Return & Risk Flashcards
What forms does investment returns come in?
Dividend income, and capital gain on the investment
What does dividend income plus capital gains equal?
Total monetary return
What does dividend yield mean?
The percentage of income return
What does capital gains yield mean?
The change in the price of shares divided by the initial price
What does the total return (%) mean?
The sum of dividend yield and capital gains yield
What is holding period return?
The return you earn from holding an asset for a certain period
What does the holding period return show?
That the worth of the investment would have been if the money that was initially invested had been left in the stock market, and if each year the dividends from the previous year had been reinvested in more shares
How do you calculate the geometric average return?
Take each of the T annual returns Rt and add 1 to each, multiply all the numbers from step 1 together, take the result from step 2 and raise it to the power of 1/T, and finally, subtract 1 from the rest of step 3
What does arithmetic return mean?
Tells you what you earn in a typical year
What does geometric return mean?
Tells you what you actually earned per year on average, compounded annually
What is a risk premium?
The return on a risky asset less the return on the risk-free security. The higher the risk premium, the more risky the investment
What are government treasury bills used as?
The risk-free asset
What do T-bills never produce?
Negative returns, this debt is virtually free of the risk of default
How do we characterise the distribution of returns?
We use a measure of risk in returns
What is a risk of return?
The spread over a period, or dispersion of a distribution
What is the most common measures of variability of dispersion?
The variance and its square root, and the standard deviation
What are the steps to calculate the standard deviation?
Calculate the average return first, take the T individual returns and subtract the average return, square the result and add them up, then the total must be divided by the number of returns less one (T-1), and the square toor of the variance is the standard deviation
What is the expected return of a security?
The average return per period that a security has earned in the past
What is the volatility of a security’s return?
Variance and standard deviation
What is the interrelationship between two securities: covariance and correlation?
A measure of the degree to which returns on two securities move in relation to each other
How is covariance calculated?
Multiplying security A’s deviation from its expected return and security B’s deviation from its expected return, then calculate the average (expected) value
What is a positive covariance?
When one asset’s return is above average the other asset’s return tends to be above average, and also when one asset’s return is below average the other asset’s return tends to be below average
What is a negative covariance?
When one asset’s return is above average the other asset’s return tends to be below average
How is correlation calculated?
By dividing the covariance by the standard deviations of both the two securities - standardising procedure
What is the key to diversification?
Relationship between the asset returns
What is the expected return on a portfolio?
A weighted average of the expected returns on the individual securities
What does the variance of a portfolio involve?
The covariance between them in addition to their variances
What is the variance of the return on a portfolio with many securities more dependent on?
The covariances between the individual securities than on the variances of the individual securities
What does systematic risk plus unsystematic risk equal?
Total risk of individual security
What does homogeneous expectations mean?
All investors have the same information and the same ability to analyse it
What does heterogeneous expectations mean?
Investors have different information and different abilities to analyse the information
What does market portfolio mean?
In a world with homogeneous expectations, all investors would hold only one portfolio of risky assets
What does the security market line examine?
Individual asset risk premiums, and with individual assets, the only relevant risk is systematic risk, hence we examine beta
What does the capital market line examine?
Efficient portfolio risk premiums, and with well diversified portfolios, the relevant measure of risk is total risk, hence we examine standard deviation
What is linearity?
The relationship between expected return and beta correspond to a straight in SML. Securities lying above the SML are underpriced and securities lying below the SML are overpriced
What is a CAPM?
It holds for portfolios as well as individual securities
What is the beta of a portfolio?
A weighted average of the betas of individual securities
What does SML represent?
The line along which fairly priced securities are plotted
What is the degree of misprision measured by?
The alpha value of the security
What does alpha mean?
It is a risk-adjusted measure of the so-called active return on an investment. It is the difference between the fair expected return and the actual expected return
What do positive alphas indicate?
An underpriced security
What do negative alphas indicate?
An overpriced security
What is the alpha coefficient (a)?
A parameter in the capital asset pricing model
What happens if a < 0?
The investment has earned too little for its risk
What happens if a = 0?
The investment has earned a return adequate for the risk taken
What happens if a > 0?
The investment has a return in excess of the reward for the assumed risk
What is market timing ability indicated by?
The curvature of the plotted line
What does marketing timing ability involve?
Shifting funds between a market-index portfolio and a risk-free asset
