Chapter 2: Measuring Returns & Risk Flashcards
Holding Period Return (HPR)
(definition and equation)
The basic measure of overall profitability. It relates the profit on an investment directly to its beginning value.
HPR = (Income received + Change in value) / Beginning Value
Holding Period Return Relative (HPRR)
(definition and equation)
The sum of the income received from an investments and the ending market value divided by the geginning value (or cost) of the investments.
HPRR = (Income received + Ending value) / Beginning value
or
HPRR = HPR + 1
Ex Post
“After the fact” historical data. Most common data for calculations.
Ex Ante
“Before the fact” data for calculating expected returns.
Expected HPR
A calculation of HPR using ex ante (expected) data.
Per-Period Return (PPR)
The sum of a period’s income and change in value divided by its beginning-of-period makret value.
PPR = (Period’s income + Period’s change in value) / Beginning of period value
Compounding
This describes how return for each period is added to the principal so that subsequent income is paid on both principal and accumulated income.
Geometric Mean Return
The approach to computing the annualized rate of return when an inestment is held for multiple time periods. Probably the best measure for calculating returns over time.
What are 3 concepts to remember regarding the relationship between GMR and arithmetic mean returns?
- Only when all PPR’s are identical will GMR and AMR be equal.
- If PPR’s are not identical, then GMR will always be less than AMR.
- Difference increases as varibility among PPR’s increases.
Pure Risk
Risk which only has only the chance for loss or no loss. There is no chance for profit.
Speculative Risk
The variability in an investment’s rate of return. The greater the potential variation in the return, the great the speculative risk of the investment.
Market Risk
Any risk from any events that affect all investments. Also called systematic risk.
Inlation risk and interest rate risk are components of market risk. Market risk can also derive from political, economic, demographic .or social events and trends.
Inflation Risk
Purchasing power risk. The variation in real returns caused by changes in the general level of prices.
Interest Rate Risk
Refers to the degree to which an investment is affected by change in interest rates. It has two components: price risk and reinvestment risk.
Price Risk
Refers to the fact that any change in market interest rates typically leads to an opposite change in vlaue of investments–when interest rates rise (fall), the value of an invesment declines (increases). This inverse relationship is most pronounced for financial instruments that have a contractually specified rate of return and a long maturity, such as bonds.
Reinvestment Rate Risk
The risk related to what the interest rate will be when income and/or principal from investments is reinvested.
Business Risk
Risk that comes from events that affet a single firm or small number of closely related firms. Also called systematic risk or nonmarket or diversifiable risk.
Default Risk
The risk that contractual payments on debt securities will not be honored.
Liquidity Risk
The risk associated with the ability to quickly convert an asset to cash with little or no price concession.
(All liquid assets are marketable, but not all marketable assets are liquid.)
Political Risk
Risk which includes the effects of trade disputes, wars, political unrest, tariffs, corruption, and expropriation.
Sovereign Risk
The risk of a government defaulting on its debt obligations.
Exhange Rate Risk
Movements in currency exchange rates can be a significant source of risk. Also called currency risk.
Tax Risk
The extent to which an investment is exposed to changes in tax laws.
Investment Manager Risk
Risk that can be characterized as the potential failure of the asset manager to select good investments, effectively anticipate and act on market movements, and/or otherwise execute an investment stategy.
