lecture 10 Flashcards
cost of capitl determines
whether investments are made.
what does cost of capital balance
it balances the trade-off between risk and return.
stock market indicies like S&P 500, FTSE 100 measure?
measure stock performance across the overall market.
equities meaning
diversified portfolio of stocks
bonds meaning
: 10-year government bonds.
Referred to as ‘Treasury Bonds’.
bills meaning
: Short-term (3 month)
government bonds. Referred to as
‘Treasury Bills’
rate of return equation (on common stocks)
risk free rate + risk premium
which asset would u hold for an investment in 50 years
Government bonds are chosen
because they are low-risk and suitable for long-term funding, especially when the funds must be secured over several decades
what is risk
dispersion in the possible
outcomes, ie variability of returns.
common stocks with wide range of possible returns means
This indicates high variability, meaning common stocks are associated with higher risk and potential for both significant losses and gains.
bonds have narrow distribution
The histogram for bonds shows a much narrower distribution compared to common stocks.
indicates lower volatility, implying that bonds are generally safer investments compared to stocks.
treasury builds measuring risk
distribution is extremely tight, reflects their nature as low-risk, low-return assets.
methods to measure risk
mean return, variance, standard deviation
what is mean return also knwon as
expected return
how to work out mean
sum of all probabilities * the outcomes
what is the variance
is a measure of volatility:
how to measure variance
Variance = mean of the squared deviations from the mean
what is standard deviation
a measure of volatility and is
a more commonly used measure to represent ‘risk’:
how to work out standard deviation
square root of the variance
normal distributuon in terms of the mean
indicating that most investment returns are concentrated around the mean, with decreasing frequency as you move further from the mean.
what if theres a higher standard deviation
A higher standard deviation indicates greater variability and, therefore, higher risk.
what is the most important element to analyse when measurinf risk
standard deviation
diverisifcation concept
Diversification is an investment strategy aimed at reducing overall risk by spreading investments across a range of assets.
when does diverisifcation work best
when the returns of different assets are negatively correlated (i.e., they move in opposite directions).
