Investments Ch 5-8 Flashcards
Nominal Interest Rate
The interest rate in terms of nominal (not adjusted for purchasing power) dollars.
Real Interest Rate
The growth rate of purchasing power; the excess of the interest rate over the inflation rate.
Effective Annual Rate (EAR)
Interest rate annualized using compound rather than simple interest.
Annual Percentage Rate (APR)
Interest rate is annualized using simple rather than compound interest.
Dividend Yield
The rate of return provided by a stock’s dividend payments.
Risk-Free Rate
The interest rate that can be earned with certainty by leaving money in risk-free assets such as T-bills, money market funds, or the bank.
Risk Premium
An expected return in excess of that on risk-free securities. The premium provides compensation for the risk of an investment.
Excess Return
Rate of return in excess of the risk-free rate.
Risk-Averse
A risk-averse investor will consider risky portfolios only if they provide compensation for risk via a risk premium.
Risk-Neutral
A risk-neutral investor finds the level of risk irrelevant and considers only the expected return of risk prospects.
Risk lover
A risk lover is willing to accept lower expected return on prospects with higher amounts of risk.
Value At Risk (VaR)
Measure of downside risk. The loss that will be incurred in the event of an extreme adverse price change with some given, typically low, probability.
Kurtosis
Indicates probability of observing extreme high or low values.
Expected Shortfall (ES)
or
Conditional Tail Expectation (CTE)
The expected loss on a security conditional on returns being in the left tail of the probability distribution.
Sharpe Ratio
Reward-to-volatility ratio; ratio of portfolio excess return to standard deviation.
Sortino Ratio
Excess return divided by lower partial standard deviation.
Fair Game
An investment prospect that has a zero risk premium.
Utility
The measure of welfare or satisfaction of an investor.
Certainty Equivalent Rate
The rate that a risk-free investment would need to offer to provide the same utility score as the risky portfolio.
Mean-Variance Criterion
The selection of portfolios based on the means and variances of their returns. The choice of the higher expected return portfolio for a given level of variance or the lower variance portfolio for a given expected return.
Indifference Curve
A curve connecting all portfolios with the same utility according to their means and standard deviations.
Capital Allocation Decision
The allocation of invested funds between risk-free assets versus the risky portfolio.
Capital Allocation Line (CAL)
A graph showing all feasible risk-return combinations of a risky and risk-free asset.
Capital Market Line (CML)
A capital allocation line provided by the market-index portfolio.
Diversification
Spreading a portfolio over many investments to avoid excessive exposure to any one source of risk.
Insurance Principle
The law of averages. The average outcome for many independent trials of an experiment will approach the expected value of the experiment.
Systematic Risk,
Market Risk,
or
Nondiversifiable Risk
Risk factors common to the whole economy.
Nonsystematic risk, Unique Risk, Firm-Specific Risk, or Diversifiable Risk
Risk factors that can be eliminated by diversification.
Portfolio Opportunity Set
The expected return-standard deviation pairs of all portfolios that can be constructed from a given set of assets.
Optimal Risky Portfolio
An investor’s best combination of risky assets to be mixed with safe assets to form the complete portfolio.
Minimum-Variance Frontier
Graph of the lowest possible portfolio variance that is attainable for a given portfolio expected return.
Efficient Frontier of Risky Assets
The portion of the minimum-variance frontier that lies above the global minimum-variance portfolio.
Input List
List of parameters such as expected returns, variances, and covariances necessary to determine the optimal risky portfolio.
Separation Property
The property that 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.
Risk Sharing
Sharing the risk of a portfolio of given size among many investors.
Risk Pooling
Investing the portfolio in many risky assets.
Single-Factor Model
A model of security returns that acknowledges only one common factor. A factor-model is a way of decomposing the factors that influence a security’s rate of return into common and firm-specific influences.
Single-Index Model
A model of stock returns that decomposes influences on returns into a systematic factor, as measured by the return on a broad market index, and firm-specific factors.
Regression Equation
An equation that describes the average relationship between a dependent variable and a set of explanatory variables.
Residuals
Parts of stock returns not explained by the explanatory variables (the market-index return). They measure the impact of firm-specific events during a particular period.
Security Characteristic Line
A plot of the excess return on a security over the risk-free rate as a function of the excess return on the market.
Scatter Diagram
Plot of returns of one security versus returns of another security. Each point represents on pair of returns for a given holding period.
Information Ratio
Ratio of alpha to the standard deviation of diversifiable risk
Tracking Portfolio
A portfolio constructed to have returns with the highest possible correlation with a systematic risk factor.
