Lecture 1 Flashcards
What is the relationship between risk and return?
Greater risks accompany greater returns.
What is total return on a stock?
Total return = dividend income + capital gain (or loss).
How is % Return calculated?
% Return = total return on a stock / initial stock price.
What does Effective Annual Return (EAR) represent?
The return on investment expressed on an ‘annualised’ basis.
What is the risk-free rate?
The rate of return on a risk less investment.
What is a risk premium?
The extra return on a risky asset over the risk-free rate.
Define normal distribution.
A symmetric bell-shaped frequency distribution described with an average and a standard deviation.
Why doesn’t normal distribution adequately describe asset returns?
Empirical asset return distributions exhibit higher kurtosis and heavier tails than the normal distribution.
What does the risk-free rate compensate for?
Compensation for deferring consumption, known as the ‘time value of money’.
How is the arithmetic average calculated?
Arithmetic average = (i1 + i2 + … + in) / n.
How is the geometric average calculated?
Geometric average: (1 + ig)n = (1 + i1)(1 + i2)…(1 + in).
When should you use the arithmetic average for forecasting returns?
For short-term analysis.
When should you use the geometric average for forecasting returns?
For long-term analysis.
What is a broker?
An intermediary who arranges transactions among investors.
Name the types of brokers.
- Online brokers
- Deep-discount brokers
- Discount brokers
- Full-service brokers
What is a cash account?
A brokerage account in which securities are paid for in full.
What is a margin account?
A brokerage account where securities can be bought and sold short on credit, subject to limits.
What is margin in a margin purchase?
The proportion of the value not borrowed.
How is margin calculated?
Margin = account equity / value of investments.
What incurs interest in a margin account?
The portion that’s borrowed incurs an interest charge.
What is the initial margin?
The minimum margin that must be supplied in a margin account.
What is a maintenance margin?
The margin that must be present at all times in a margin account.
What is a margin call?
When the broker demands more funds due to margin dropping below maintenance margin.
What is a short sale?
A sale in which the seller doesn’t own the security that is sold.
