrage considerations in large capital markets.
Define ‘factor portfolio’.
A well-diversified portfolio constructed to have a beta of 1 on one factor and a beta of 0 on any other factor.
