Chapter 3 (Risk and Return) Flashcards
((Ending Value - Beginning Value)+/-Cash Flows) / Beginning Value
Holding Period Return
GR = [(1+R1)(1+R2)…(1+RN)]^(1/n). -1
R = Holding period returns for n
Geometric Return
This formula calculates the average return over time assuming all earnings remain invested
Geometric Mean
The geometric mean is equivalent to the (x) for a set of cash flows
IRR
What is the earnings rate of a series of cash inflows and outflows over a period of time assuming all earnings are reinvested
IRR
CF0 = (CF1/(1+IRR)^1)+(CF2/(1+IRR)^2)+…(CFN/1+IRR)^N)
Calculating Initial Cost
What uses only the returns generated by the investment, and ignores the timing of the investor’s cash flows.
Time-weighted Return
What rate takes compounding into account?
Effective Annual Rate
EAR = (1+(i/n))^n -1
Formula
What is a method of determining the yield for a bond sold at a discount based on the current price and the remaining days until maturity.
BEY (Beyond Equivalent Yield)
BEY = ((Par Value-Price)/Price))*(365/d)
d = number of days to maturity
Formula
The overall weighted average return is computed by:
1. summing the market value of the investments,
2. multiplying the percent return of each security by the individual market value to obtain the individual dollar returns, which are then added together, and
3. dividing the total dollar return by the total market value.
Overall Weighted Average Return
After-Tax Return =
Realized Taxable Return *
(1 - Marginal Income Tax Rate)
After-Tax Return
[((1+Rn)/(1+i))-1]
Rn = nominal rate of return
i = inflation
Real Rate of Return
What represents the tendency for changes in the market to influence the prices of equities.
Market Risk
The variability in asset prices due to changes in interest rates or yields
Interest Rate Risk
What is the risk that the investor is unable to reinvest cash flows at the IRR
Reinvestment Rate Risk
This measures only the variation related to the systematic risk
Beta
What is total portfolio risk is measured by
Standard Deviation
A firm is exposed to (x) when it uses debt to finance its operations.
Financial Risk
A – Accounting risk (misstatements and/or inaccuracies in accounting information)
B – Business risk (risks unique to a specific business or industry)
C – Country risk (risks unique to a specific country or region)
D – Default risk (likelihood of not repaying debt)
E – Executive risk (risk that an executive will make decisions that negatively impact a business)
F – Financial risk (the amount of leverage within the business capital structure)
Unsystematic Risks
This is an investor’s ability to easily find a market to sell an investment.
Marketability
This is the ability to quickly sell an asset at its fair market price.
Liquidity
- Compute the mean of the data set.
- Subtract the mean from each possible outcome and square the difference.
- Sum the squared differences.
- Divide the sum by the total number of observations (for population SD) or the total number of observations less 1 (for the sample SD).
- Take the square root of the result.
Standard Deviation Formula
The (x) is simply the standard deviation squared, and investments with high variances tend to be riskier than those with lower variances.
Variance
This is a measure of the lack of symmetry for a data set.
More clumps left = positively
More clumps right = negatively
Skewness
This is a measure of whether the data are heavy-tailed or light-tailed relative to a normal distribution.
High Kurtosis = Heavy tails/Outliers
Low Kurtosis = Light tails/Lack outliers
Kurtosis
Standard Dev Calc:
(Return, -> E+ key)
(Return2, ->E+ key)
…
2nd Orange 8
Standard Dev Calculator Calc
This is a measure of how much two assets move together.
Covariance
Covariance Formula:
CovAB=SigmaASigmaBrAB
CovAB= covariance between assets A & B
SigmaA= Standard Dev of Asset A
rAB=correlation between assets A & B
Covariance Formula
Measures the variation in returns that were below the average return and excludes returns that exceeded the average return
Semi-Variance
Measures risk relative to return (Higher the CV, greater the risk per unit of return)
Standard Dev/Average or Expected Return
Coefficient of Variation
