Fin 322: Chapter 6 -- Efficient Diversification

Front 1

Market risk, systematic risk, nondiversifiable risk

Back 1

Risk factors common to the whole economy

Front 2

Unique risk, firm-specific risk, nonsystematic risk, diversifiable risk

Back 2

Risk that can be eliminated by diversification.

Front 3

Investment opportunity set

Back 3

Set of available portfolio risk-return combinations.

Front 4

Optimal risky portfolio

Back 4

The best combination of risk assets to be mixed with safe assets to form the complete portfolio.

Front 5

Efficient frontier

Back 5

Graph representing a set of portfolios that maximizes expected return at each level of portfolio risk.

Front 6

Separation property

Back 6

The property that implies portfolio choice can be separated into two independent tasks: (1) determination of the optimal risky portfolio, which is a purely technical problem, and (2) the personal choice of the best mix of the risky portfolio and the risk-free asset.

Front 7

Index model

Back 7

Model that relates stock returns to returns on both a broad market index as well as firm-specific influences

Front 8

Excess return

Back 8

Rate of return in excess of the risk-free rate.

Front 9

Beta

Back 9

The sensitivity of a security's returns to the systematic or market factor.

Front 10

Firm-specific or residual risk

Back 10

Component of return variability that is independent of broad market movements.

Front 11

Alpha

Back 11

A stock's expected return beyond that induced by the broad market; its expected excess return when the market's excess return is zero.

Front 12

Security characteristic line

Back 12

Plot of a security's excess return as a function of the excess return of the market.

Front 13

Information ratio

Back 13

Ratio of alpha to standard deviation of residual return.

Front 14

Active portfolio

Back 14

The portfolio formed by optimally combining analyzed stocks with perceived non-zero alpha values.