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Portfolio NEK308 > Chapter 5-7 > Flashcards

Chapter 5-7 Flashcards

1
Q

effective annual rate (EAR)

A

Interest rate annualized using compound rather than simple interest.

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2
Q

annual percentage rate (APR)

A

Interest rate is annualized using simple rather than compound interest.

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3
Q

nominal interest rate

A

The interest rate in terms of nominal (not adjusted for purchasing power) dollars.

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4
Q

real interest rate

A
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5
Q

dividend yield

A

The annual dividend payment expressed as a percent of the stock price.

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6
Q

mean return

A

Another term for expected return.

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7
Q

variance

A

A measure of the dispersion of a random vari- able. Equals the expected value of the squared deviation from the mean.

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8
Q

standard deviation

A

Square root of the variance.

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9
Q

risk-free rate

A

The interest rate that can be earned with certainty, commonly taken to be the rate on short-term Treasury bills.

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10
Q

risk premium

A

An expected return in excess of that on risk- free securities. The premium provides compensation for the
risk of an investment.

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11
Q

excess return

A

The probability-weighted average of the possible outcomes.

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12
Q

normal distribution

A

Bell-shaped probability distribution that characterizes many natural phenomena.

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13
Q

event tree

A

Depicts all possible sequences of events.

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14
Q

skew

A

Measure of the asymmetry of a probability distribution.

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15
Q

kurtosis

A

Measure of the fatness of the tails of a probability distribution. Indicates probability of observing extreme high or low values.

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16
Q

tail risk

A

Risk of extreme events in the far tail of the prob- ability distribution

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17
Q

value at risk (VaR)

A

Measure of downside risk. The loss that will be incurred in the event of an extreme adverse price change with some given, typically low, probability.

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18
Q

expected shortfall (ES)

A

The expected loss on a security conditional on returns being in the left tail of the probability distribution.

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19
Q

conditional tail expectation
(CTE)

A

Expectation of a random variable conditional on its falling below some threshold value. Often used as a measure of downside risk.

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20
Q

lower partial standard deviation (LPSD)

A

Standard deviation computed using only the portion of the return distribution below a threshold such as the risk-free rate or the sample average.

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21
Q

Sortino ratio

A

Excess return divided by lower partial standard deviation.

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22
Q

lognormal distribution

A

The probability distribution that characterizes a variable whose log has a normal (bell- shaped) distribution.

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23
Q

risk premium

A

An expected return in excess of that on risk- free securities. The premium provides compensation for the
risk of an investment.

24
Q

fair game

A

An investment prospect that has a zero risk
premium.

25
Q

risk averse

A

An investor who will consider risky portfo- lios only if they provide compensation for risk via a risk premium.

25
Q

utility

A

The measure of the welfare or satisfaction of an investor.

26
Q

certainty equivalent rate

A

The certain return providing the same utility as a risky portfolio.

27
Q

risk neutral

A

An investor who finds the level of risk irrelevant and considers only the expected return of risk prospects.

28
Q

risk lover

A

An investor who is willing to accept lower expected returns on prospects with higher amounts of risk.

29
Q

mean-variance (M-V)
criterion

A

The selection of portfolios based on the means and variances of their returns. The choice of the highest expected return portfolio for a given level of variance or the lowest variance portfolio for a given expected return.

30
Q

indifference curve

A

A curve connecting all portfolios with the
same utility according to their means and standard deviations

31
Q

complete portfolio

A

The entire portfolio, including risky and risk-free assets.

32
Q

risk-free asset

A

An asset with a certain rate of return; often taken to be short-term T-bills.

32
Q

capital allocation line (CAL)

A

A graph showing all feasible risk–return combinations of a risky and risk-free asset.

33
Q

reward-to-volatility or Sharpe
ratio

A

Ratio of excess return to portfolio standard deviation.

33
Q

passive strategy

A

A portfolio decision that avoids any direct or indirect security analysis. See passive management.

33
Q

capital market line (CML)

A

The capital allocation line that results when using the market index as the risky portfolio.

34
Q

diversification

A

Spreading a portfolio over many investments to avoid excessive exposure to any one source of risk.

35
Q

insurance principle

A

The law of averages. The average outcome for many independent trials of an experiment will approach the expected value of the experiment.

36
Q

market risk

A

Risk factors common to the whole economy; also called systematic or nondiversifiable risk.

37
Q

systematic risk

A

Risk of breakdown in the financial system, particularly due to spillover effects from one market into others.

38
Q

nondiversifiable risk

A

Risk factors common to the whole economy; also called market risk or systematic risk.

39
Q

unique risk

A

Nonmarket or firm-specific risk factors
that can be eliminated by diversification. Also called firm- specific risk, nonsystematic risk, or diversifiable risk.

40
Q

firm-specific risk

A

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also called unique risk, nonsystematic risk, or diversifiable risk.

41
Q

nonsystematic risk

A

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also called unique risk, firm-specific risk, or diversifiable risk. Systematic risk refers to risk factors common to the entire economy.

42
Q

diversifiable risk

A

Nonmarket or firm-specific risk factors that can be eliminated by diversification. Also called unique risk, firm-specific risk, or nonsystematic risk. Nondiversifi- able risk refers to systematic or market risk.

43
Q

minimum-variance
portfolio

A

The portfolio of risky assets with lowest possible variance.

44
Q

portfolio opportunity set

A

The expected return–standard deviation pairs of all portfolios that can be constructed from a given set of assets.

45
Q

optimal risky portfolio

A

An investor’s best combination of risky assets; the combination that maximizes the Sharpe ratio.

46
Q

minimum-variance frontier

A

Graph of the lowest possible portfolio standard deviation corresponding to each value of portfolio expected return.

47
Q

efficient frontier of risky assets

A

The portion of the minimum- variance frontier that lies above the global minimum-variance portfolio.

48
Q

input list

A

List of parameters such as expected returns, variances, and covariances necessary to determine the optimal risky portfolio.

49
Q

separation property

A

The property that portfolio choice can be separated into two independent tasks: (1) determination
of the optimal risky portfolio, which is a purely technical problem, and (2) the personal choice of the best mix of the risky portfolio and the risk-free asset

50
Q

risk pooling

A

Adding uncorrelated, risky investments to the portfolio

51
Q

risk sharing

A

Spreading risk across many investors so that each investor bears only a fraction of the total risk.

Portfolio NEK308 (5 decks)

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