Ch. 8 - Investing and Portfolio Diversification Flashcards
How to calculate expected return on a single security
weighted possibility to return
relationship between standards deviation and risk
higher standard deviation, higher risk
how to calculate the standard deviation
square root of the variance
how to calculate the variance
- difference between return and expected return
- square each difference
- multiply each squared difference by its probability
- total the weighted squared differences
Covariance meaning
a statistical measure of how much two random variables move together
correlation meaning
a statistical measure of how much two variables are related
correlation - how represented
a figure between -1 and +1
Three types of risk:
- systematic risk
- unsystematic risk
- total risk
systematic risk:
the portion of total risk that can be eliminated by combining securities
systematic risk:
the portion of total risk that cannot be eliminated by diversification of securities
Beta:
a measure of return in comparison to market returns
The market risk premium:
expected return - risk free return
Expected return calculation:
RF + ( B x RPM) where: RF = risk free rate B = Beta RPM = market risk premium
Sharpe Ratio - what it does and how it works
used to determine the risk taken in relation to the rewards expected
the higher the output, the better the return for the risk
Sharpe Ratio - calculation
(RP - RF) / SD Where: RP = Risk of portfolio RF = Risk free return SD = Standards deviation
