Chapter 5 - Portfolio Theory Flashcards
Define Arithmetic Average
The sum of returns in each period divided by the number of periods.
Define Asset Allocation
Portfolio choice among broad investment classes.
Define Capital Allocation
The choice between risky and risk-free assets.
Define Capital Allocation Line (CAL)
Plot of risk-return combinations available by varying portfolio allocation between a risk-free asset and a risky portfolio.
Define Capital Market Line
The capital allocation line using the market index portfolio as the risky asset.
Define Complete Portfolio
The entire portfolio including risky and risk-free assets.
Define Dollar-Weighted Average Return
The internal rate of return on an investment.
Define Excess Return
Rate of return in excess of the risk-free rate.
Define Expected Return
The mean value of the distribution of HPR.
Define Geometric Average
The single per-period return that gives the same cumulative performance as the sequence of actual returns.
Define Holding-Period Return
Rate of return over a given investment period.
Define Inflation Rate
The rate at which prices are rising, measured as the rate of increase of the CPI.
Define Kurtosis
Measure of the fatness of the rails of a probability distribution relative to that of a normal distribution. Indicates likelihood of extreme outcomes.
Define Mean-Variance Analysis
Ranking portfolios by their Sharpe ratios.
Define Nominal Interest Rate
The interest rate in terms of nominal (not adjusted for purchasing power) dollars.
Define Passive Strategy
Investment policy that avoids security analysis.
Define Price of Risk
The ratio of portfolio risk premium to variance.
Define Probability Distribution of HPR
List of possible outcomes with associated probabilities.
Define Real Interest Rate
The excess of the interest rate over the inflation rate. The growth rate of purchasing power derived from an investment.
Define Risk Aversion
Reluctance to accept risk.
Define Risk-Free Rate
The rate of return that can be earned with certainty.
Define Risk Premium
An expected return in excess of that on risk-free securities.
Define Scenario Analysis of HPR
Process of devising a list of possible economic scenarios and specifying the likelihood of each one, as well as the HPR that will be realized in each case.
Define Sharpe Ratio (Reward-To-Volatility)
Ratio of portfolio risk premium to standard deviation.
Define Skew
Measure of the asymmetry of a probability distribution.
Define Standard Deviation
The square root of the variance.
Define Value At Risk (VaR)
Measure of the downside risk. The worst loss that will be suffered with a given probability, often 5%.
Define Variance
The expected value of the squared deviation from the mean.
What is the other name for geometric returns?
Time-weighted average return
Why is the effective rate of return used?
Because APR ignores compounding.
In scenario analysis, what is the ‘surprise’ return?
The difference between the actual return and the expected return.
What is the market price of risk?
The price of risk of the market index portfolio, which reflects the risk aversion of the average investor.
What three types of securities do money market mutual funds typically hold?
- Treasury bills
- Bank CDs
- Commercial Paper
