Exam 1 Review

Question 1

Real Assets

Answer 1

Assets used to produce goods and services.

Question 2

Financial Assets

Answer 2

Claims on real assets or the income generated by them.

Question 3

Asset Allocation

Answer 3

• Portfolio choice among broad investment classes.

- Allocation of an investment portfolio across broad asset classes.

Question 4

Active Management

Answer 4

-Attempts to achieve returns higher than commensurate with risk by forecasting broad markets and/or by identifying mispriced securities.

Question 5

Passive Management

Answer 5

-Buying and holding a diversified portfolio without attempting to identify mispriced securities.

Question 6

Arithmetic Return

Answer 6

-The sum of returns in each period divided by the number of periods.

Question 7

Geometric Return

Answer 7

• The single per-period return that gives the same cumulative performance as the sequence of actual returns.

Question 8

Dollar Weighted Return

Answer 8

• The internal rate of return on an investment.

Question 9

Time Weighted Return

Answer 9

(geometric return)
• Not considering the fund flow
• Measuring manager performance

Question 10

Holding Period Return

Answer 10

• Rate of return over a given investment period.

Question 11

Scenario Analysis

Answer 11

• 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.

Question 12

Sources of Risk

Answer 12

• systematic (market risk)

- unsystematic(diversifiable risk)

Question 13

Capital Allocation Line

Answer 13

• Plot of risk-return combinations available by varying portfolio allocation between a risk-free asset and a risky

Question 14

Capital Market Line

Answer 14

• The capital allocation line using the market index portfolio as the risky asset.

Question 15

Security Market Line

Answer 15

• Graphical representation of the expected return–beta relationship of the CAPM.

Question 16

Mutual Fund Theorem

Answer 16

• States that all investors desire the same portfolio of risky assets and can be satisfied by a single mutual fund composed of that portfolio.

Question 17

CAPM Model

Answer 17

• A model that relates the required rate of return on a security to its systematic risk as measured by beta.

Question 18

Beta

Answer 18

• The sensitivity of a security’s returns to the market factor.

Question 19

Alpha

Answer 19

• A stock’s expected return beyond that induced by the market index; its expected excess return when the market’s excess return is zero.

Question 20

Multifactor Model

Answer 20

• Models of security returns that respond to several systematic factors.

Question 21

Forms of Market Efficiency (3)

Answer 21

• Weak
• Semi-strong
• Strong

Question 22

Supporting Evidences

Answer 22

50/50 winners and losers each year

• 25% chance will win 2 years in a row
• 12.5% chance will win 3 years in a row

Question 23

Size/Value Stocks

Answer 23

-Two systematic factors the security returns respond to

Question 24

Momentum

Answer 24

• The tendency of poorly performing stocks and well-performing stocks in one period to continue that abnormal performance in following periods.

Question 25

Complete Portfolio

Answer 25

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

Question 26

Variance and Standard

Answer 26

- The expected value of the squared deviation from the mean.

Question 27

Standard Deviation

Answer 27

- The square root of the variance.

Question 28

Normal Distribution

Answer 28

- meets the three standard measures of "typical" results - mean - median - mode

Question 29

Sharpe Ratio

Answer 29

- Reward-to-volatility ratio; ratio of portfolio excess return to standard deviation.

Question 30

Real Rate of Return

Answer 30

-Difference of the nominal interest rate and Inflation rate`

Question 31

Covariance

Answer 31

- Average tendency of the asset returns to vary in tandem - Probability-weighted average - Negative value indicates that two assets on average vary inversely

Question 32

Diversification

Answer 32

- a combination of assets in a portfolio to help limit the exposure to firm-specific factors

Question 33

Systematic Risk

Answer 33

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

Question 34

MV Criteria and Efficient Frontier

Answer 34

- Graph representing a set of portfolios that maximizes expected return at each level of portfolio risk.

Question 35

Correlation coefficient

Answer 35

- a mutual relationship or connection between two or more assets - seek investment options with lower correlations - =1; no diversification benefit - <1 ; benefit of diversification starts to occur - =-1 ; there is no risk arbitrage opportunity, the return varies perfectly inversely with the other - =0 ; indicates unrelated returns

Question 36

Systematic Risk

Answer 36

- impact on the whole financial system

Question 37

Unsystematic Risk

Answer 37

- unique to one firm, industry, specific area

Question 38

Weak Form Efficiency

Answer 38

- stock prices already reflect all information contained in trading history, historical prices - technical analysis

Question 39

Semi-Strong Efficiency

Answer 39

-stock prices already reflect all public information EX) Financial Statements -fundamental analysis

Question 40

Strong Form Efficiency

Answer 40

-stock prices already reflect ALL relevant information, including inside information

Question 41

What is the difference between the Capital Market Line and the Security Market Line?

Answer 41

1) The CML is used to express the risk and return relationship for diversified portfolios, only, whereas the SML can be used to show the relationship between risk and return for any asset. 2) The CML uses standard deviation as the risk measure, whereas the SML uses beta.