Chapter 3 Flashcards
What do we use to measure different levels of risk?
Standard Deviation
What is standard deviation?
A figure that tells you how tightly all the various examples are gathered around the mean for a particular set of data.
What does standard deviation measure with regards to investments?
How widely the actual return on an investment varies around its average or mean return.
The greater the standard deviation, the more varied from the average return.
A higher standard deviation means higher volatility and therefore greater risk.
What are the rules of standard deviation?
68% of outcomes will be within 1 standard deviation of the mean.
95% of outcomes will be within 2 standard deviations of the mean.
99% of outcomes will be within 3 standard deviations of the mean.
When is standard deviation an acceptable measure of risk?
If the returns are distributed normally.
What is positive correlation?
Profits and share values move in the same general direction as each other because they are influenced by the same thing.
What is negative correlation?
It is where the profits of companies move in opposite directions. Eg: companies that face seasonal changes (umbrellas and suncream)
What is no correlation?
Where the profit and shares of companies have no relationship to each other at all. Eg: shares in a Japanese company and an ice cream company
What is the efficient frontier?
It explains the relationship between the return that can be expected and the portfolios risk.
What does the capital asset pricing model do?
Measures the riskiness of a security by comparing it to the market. It uses beta as part of its measure.
How do you calculate capital asset pricing?
Expected return = risk free + beta x (market premium - risk free)
What is the efficient market hypothesis?
It should be impossible to achieve returns in excess of the market average over the longer term.
