Finance: Chapter 5-Risk And Return

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portfolio

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a collection, or group, of assets

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risk

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the chance of financial loss or, more formally, the variability of returns associated with a given asset

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return

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the total gain or loss experienced on an investment over a given period of time; calculated by dividing the asset's cash distributions during the period, plus change in value, by its beginning of period investment value

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risk-averse

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the attitude toward risk in which an increased return would be required for an increase in risk

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scenario analysis

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an approach for assessing risk that uses several possible alternative outcomes (scenarios) to obtain a sense of the variability amond returns

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range

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a measure of an asset's risk, which is found by subtracting the return associated with the pessimistic (worst) outcome from the return associated with the optimistic (best) outcome.

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probability

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the chance that a given outcome will occur

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probability distribution

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a model that relates probabilities to the associated outcomes

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bar chart

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the simplest type of probability distribution; shows only a limited number of outcomes and associated probabilities for a given event.

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continuous probability distribution

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a probability distribution showing all the possible outcomes and associated probabilities for a given event.

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standard deviation

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the most common statistical indicator of an asset's risk; it measures the dispersion around the expected value.

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expected value of a return

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the most likely return on a given asset

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coefficient of variation (CV)

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a measure of relative dispersion that is useful in comparing the risks of assets with differing expected returns

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efficient portfolio

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a portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return

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correlation

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a statistical measure of the relationship between any tow series of numbers representing data or any kind

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positively correlated

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describes two series that move in the same direction

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negatively correlated

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describes two series that move in opposite directions

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correlation coefficient

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a measure of the degree of correlation between tow series

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perfectly positively correlated

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describes two positively correlated series that have a correlation coefficient of +1

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Perfectly negatively correlated

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describes two negatively correlated series that have a correlation coefficient of -1

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uncorrelated

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describes two series that lack any interaction and therefore have a correlation coefficient close to zero

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political risk

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risk that arises from the possibility that a host government will take actions harmful to foreign investors or that political turmoil will endanger investments

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capital asset pricing model (CAPM)

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the basic theory that links risk and return for all assets

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total risk

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the combination of a security's nondiversifiable risk and diversifiable risk

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diversifiable risk

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the portion of an asset's risk that is attributable to firm specific, random causes; can be eliminated through diversification. Also called unsystematic risk.

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nondiversifiable risk

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the relevant portion of an asset's risk attributable to market factors that affect all firms; cannot be eliminated through diversification. Also called systematic risk

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beta coefficient (b)

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a relative measure of nondiversifiable risk. An index of the degree of movement of an asset's return in response to a change in the market return.

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market return

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the return on the market portfolio of all traded securities.

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risk-free rate of return (Rf)

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the required return on a risk free asset, typically a 3-month U.S. treasury bill

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U.S. Treasury Bills (T-Bills)

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short tern IOUs issued by the U.S. treasury; considered the risk-free asset.

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security market line (SML)

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the depiction of the capital asset pricing model (CAPM) as a graph that reflects the required return in the marketplace for each level of nondiversifiable risk (beta).

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efficient market

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a market with the following characteristics: many smal investors, all having the same information and expectations with respect to securities no restrictions on investment, no taxes, and no transaction costs; and rational investors who view securities similarly and are risk-averse, preferring higher returns and lower risk.