Investment Planning: Risk and Return Flashcards by Riley Giauque

Measures the total return over the entire period of the investment?

Holding Period Return

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Calculated by summing the annual holding period returns and dividing the sum by the number of years.

Arithemetic Mean (Simple Average Return)

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Calculates the average return over time assuming all earnings remain invested. Calculates the compound annual return.

Geometric Mean

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When does the arithmetic average become less and less accurate?

With increased volatility

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The earnings rate of a series of cash inflows and outflows over a period of time assuming all earnings are reinvested.

Internal Rate of Return

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What is NPV (Net Present Value)?

NPV is the difference between the

initial cash outflow
and the discounted future cashflows

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Geometric mean is actually another way of calculating the ______ ?

IRR (Internal Rate of Return)

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What is the geometric mean often used to determine vs the IRR formula?

Geometric mean (used to determine):

Annualized compound return from a set of INVESTMENT RETURNS

IRR (used to determine):

Annualized compound return from a set of CASHFLOWS

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Measures the effect of all cashflows that an investor controls.

Dollar Weighted IRR

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Measures the effect of any cashflows associated with the investment security, but ignores the dollar volume and timing of investor driven transactions during the period.

Time Weighted IRR

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Which geometric mean calculation is more appropriate for assessing the performance of a fund manager?

Time Weighted IRR

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How does one calculate the effective annual rate or EAR?

EAR = (1 + i/n)^n - 1

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Method of determining the yield of a bond sold at a discount based on the current price and remaining days to maturity.

BEY (Bond Equivalent Yield)

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What is the formula to calculate the Bond Equivalent Yield?

((Par value - Price )/ (Price)) X (365/Days to Maturity)

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How does one calculate the Weighted-Average Return?

Total Dollar Return / Total Market Value Invested

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How to calculate the tax amount that makes each of the return rates indifferent?

Return Option #1 X (1 - Tax Rate) = Return Option #2

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What is the formula for calculating the Real Rate of Return?

[(1 + Nominal ROR / 1 + Inflation) - 1]

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List the 5 biggest systematic risks:

1) Purchasing Power Risk
2) Reinvestment Rate Risk
3) Interest Rate Risk
4) Market Risk
5) Exchange Rate Risk

PRIME

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List the 7 biggest unsystematic risks:

Accounting Risk
Business Risk 
Country (Political Risk)
Default (Credit Risk)
Executive Risk
Financial Risk
Government Risk

A, B, C, D, E, F

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What is the best way to eliminate unsystematic risk?

Diversification

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How is total risk best measured?

Standard deviation

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The variability in stock returns due to changes in economic factors and the tendency for changes in the market to influence prices of equities.

Market Risk

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The variability in asset prices due to changes in interest rates or yields.

Interest Rate Risk

Why do equity prices typically drop when interest rates rise?

1) Increased borrowing costs
2) Attractiveness to Alternative Investments
3) Valuation of Securities

A rate of return that is used in a business valuation to convert a series of future anticipated cash flow from a company to present value under the discounted cash flow approach

Discount Rate

The variability in asset values due to changes in inflation defines _____________ .

Purchasing Power Risk (Inflation Risk)

The uncertainty of returns in foreign investments due to changes in the value of a foreign currency relative to the valuation of the investors domestic currency.

Exchange Rate Risk

The risk that the investor is unable to invest cashflows at the IRR?

Reinvestment Rate Risk

What are also referred to as unique or firm specific risks?

Unsystematic Risk

Why is Beta not generally recommended as an appropriate measure of investment risk?

It measures the variation only related to systematic risk (it does not include company specific risk)

The risk that financial statements do not accurately reflect the firms financial results.

Accounting Risk

Risk in nature of assets and industry in which company operates

Business Risk

Risk associated with the liability side of a balance sheet and relates to the debt ratio or overall leverage that a company maintains.

Financial Risk

Risk of companies inability to meet current debt and interest obligations causing creditors to foreclose on any pledged assets.

Default (Credit) Risk

Describes how much returns vary in relation to average return for a period of time?

Standard Deviation

How is standard deviation calculated?

1) Summing the squared differences between each outcome and the mean 2) Dividing the sum of the squared differences by the number of outcomes (minus 1 for historical returns) 3) Taking the square root of the division

How is variance calculated?

Standard Deviation Squared

Measure of the lack of symmetry for a data set.

Skewness

Measure of whether data are heavy tailed or light tailed relative to a normal distribution.

Kurtosis

A distribution that is more peaked with more kurtosis than normal.

Leptokurtic

A distribution that is less peaked with less kurtosis is _____________ .

Platykurtic

Statistical method for measuring the relationship between variables

Regression Analysis

What do positive versus negative beta mean?

Positive Beta means - moves with the market | Negative Beta means - Opposite movements in relation to the market

What does R (Correlation Coefficient) equal to 1 represent?

Perfectly Positive Relationship

Occurs on a graph when one variable/axis goes up while the other variable/axis goes down?

Negative Correlation

Measure of the strength of a relationship between two variables?

R squared (Coefficient of Determination)

A measure of how much two assets move together?

Covariance

The more positive the covariance between 2 variables, the more likely they are to _______ ______ .

Move together

How is covariance calculated?

Multiply the standard deviation of each variable X correlation between variables

Concept that only takes into consideration volatility below the mean return.

Semivariance

Measures the amount of risk per unit of return. Standard Deviation divided by average return.

CV - Coefficient of Variation

Ranges from -1 to +1. Maximum risk reduction occurs at perfect negative (-1). No risk reduction occurs at perfect positive (+1).

Correlation Coefficient

What percent of outcomes are typically within: 1 standard deviation: 2 standard deviations: 3 standard deviations:

1 standard deviation: 68% 2 standard deviations: 95% 3 standard deviations: 99%

If comparing multiple bonds with equal terms the bond with the _________ coupon will have the longest duration.

Lowest Coupon

How do you calculate the geometric mean?

Variables times each other, squared root ^ to the amount of variables - 1 Calculator = N1 X N2 X N3 OSy^x 3 OS1/x = (Answer - 1)*100