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15 Cards in this Set
- Front
- Back
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Risk Aversion |
Investors dislike risk and require higher expected rate of return so that more of them invest in a particular investment. |
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Risk |
the chance that some unfavorable event will occur. |
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How many ways can we analyze an asset risk? what are they?
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two ways.
Stand Alone basis: the asset is considered in isolation.
Portfolio Basis: the asset is held as one of a number of assets in a portfolio.
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Stand Alone Risk |
is the risk an investor would face if she held only this one asset. |
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Probability Distribution |
it lists all possible events or outcomes and probability is assigned to each event. (examples are on pages 238 to 239.)
The weights are the probabilities |
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Normal Distribution |
the actual return will be within plus and minus 1 standard deviation of the expected return 68.26% of the time. |
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Correlation |
The tendency of two variables to move together |
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Correlation Coefficient,p (rho) |
a standardized measure of how two random variables covary. A correlation coefficient (p) of +1.0 means that the two variables move up and down in perfect synchronization, whereas a coefficient of -1.0 means the variables always move in opposite directions. A correlation coefficient of zero suggests that the two variables are not related to one another ; that is , they are independent. |
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Market Portfolio |
A Portfolio consists of all stocks |
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Market Risk |
Almost half of the risk inherent in an average individual stock can be eliminated if the stock that is held in a reasonably well-diversified portfolio, which is one containing 40 or more stocks in a number of different industries.
It stems from factors that systematically affect most firms: war, inflation, recession, and high interest rates. |
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Diversifiable risk |
the part of a security's total risk associated with random events not affecting the market as a whole. this risk can be eliminated by proper diversification. Also known as company specific risk. |
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Capital Asset Pricing Model |
A model based on the proposition that any stock's required rate of return is equal to the risk free rate of return plus a risk premium reflecting only the risk remaining after diversification. the CAPM equation is ri= risk free rate+beta i *(return on market - risk free rate) |
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Beta |
Measures risk.
1. A portfolio with a beta greater than 1 will have a bigger standard deviation than the market portfolio.
2. A portfolio with a beta equal to 1 will have the same standard deviation as the market.
3. A portfolio with a beta less than 1 will have a smaller standard deviation than the market. |
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Market Risk Premium |
The extra rate of return that investors require to invest in the stock market rather than purchase risk free securities |
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Efficient Market Hypothesis |
1. Stocks are always in equilibrium. 2. It is impossible for an investor to beat the market and consistently earn a higher rate of return than is justified by the stock's risk. |
