Module 4

Question 1

what info do financial markets provide us with?

Answer 1

the returns that are required at diff risk levels

Question 2

holding period returns formula?

Answer 2

(P1 - P0 + CF1) / P0

Question 3

what is the expected return?

Answer 3

the weighted average of possible inv returns

Question 4

what is risk?

Answer 4

the degree of uncertainty/variability in year-to-year returns on an investment

Question 5

two basic measures of risk?

Answer 5

SD

variance

Question 6

what does greater SD and var mean?

Answer 6

greater risk

Question 7

what is the SD?

Answer 7

a measure of the amount of variation/dispersion of a set of values

Question 8

low vs high SD?

Answer 8

• most numbers close to average (low)

- spread out (high)

Question 9

what does SD tell us?

Answer 9

• width of normal distribution / variation in individual values
• the probability an outcome will fall within a particular distance from the mean

Question 10

what is a portfolio?

Answer 10

a collection of assets

Question 11

what is covariance?

Answer 11

it is a measure of how returns of two shares in a portfolio move together

Question 12

what does the correlation coefficient do?

Answer 12

• measures the strength of the relationship between the returns on two shares in a portfolio
• always between -1 and 1

Question 13

positive correlation?

Answer 13

both positive

Question 14

negative correlation?

Answer 14

one neg, one pos

Question 15

what is the expected average portfolio return?

Answer 15

it is the sum of the weighted average of expected returns of each of the assets in a portfolio

Question 16

what are portfolio weights?

Answer 16

percentages of money invested in assets that are part of the portfolio

Question 17

how do we diversify?

Answer 17

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.

Question 18

what kind of risks can you divesify?

Answer 18

only risks that are unique to individual assets but not risks common to all

Question 19

diversification of systematic and unsystematic risk?

Answer 19

unsys = risk that can be diversified away
sys = cannot be

Question 20

what is systematic risk of an individual asset?

Answer 20

is a measure of the relationship between the returns on the asset and the returns on a market

Question 21

what is Beta?

Answer 21

(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)

Question 22

if B = 1?

Answer 22

market risk = systemic asset risk

Question 23

if B > 1?

Answer 23

asset has more risk

Question 24

if B = 0?

Answer 24

• asset is risk free

Question 25

why would an investor want compensation for bearing risk?

Answer 25

• inflation
• giving up the use of money for a time period
• systematic risk associated with investment

Question 26

do government securities have risk?

Answer 26

no

Question 27

what would represent compensation investors require?

Answer 27

the diff between required return on gov securities and that of a risky investment

Question 28

what does the CAPM describe?

Answer 28

the relationship between risk and expected returns

Question 29

what does the security market line show us?

Answer 29

shows the relationship between expected returns and systematic risk measured by B

Question 30

what does the security market line say about B?

Answer 30

• 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