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Finance I > Return & Risk > Flashcards

Return & Risk Flashcards

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1
Q

What forms does investment returns come in?

A

Dividend income, and capital gain on the investment

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2
Q

What does dividend income plus capital gains equal?

A

Total monetary return

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3
Q

What does dividend yield mean?

A

The percentage of income return

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4
Q

What does capital gains yield mean?

A

The change in the price of shares divided by the initial price

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5
Q

What does the total return (%) mean?

A

The sum of dividend yield and capital gains yield

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6
Q

What is holding period return?

A

The return you earn from holding an asset for a certain period

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7
Q

What does the holding period return show?

A

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

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8
Q

How do you calculate the geometric average return?

A

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

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9
Q

What does arithmetic return mean?

A

Tells you what you earn in a typical year

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10
Q

What does geometric return mean?

A

Tells you what you actually earned per year on average, compounded annually

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11
Q

What is a risk premium?

A

The return on a risky asset less the return on the risk-free security. The higher the risk premium, the more risky the investment

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12
Q

What are government treasury bills used as?

A

The risk-free asset

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13
Q

What do T-bills never produce?

A

Negative returns, this debt is virtually free of the risk of default

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14
Q

How do we characterise the distribution of returns?

A

We use a measure of risk in returns

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15
Q

What is a risk of return?

A

The spread over a period, or dispersion of a distribution

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16
Q

What is the most common measures of variability of dispersion?

A

The variance and its square root, and the standard deviation

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17
Q

What are the steps to calculate the standard deviation?

A

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

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18
Q

What is the expected return of a security?

A

The average return per period that a security has earned in the past

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19
Q

What is the volatility of a security’s return?

A

Variance and standard deviation

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20
Q

What is the interrelationship between two securities: covariance and correlation?

A

A measure of the degree to which returns on two securities move in relation to each other

21
Q

How is covariance calculated?

A

Multiplying security A’s deviation from its expected return and security B’s deviation from its expected return, then calculate the average (expected) value

22
Q

What is a positive covariance?

A

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

23
Q

What is a negative covariance?

A

When one asset’s return is above average the other asset’s return tends to be below average

24
Q

How is correlation calculated?

A

By dividing the covariance by the standard deviations of both the two securities - standardising procedure

25
Q

What is the key to diversification?

A

Relationship between the asset returns

26
Q

What is the expected return on a portfolio?

A

A weighted average of the expected returns on the individual securities

27
Q

What does the variance of a portfolio involve?

A

The covariance between them in addition to their variances

28
Q

What is the variance of the return on a portfolio with many securities more dependent on?

A

The covariances between the individual securities than on the variances of the individual securities

29
Q

What does systematic risk plus unsystematic risk equal?

A

Total risk of individual security

30
Q

What does homogeneous expectations mean?

A

All investors have the same information and the same ability to analyse it

31
Q

What does heterogeneous expectations mean?

A

Investors have different information and different abilities to analyse the information

32
Q

What does market portfolio mean?

A

In a world with homogeneous expectations, all investors would hold only one portfolio of risky assets

33
Q

What does the security market line examine?

A

Individual asset risk premiums, and with individual assets, the only relevant risk is systematic risk, hence we examine beta

34
Q

What does the capital market line examine?

A

Efficient portfolio risk premiums, and with well diversified portfolios, the relevant measure of risk is total risk, hence we examine standard deviation

35
Q

What is linearity?

A

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

36
Q

What is a CAPM?

A

It holds for portfolios as well as individual securities

37
Q

What is the beta of a portfolio?

A

A weighted average of the betas of individual securities

38
Q

What does SML represent?

A

The line along which fairly priced securities are plotted

39
Q

What is the degree of misprision measured by?

A

The alpha value of the security

40
Q

What does alpha mean?

A

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

41
Q

What do positive alphas indicate?

A

An underpriced security

42
Q

What do negative alphas indicate?

A

An overpriced security

43
Q

What is the alpha coefficient (a)?

A

A parameter in the capital asset pricing model

44
Q

What happens if a < 0?

A

The investment has earned too little for its risk

45
Q

What happens if a = 0?

A

The investment has earned a return adequate for the risk taken

46
Q

What happens if a > 0?

A

The investment has a return in excess of the reward for the assumed risk

47
Q

What is market timing ability indicated by?

A

The curvature of the plotted line

48
Q

What does marketing timing ability involve?

A

Shifting funds between a market-index portfolio and a risk-free asset

Finance I (8 decks)

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