Chapter 3 (Risk and Return)

Question 1

((Ending Value - Beginning Value)+/-Cash Flows) / Beginning Value

Answer 1

Holding Period Return

Question 2

GR = [(1+R1)(1+R2)…(1+RN)]^(1/n). -1

R = Holding period returns for n

Answer 2

Geometric Return

Question 3

This formula calculates the average return over time assuming all earnings remain invested

Answer 3

Geometric Mean

Question 4

The geometric mean is equivalent to the (x) for a set of cash flows

Answer 4

IRR

Question 5

What is the earnings rate of a series of cash inflows and outflows over a period of time assuming all earnings are reinvested

Answer 5

IRR

Question 6

CF0 = (CF1/(1+IRR)^1)+(CF2/(1+IRR)^2)+…(CFN/1+IRR)^N)

Answer 6

Calculating Initial Cost

Question 7

What uses only the returns generated by the investment, and ignores the timing of the investor’s cash flows.

Answer 7

Time-weighted Return

Question 8

What rate takes compounding into account?

Answer 8

Effective Annual Rate

Question 9

EAR = (1+(i/n))^n -1

Answer 9

Formula

Question 10

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.

Answer 10

BEY (Beyond Equivalent Yield)

Question 11

BEY = ((Par Value-Price)/Price))*(365/d)

d = number of days to maturity

Answer 11

Formula

Question 12

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.

Answer 12

Overall Weighted Average Return

Question 13

After-Tax Return =
Realized Taxable Return *
(1 - Marginal Income Tax Rate)

Answer 13

After-Tax Return

Question 14

[((1+Rn)/(1+i))-1]

Rn = nominal rate of return
i = inflation

Answer 14

Real Rate of Return

Question 15

What represents the tendency for changes in the market to influence the prices of equities.

Answer 15

Market Risk

Question 16

The variability in asset prices due to changes in interest rates or yields

Answer 16

Interest Rate Risk

Question 17

What is the risk that the investor is unable to reinvest cash flows at the IRR

Answer 17

Reinvestment Rate Risk

Question 18

This measures only the variation related to the systematic risk

Answer 18

Beta

Question 19

What is total portfolio risk is measured by

Answer 19

Standard Deviation

Question 20

A firm is exposed to (x) when it uses debt to finance its operations.

Answer 20

Financial Risk

Question 21

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)

Answer 21

Unsystematic Risks

Question 22

This is an investor’s ability to easily find a market to sell an investment.

Answer 22

Marketability

Question 23

This is the ability to quickly sell an asset at its fair market price.

Answer 23

Liquidity

Question 24

1. Compute the mean of the data set.
2. Subtract the mean from each possible outcome and square the difference.
3. Sum the squared differences.
4. Divide the sum by the total number of observations (for population SD) or the total number of observations less 1 (for the sample SD).
5. Take the square root of the result.

Answer 24

Standard Deviation Formula

Question 25

The (x) is simply the standard deviation squared, and investments with high variances tend to be riskier than those with lower variances.

Answer 25

Variance

Question 26

This is a measure of the lack of symmetry for a data set.

More clumps left = positively
More clumps right = negatively

Answer 26

Skewness

Question 27

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

Answer 27

Kurtosis

Question 28

Standard Dev Calc:
(Return, -> E+ key)
(Return2, ->E+ key)
…
2nd Orange 8

Answer 28

Standard Dev Calculator Calc

Question 29

This is a measure of how much two assets move together.

Answer 29

Covariance

Question 30

Covariance Formula:
CovAB=SigmaASigmaBrAB

CovAB= covariance between assets A & B
SigmaA= Standard Dev of Asset A
rAB=correlation between assets A & B

Answer 30

Covariance Formula

Question 31

Measures the variation in returns that were below the average return and excludes returns that exceeded the average return

Answer 31

Semi-Variance

Question 32

Measures risk relative to return (Higher the CV, greater the risk per unit of return)
Standard Dev/Average or Expected Return

Answer 32

Coefficient of Variation