Portfolio Management: Portfolio Risk & Return Flashcards
Capital allocation line
CAL) A graph line that describes the combinations of expected return and standard deviation of return available to an investor from combining the optimal portfolio of risky assets with the risk-free asset.
Correlation coefficient
A number between −1 and +1 that measures the consistency or tendency for two investments to act in a similar way. It is used to determine the effect on portfolio risk when two assets are combined.
Covariance
A measure of the co-movement (linear association) between two random variables.
Efficient market
A market in which asset prices reflect new information quickly and rationally.
Global minimum-variance portfolio
The portfolio on the minimum-variance frontier with the smallest variance of return.
Holding period return
The return that an investor earns during a specified holding period; a synonym for total return.
Indifference curve
A curve representing all the combinations of two goods or attributes such that the consumer is entirely indifferent among them.
Internal rate of return
(IRR) The discount rate that makes net present value equal 0; the discount rate that makes the present value of an investment’s costs (outflows) equal to the present value of the investment’s benefits (inflows).
Kurtosis
The statistical measure that indicates the combined weight of the tails of a distribution relative to the rest of the distribution.
Leverage
In the context of corporate finance, leverage refers to the use of fixed costs within a company’s cost structure. Fixed costs that are operating costs (such as depreciation or rent) create operating leverage. Fixed costs that are financial costs (such as interest expense) create financial leverage.
Liquidity
The ability to purchase or sell an asset quickly and easily at a price close to fair market value. The ability to meet short-term obligations using assets that are the most readily converted into cash.
Markowitz efficient frontier
The graph of the set of portfolios offering the maximum expected return for their level of risk (standard deviation of return).
Minimum-variance portfolio
The portfolio with the minimum variance for each given level of expected return.
Money-weighted return
The internal rate of return on a portfolio, taking account of all cash flows.
Normal distribution
A continuous, symmetric probability distribution that is completely described by its mean and its variance.
Risk averse
The assumption that an investor will choose the least risky alternative.
Risk aversion
The degree of an investor’s inability and unwillingness to take risk.
Risk premium
An extra return expected by investors for bearing some specified risk.
Risk Tolerance
The amount of risk an investor is willing and able to bear to achieve an investment goal.
Skewness
A quantitative measure of skew (lack of symmetry); a synonym of skew.
Time-weighted rate of return
The compound rate of growth of one unit of currency invested in a portfolio during a stated measurement period; a measure of investment performance that is not sensitive to the timing and amount of withdrawals or additions to the portfolio.
Two-fund separation theorem
The theory that all investors regardless of taste, risk preferences, and initial wealth will hold a combination of two portfolios or funds: a risk-free asset and an optimal portfolio of risky assets.
Beta
A measure of the sensitivity of a given investment or portfolio to movements in the overall market.
Capital asset pricing model
(CAPM) An equation describing the expected return on any asset (or portfolio) as a linear function of its beta relative to the market portfolio.
Capital market line
(CML) The line with an intercept point equal to the risk-free rate that is tangent to the efficient frontier of risky assets; represents the efficient frontier when a risk-free asset is available for investment.
Homogeneity of expectations
The assumption that all investors have the same economic expectations and thus have the same expectations of prices, cash flows, and other investment characteristics
m2
A measure of what a portfolio would have returned if it had taken on the same total risk as the market index.
M2 Alpha
Difference between the risk-adjusted performance of the portfolio and the performance of the benchmark.
Market model
A regression equation that specifies a linear relationship between the return on a security (or portfolio) and the return on a broad market index.
Multi-factor model
A model that explains a variable in terms of the values of a set of factors.
Nonsystematic risk
Unique risk that is local or limited to a particular asset or industry that need not affect assets outside of that asset class.
Performance evaluation
The measurement and assessment of the outcomes of investment management decisions.
Return-generating model
A model that can provide an estimate of the expected return of a security given certain parameters and estimates of the values of the independent variables in the model.
Security characteristic line
A plot of the excess return of a security on the excess return of the market.
Security market line
(SML) The graph of the capital asset pricing model.
Sharpe ratio
The average return in excess of the risk-free rate divided by the standard deviation of return; a measure of the average excess return earned per unit of standard deviation of return.
Short selling
A transaction in which borrowed securities are sold with the intention to repurchase them at a lower price at a later date and return them to the lender.
Systematic risk
Risk that affects the entire market or economy; it cannot be avoided and is inherent in the overall market. Systematic risk is also known as non-diversifiable or market risk.
Treynor ratio
A measure of risk-adjusted performance that relates a portfolio’s excess returns to the portfolio’s beta.
