Exam 2 - Chapter 6 [Book] Flashcards
market risk, systematic risk, nondiversifiable risk
Risk factors common to the whole economy.
unique risk, firm-specific risk, nonsystematic risk, diversifiable risk
Risk that can be eliminated by diversification.
investment opportunity set
Set of available portfolio risk-return combinations.
optimal risky portfolio
The best combination of risky assets to be mixed with safe assets when forming the complete portfolio.
efficient frontier
Graph representing a set of portfolios that maximizes expected return at each level of portfolio volatility.
separation property
The property that implies 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.
index model
Model that relates stock returns to returns on both a broad market index and firm-specific factors.
excess return
Rate of return in excess of the risk-free rate.
alpha
Rate of return in excess of the risk-free rate.
beta
The sensitivity of a security’s return to the return on the market index.
systemic risk
The portion of risk common to the entire economy, also known as market risk or nondiversifiable risk.
firm-specific or residual risk
Component of return variance that is independent of the market factor.
security characteristic line (SCL)
Plot of a security’s predicted excess return given the excess return of the market.
information ratio
Ratio of alpha to the standard deviation of the residual.
active portfolio
The portfolio formed by optimally combining analyzed stocks.
