Exam 1 Review Flashcards
Define
Real Assets
Assets used to produce goods and services.
Financial Assets
Claims on real assets or the income generated by them.
Asset Allocation
- Portfolio choice among broad investment classes.
- Allocation of an investment portfolio across broad asset classes.
Active Management
-Attempts to achieve returns higher than commensurate with risk by forecasting broad markets and/or by identifying mispriced securities.
Passive Management
-Buying and holding a diversified portfolio without attempting to identify mispriced securities.
Arithmetic Return
-The sum of returns in each period divided by the number of periods.
Geometric Return
- The single per-period return that gives the same cumulative performance as the sequence of actual returns.
Dollar Weighted Return
- The internal rate of return on an investment.
Time Weighted Return
(geometric return)
• Not considering the fund flow
• Measuring manager performance
Holding Period Return
- Rate of return over a given investment period.
Scenario Analysis
- 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.
Sources of Risk
- systematic (market risk)
- unsystematic(diversifiable risk)
Capital Allocation Line
- Plot of risk-return combinations available by varying portfolio allocation between a risk-free asset and a risky
Capital Market Line
- The capital allocation line using the market index portfolio as the risky asset.
Security Market Line
- Graphical representation of the expected return–beta relationship of the CAPM.
Mutual Fund Theorem
- States that all investors desire the same portfolio of risky assets and can be satisfied by a single mutual fund composed of that portfolio.
CAPM Model
- A model that relates the required rate of return on a security to its systematic risk as measured by beta.
Beta
- The sensitivity of a security’s returns to the market factor.
Alpha
- A stock’s expected return beyond that induced by the market index; its expected excess return when the market’s excess return is zero.
Multifactor Model
- Models of security returns that respond to several systematic factors.
Forms of Market Efficiency (3)
- Weak
- Semi-strong
- Strong
Supporting Evidences
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
Size/Value Stocks
-Two systematic factors the security returns respond to
Momentum
- The tendency of poorly performing stocks and well-performing stocks in one period to continue that abnormal performance in following periods.
Complete Portfolio
- The entire portfolio including risky and risk-free assets.
Variance and Standard
- The expected value of the squared deviation from the mean.
Standard Deviation
- The square root of the variance.
Normal Distribution
- meets the three standard measures of “typical” results
- mean
- median
- mode
Sharpe Ratio
- Reward-to-volatility ratio; ratio of portfolio excess return to standard deviation.
Real Rate of Return
-Difference of the nominal interest rate and Inflation rate`
Covariance
- Average tendency of the asset returns to vary in tandem
- Probability-weighted average
- Negative value indicates that two assets on average vary inversely
Diversification
- a combination of assets in a portfolio to help limit the exposure to firm-specific factors
Systematic Risk
- Risk of breakdown in the financial system, particularly due to spillover effects from one market into others.
MV Criteria and Efficient Frontier
- Graph representing a set of portfolios that maximizes expected return at each level of portfolio risk.
Correlation coefficient
- 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
Systematic Risk
- impact on the whole financial system
Unsystematic Risk
- unique to one firm, industry, specific area
Weak Form Efficiency
- stock prices already reflect all information contained in trading history, historical prices
- technical analysis
Semi-Strong Efficiency
-stock prices already reflect all public information
EX) Financial Statements
-fundamental analysis
Strong Form Efficiency
-stock prices already reflect ALL relevant information, including inside information
What is the difference between the Capital Market Line and the Security Market Line?
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.
