Return, Risk, and The Security Market Line

Question 0

What are 3 types of returns

Answer 0

1) Total Dollar Return
2) Rate of Return
3) Percentage Return

Question 1

Risk is measured by ________________ of returns

Answer 1

Variability

Question 2

How to find Total Dollar Return

Answer 2

= Capital Gain (or loss) + Cash Flow (dividends, coupons, etc.)

= (Ending Market Value -Beg Market Value) + Cash Flow

Question 3

How to find Rate of Return

Answer 3

= Total Dollar Return / Beginning Market Value

Question 4

How to find Percentage Return

Answer 4

= Rate of Return x 100

Question 5

The Historical Record ~ year-to-year historical rates of return on what 5 important types of financial investments?

Answer 5

1. Large-company stocks
2. Small-company stocks
3. Long-term corporate bonds
4. Long-term U.S. government bonds
5. U.S. Treasury bills

Question 6

Historical Data: Risky??

Answer 6

Small company - YES
Large company - yes
LT Corp bonds - a little more
LT Govt. bonds - a little 
IT Govt. bonds - some 
T-bills- absolutely no risk

Question 7

“Lesson 1” - There is a reward for……

Answer 7

bearing risk

Question 8

“Lesson 2” - The greater the potential reward (risk premium), the……

Answer 8

Greater is the risk

Question 9

Risk premium

Answer 9

Excess return required from an investment in a risky asset over that required from a risk-free investment

Question 10

Variance

Answer 10

Avg squared difference between the actual return and the average return

Question 11

Standard deviation

Answer 11

the positive square root of the variance

Question 12

Normal distribution

Answer 12

Symmetric, bell-shaped frequency distribution that is completely defined by its mean and standard deviation

Question 13

Arithmetic average return

Answer 13

Return earned in an average year over a multiyear period

Question 14

Geometric average return

Answer 14

Average compound return earned per year over a multiyear period

Question 15

Uncertainty arises because we do not know what the values of the investment will be at the end of the period. Therefore, we will talk in terms of _________________

Answer 15

Expected values

Question 16

Expected return

Answer 16

The return on a risky asset expected in the future

Question 17

• collection of assets
• individual expected returns
• weighted differently

Answer 17

Portfolio

Question 18

The percentage of a portfolio’s total value that is invested in a particular asset

Answer 18

Portfolio weight

Question 19

A risk that influences a large number of assets

Also a market risk

Answer 19

Systematic risk

Question 20

A risk that affects at most a small number of assets

Also a unique or asset-specific risk

Answer 20

Unsystematic risk

Question 21

Spreading an investment across a number of assets will eliminate some, but not all, of the risk

Answer 21

Diversification

Question 22

Unsystematic risk is essentially eliminated by _________________, so a portfolio with many assets has almost no unsystematic risk.

Answer 22

Diversification