Module 4 Flashcards
what info do financial markets provide us with?
the returns that are required at diff risk levels
holding period returns formula?
(P1 - P0 + CF1) / P0
what is the expected return?
the weighted average of possible inv returns
what is risk?
the degree of uncertainty/variability in year-to-year returns on an investment
two basic measures of risk?
SD
variance
what does greater SD and var mean?
greater risk
what is the SD?
a measure of the amount of variation/dispersion of a set of values
low vs high SD?
- most numbers close to average (low)
- spread out (high)
what does SD tell us?
- width of normal distribution / variation in individual values
- the probability an outcome will fall within a particular distance from the mean
what is a portfolio?
a collection of assets
what is covariance?
it is a measure of how returns of two shares in a portfolio move together
what does the correlation coefficient do?
- measures the strength of the relationship between the returns on two shares in a portfolio
- always between -1 and 1
positive correlation?
both positive
negative correlation?
one neg, one pos
what is the expected average portfolio return?
it is the sum of the weighted average of expected returns of each of the assets in a portfolio
what are portfolio weights?
percentages of money invested in assets that are part of the portfolio
how do we diversify?
by investing in two or more assets whose returns are not perfectly pos correlated, to reduce the risk (SD) of the portfolio. SDs keep diminishing as more assets added.
what kind of risks can you divesify?
only risks that are unique to individual assets but not risks common to all
diversification of systematic and unsystematic risk?
unsys = risk that can be diversified away sys = cannot be
what is systematic risk of an individual asset?
is a measure of the relationship between the returns on the asset and the returns on a market
what is Beta?
(slope of line of best fit)
is a measure of systematic risk that is directly related to the risk of the market as a whole (reflects fluctuations)
if B = 1?
market risk = systemic asset risk
if B > 1?
asset has more risk
if B = 0?
- asset is risk free
why would an investor want compensation for bearing risk?
- inflation
- giving up the use of money for a time period
- systematic risk associated with investment
do government securities have risk?
no
what would represent compensation investors require?
the diff between required return on gov securities and that of a risky investment
what does the CAPM describe?
the relationship between risk and expected returns
what does the security market line show us?
shows the relationship between expected returns and systematic risk measured by B
what does the security market line say about B?
- if B = 0, the expected rate of return on an asset = risk free rate
- if B = 1, the expected rate of return = expected market return rate
