Topic 2 - Portfolio Theory & CAPM Flashcards
What is meant by the term ‘Returns’?
Gains/Losses made on an investment over a period of time.
What is the formula to calculate total monetary returns?
Total monetary return = dividend income + capital gain (or loss)
When a shareholder receives the return they get on their investment, it comes in two forms:
1. cash called dividends
2. capital gain/capital loss
What is the formula to calculate total cash if the equity is sold?
Total cash if equity is sold = initial investment + total monetary return
What is meant by percentage return?
Percentage gain is a measure of the gain or loss on an investment expressed as a percentage of the initial amount
What is the formula to calculate percentage return?
percentage return = dividend yield / capital gains yield
What is the formula for dividend yield?
(dividend/beginning value) x 100
What is the formula for capital gains yield?
(difference in share price/beginning value) x 100
What is meant by holding returns period?
It is a measure of the total return an investor earns or loses on an investment during the time it is held
i.e.
- you buy a share today
- hold onto it for 5+ years
- you still get a return even though you arent selling the share
- you compare the price in the market to the price you originally paid
What is the formula for HPR?
(1+r1) x (1+r2) x ….. x (1+rt) -1
What is meant by average returns?
Average returns is a measure of the average gain or loss of an investment over a specified period
basically just calculating the mean
What is the formula for average return?
Average Return = sum of returns / number of periods
What are the two measures of risk?
Standard deviation and variance
Formula for standard deviation
Standard deviation = root(variance)
What is the symbol for standard deviation?
sigma
What is the symbol for variance?
sigma^2
What is the formula for variance?
1/T-1 * (r1-mean)^2 + (r2-mean)^2 ….
Which is more favourable: a higher SD or a lower SD?
Lower - because we dont want the return to be too different from the average.
Therefore, a lower SD indicates that your return is very similar to the average return
Give an example of low-volatility securities and why do they have low volatility
Government bonds have low volatility
- Governments borrow money by issuing bonds
- Once a week, the government sells some bills at an auction
- because the government can raise taxes to pay for the debt they incur, this debt is virtually free of the risk of default (called risk-free return)
What is risk premium?
the difference between the return on the risky asset and the risk-free return
What is the formula to calculate risk premium?
risk premium = returns - risk-free return
What is meant by expected return?
This is the return that an individual expects a security to earn over the next period
How to calculate the variance after calculating the expected returns?
Var(A) = Prob * (r(A) - Er(A))^2
What is meant by covariance?
Covariance is the statistical measure that measures the interrelationship between two securities
How do you interpret a positive and a negative covariance?
A positive covariance indicates that the two variables tend to move in the same direction
A negative covariance indicates that they move in opposite directions.
However, the magnitude of the covariance is not standardized, making it challenging to compare covariances between different pairs of variables.