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22 Cards in this Set
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Business Risk: The possibility that a company will have lower than anticipated profits or that it will experience a loss |
Financial Risk: The possibility that shareholders will lose money when they invest in a company that has debt, if that company's CFs prove inadequate to meet its financial obligations |
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Normal Distribution: Bell-shaped distribution that describes the variation of many natural qualities, such as height and weight. It has the property that small deviations from the mean are more probable than large deviations. |
Skew: A measure of symmetry |
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Standard Deviation: Historical volatility used by investors as a gauge for the amount of expected volatility. It is a measure of the dispersion of a set of data from its mean. |
Kurtosis: Measures the degree to which a distribution is more or less peaked than a normal distribution. It measures the degree of "fat tails" |
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Serial Correlation: The relationship between a given variable and itself over various time intervals |
Sharpe Ratio: A measure for calculating risk-adjusted returns. It is the rewardd-to-variability (Sharpe) ratio that measures Risk Premium/Standard Deviation |
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Lower Partial Standard Deviation (LPSD): Measure of risk for non-normal distribution that is computed solely from values below the expected return. It ignores the upside risk. |
Conditional Tail Expectation (CTE): Assuming the terminal value of the portfolio values in the bottom 5% of possible outcomes, what is its expected value? |
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Risk: The chance that the actual return will not equal the expected return |
Speculation: Attempt to predict future prices or some other financial measure and then buy and sell instruments that would yield a profit if they are correct. |
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Commensurate Gain: Positive expected profit beyond the risk-free alternative |
Fair Game: A prospect that has a zero-risk premium |
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Risk-Averse: Reject portfolios that are fair games or worse |
Utility: As assigned score to competing investment portfolios based on their expected returns and risk. A higher value indicates higher expected returns. |
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Certainty Equivalent Rate: The rate that risk-free investments would need to offer with certainty to be considered equally attractive to the risky portfolio |
Risk-Neutral: Judge risky prospects solely by their expected rates of return. No penalization for risk. |
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Risk Lover: Willing to engage in fair games and gambles. |
Mean-Variance (M-V) Criterion: The process of weighting risk (variance) against expected return. |
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Indifference Curves: Where equally preferred portfolios lie on a curve in the mean standard deviation graph that connects all points with the same utility value. An investor will accept any portfolio with a utility score on their risk-indifference curve as being equally acceptable. |
Utility Score: Amount an investor is willing to pay for protection against the potential loss. |
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Investment Opportunity Set: The set of all combinations of the risk and risk-free assets, graphed as a line that beings at the intercept with the minimum return and no risk up to the maximum return and risk when the entire portfolio is invested in the risky asset. |
Asset Allocation: The apportionment of funds among different types of assets with different ranges of expected returns |
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Capital Allocation: The apportionment of funds between risk-free and risky assets |
Capital Allocation Line (CAL): Graphs all the possible combinations of the risk-free and risky asset Its slope is the Reward-to-Variability ratio |
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Complete Portfolio: The entire portfolio |
Reward-To-Variability Ratio: The slope of the CAL, which is the measure of extra return per extra risk |
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Optimal Portfolio: A portfolio on the efficient frontier that would yield the best combination of return and risk for a given investor, which would give them the most satisfied. It is where the indifference curve intersects the efficient frontier at a single point. |
Capital Market Line (CML): The capital allocation line for the market provided by one-month T-Bills. It represents an investment opportunity set generated by a passive strategy. |
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Diversification: Reduces risk from firm-specific influences by choosing individual investments that rise/fall at different times from other investments in the portfolio. |
Market (Systematic/Nondiversifiable) Risk: The risk that remains even after extensive diversification. |
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Unique (Firm-Specific/Non-Systematic/Diversifiable) Risk: Risk that can be eliminated by diversification |
Covariance: The measure of how much an investment moves in relation to another.
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Correlation Coefficient: Measures the degree of correlation |
Minimum-Variance Portfolio: A portfolio of risky assets with the lowest possible variance |
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Minimum-Variance Frontier: The set of all portfolios that represent the lowest level of risk (variance) that can be achieved for each possible level of return. |
Global Minimum-Variance Portfolio: The portfolio with the lowest variance for all the portfolios |
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Efficient Frontier: A plot of the set of expected returns and standard deviations for all efficient portfolios above the global minimum variance portfolio |
Portfolio Opportunity Set: The expected return/standard deviation pairs of all portfolios that can be constructed from a given set of assets |
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Markowitz Portfolio Theory: Based on the idea that risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward. |
Separation Property: The ability of a portfolio manager to identify a client's needs by separating them into two duties:
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Optimal Risky Portfolio: The portfolio with the highest Sharpe Ratio |
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