Chapter 12: CAPM Flashcards
Income derived from regular business activities
Ordinary income
When a stock is sold at an increase in price and the investor does what to that gain and a payment of tax may be due
Realized capital gain
If the stock price increases but the investor does not sell the stock, the gain is what and it is not taxed
Unrealized capital gain
An asset held for one year or more
Long term capital gain
An asset held for less than one year usually subject to taxes
Short term capital gain
The rate of return an investor expects to receive on a risky asset over a period of time
Expected return on a risky asset
E(Ri)
The expected rate of return on each risky asset in a portfolio, multiplied by its portfolio weight
Expected return on a portfolio of risky assets
The rate of return an investor expects to receive on a diversified portfolio of common stock
Expected return on the market
E(Rm)
The rate of return that an investor receives on a safe assets, one that is free from credit risk
Return on the risk-free asset
Rf
The additional return that investors expect to receive if they buy a stock of average risk as opposed to a treasury bond
Market risk premium {E(Rm)-Rf}
The chance that an investments actual return will be different than expected
Risk
Risk includes the possibility of
Losing some or all of the original investment
How is risk measured
It is usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment
Risk that affects a very small number of assets
Unsystematic risk (specific risk)
The risk inherent to the entire market or entire market segment
Systematic risk
Systematic risk is defined by
Beta
A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole
Beta (beta coefficient)
The risk inherent in the market from economic forces
Market risk (unsystematic risk)
A measure of the s dispersion of a set of data from its mean
Standard deviation of return
The more spread apart the data is does what to standard deviation
The higher the deviation
In finance, standard deviation is applied to what
The annual rate of return of an investment to measure the investment’s volatility (risk)
A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities
CAPM
The general idea behind CAPM is that investors need to be compensated in what two ways
TVM and risk
The time value of money is represented by the
Risk-free Rate in the formula and compensated the investors for placing money in any investment over a period of time
The group of assets—such as stocks, bonds and mutual funds—held by an investor
Portfolio
A portfolio including a number of securities, leads to lower risk
Well-diversified portfolio
Evaluating the performance of stocks, bonds or portfolios of securities
Performance evaluation
To properly evaluate investment performance, we must adjust for
The risk associated with the security portfolio
An investor who performs above the CAPM line. The investor outperformed the returns expected under the CAPM benchmark
Positive alpha
An investor who performs below the CAPM line. The investor underperformed the returns expected under the CAPM benchmark
Negative alpha
