Chapter 3

Question 1

Appreciation

Answer 1

Appreciation - The change in the investment’s value from the beginning of the year to the end of the year.

Question 2

Arithmetic Mean

Answer 2

Arithmetic Mean - Calculated by summing the annual holding period returns and dividing the sum by the number of years.

Question 3

Beta

Answer 3

Beta - Commonly used to measure the volatility of a portfolio or security relative to the market.

Question 4

Coefficient of Determination (r2 or R2)

Answer 4

Coefficient of Determination (r2 or R2) - A measure of the strength of the relationship between two variables.

Question 5

Coefficient of Variation (CV)

Answer 5

Coefficient of Variation (CV) - Measures the amount of risk per unit of return. Standard deviation divided by expected return.

Question 6

Correlation Coefficient

Answer 6

Correlation Coefficient - Ranges from –1.0 to + 1.0. Maximum risk reduction occurs at perfect negative (–1.0). No risk reduction occurs at perfect positive (+1.0).

Question 7

Covariance

Answer 7

Covariance - A measure of how much two assets move together.

Question 8

Dollar-Weighted Internal Rate of Return

Answer 8

Dollar-Weighted Internal Rate of Return - Measures the effect of all of the cash flows an investor controls. The objective is to determine the combined result of the timing and dollar volume of the transactions during the period, as well as the performance of the investment security. It would also be appropriate for gauging the performance of an investment manager with full discretion over an investor’s account.

Question 9

Exchange Rate Risk

Answer 9

Exchange Rate Risk - Investments that are denominated in a foreign currency face this additional systematic risk.

Question 10

Geometric Mean

Answer 10

Geometric Mean - Calculates the average return over time assuming all earnings remain invested.

Question 11

Holding Period Return (HPR)

Answer 11

Holding Period Return (HPR) - Measures the total return over the entire period of investment. The Holding Period Return (HPR) is the ending value of the investment less the beginning value of the investment, plus or minus any cash flows, divided by the beginning value of the investment.

Question 12

Internal Rate of Return (IRR)

Answer 12

Internal Rate of Return (IRR) - The earnings rate of a series of cash inflows and outflows over a period of time assuming all earnings are reinvested.

Question 13

Kurtosis

Answer 13

Kurtosis - A measure of whether the data are heavy-tailed or light-tailed relative to a normal distribution.

Question 14

Leptokurtic

Answer 14

Leptokurtic - A distribution that is more peaked (more kurtosis) than a normal distribution.

Question 15

Liquidity

Answer 15

Liquidity - The ability to sell an investment quickly at a competitive price without any loss of principal or any price concessions.

Question 16

Marginal Income Tax Rate

Answer 16

Marginal Income Tax Rate - The tax rate percentage applied to incremental taxable income.

Question 17

Marketability

Answer 17

Marketability - The investor’s ability to easily find a market to sell his or her investment.

Question 18

Net Present Value (NPV)

Answer 18

Net Present Value (NPV) - The difference between the initial cash outflow and the discounted future cash flows.

Question 19

Platykurtic

Answer 19

Platykurtic - A distribution that is less peaked (less kurtosis) than a normal distribution.

Question 20

Portfolio Risk (Total Risk)

Answer 20

Portfolio Risk (Total Risk) - The combination of systematic and unsystematic risk, which can be reduced through diversification.

Question 21

Real Rate of Return

Answer 21

Real Rate of Return - Also called the inflation-adjusted return. Adjusts the nominal return to account for the loss of purchasing power due to inflation.

Question 22

Realized Taxable Return

Answer 22

Realized Taxable Return - The return from the investment without considering income tax

Question 23

Regression Analysis

Answer 23

Regression Analysis - A statistical method for estimating the relationship among variables.

Question 24

Reinvestment Rate Risk

Answer 24

Reinvestment Rate Risk - The risk that the investor is unable to reinvest cash flows at the IRR.

Question 25

Risk

Answer 25

Risk - The uncertainty of future outcomes or the possibility of an adverse result.

Question 26

Semivariance

Answer 26

Semivariance - Only takes into consideration volatility below the mean return.

Question 27

Skewness

Answer 27

Skewness - A measure of the lack of symmetry for a data set.

Question 28

Standard Deviation

Answer 28

Standard Deviation - A statistical measure of the variation of numbers or data around the mean of those numbers or data.

Question 29

Systematic Risks

Answer 29

Systematic Risks - Driven by macroeconomic factors that affect nearly all investments. Investors generally cannot avoid these types of risks by diversifying their portfolios.

Question 30

Time-Weighted Internal Rate of Return

Answer 30

Time-Weighted Internal Rate of Return - Measures the effect of any cash flows associated with the investment security (such as a mutual fund or stock), but ignores the dollar volume and timing of investor-driven transactions during the period. This method is more appropriate for assessing the performance of a fund manager or a security because it includes the capital appreciation and dividends earned, but it is not affected by an investor’s timing decisions.

Question 31

Total Risk (Portfolio Risk)

Answer 31

Total Risk (Portfolio Risk) - The combination of systematic and unsystematic risk and can be reduced through diversification.

Question 32

Unsystematic Risks

Answer 32

Unsystematic Risks - Affect some individual types of investments while not necessarily affecting others. Typically, the effects of unsystematic risks can be eliminated through proper diversification strategies.

Question 33

Variance

Answer 33

Variance - Calculated by squaring the standard deviation. Investments with high variances tend to be riskier than those with low variances.

Question 34

Yield

Answer 34

Yield - The amount of cash the investment generates and the amount the investor receives or reinvests in a year.

Question 35

Z-Scores

Answer 35

Z-Scores - Have a mean of 0 and a standard deviation of 1.0, which is the same as a standard normal distribution. A z-score equals the number of standard deviations that a result is from the mean. 122