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32 Cards in this Set
- Front
- Back
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periodic income and price changes
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Return
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ending price – beginning price + income
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Dollar return
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Dollar return/beginning price
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Percentage return
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based on deviations over time around the average return
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Risk
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Sum of returns / number of periods
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Average return (AR)
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Rt - AR
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Deviation
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sum sign(Rt - AR)^2 / n - 1
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Variance
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Returns are squared therefore...
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Percent is squared and dollars are squared
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Standard deviation / Average return
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Coefficient of variation (It measures risk per unit of return
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Estimating the probability or likelihood of each scenario: growth %, normal %, recession %
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Forecasting return, risk
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Risk drives expected returns
Developed capital markets, such as those in the U.S., are, to a large extent, efficient markets. |
Two good investment rules to remember
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Many investors/traders
News occurs randomly Prices adjust quickly to news on average reflecting the impact of the news and market expectations |
An efficient market
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After adjusting for risk differences, investors cannot consistently earn above-average returns
Expected events don’t move prices; only unexpected events (“surprises”) move prices or events which differ from the market’s consensus |
An efficient market
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Market price changes show corporate management the reception of announcements by the firm
Investors: consider indexing rather than stock-picking Invest at your desired level of risk Diversify your investment portfolio |
Things that become possible because of Efficient Markets
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a combination of assets or investments
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Portfolio
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E(Ri) = expected return on asset i
wi = weight or proportion of asset i in the portfolio |
expected return on a portfolio variables
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E(Rp) = .75 (8%) + .25 (20%) = 11%
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More conservative portfolio
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E(Rp) = .25 (8%) + .75 (20%) = 17%
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More aggressive portfolio
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The risk of the portfolio may be less than the risk of its component assets
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Portfolio "Magic"
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a measure of how returns of two assets move together over time
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Correlation
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Correlation > 0
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the returns tend to move in the same direction
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Correlation < 0
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the returns tend to move in opposite directions
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If correlation between two assets (or between a portfolio and an asset) is low or negative, the resulting portfolio may have lower variance than either asset.
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Diversification
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Splitting funds among several investments reduces the affect of one asset’s poor performance on the overall portfolio
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Diversification
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Is there only one type of investment risk?
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No. There is both risk that can and cannot be diversified away.
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The model that analyzes an asset’s risk which depends upon whether it makes the portfolio more or less risky
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Capital Asset Pricing Model
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Contains all assets--it represents the “market”
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Market portfolio
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The total risk of the market portfolio (its variance)
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Systematic risk
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asset’s returns are usually higher (lower) than the market’s when the market rises (falls)
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A typically risky asset
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asset’s returns fluctuate less than the market’s over time
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A typically less risky asset
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measured relative to the risk of the market portfolio
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Systematic risk
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When an asset is half as variable as the market portfolio
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Systematic (B looking thing) is 0.5
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