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26 Cards in this Set
- Front
- Back
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Define: risk premium. How is it calculated? |
The average reward for a risk bearing investment. Return of a risky investment less return of a risk-free investment (i.e. T-Bills) |
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What are the two types of risk associated with investments? |
Systematic and unsytematic |
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How is expected return of an investment calculated? |
∑[n, i = 1, R(i) * P(R(i))]. The sum of its possible returns multiplied by each one's corresponding probabilities. |
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How is the risk premium of an asset calculated with regards to its expected returns? |
Expected Returns less Risk free rate (R(f)) |
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Define: portfolio |
A group of assets held by an investor such as bonds and stocks. |
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Define: portfolio weight |
Percentage of a particular asset in a portfolio's total value. |
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What is the relationship between the standard deviation of a portfolio and the standard deviations its assets? |
(to be added) |
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Formula: total return of a security |
R = Expected Return + Unexpected Return |
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During news announcements, what is the market reaction consists of? |
The unexpected, or surprise, element of the announcement as the expected has already been "discounted". |
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Under what conditions will an announcement have no effect on common stock prices? |
When the announcement is expected and has already been taken into consideration. |
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What is the true risk of an investment? Why? |
The unexpected announcements because the expected has already been predicted. |
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Define: systematic risk |
A type of risk which influences a large number of assets. (AKA Market Risk) |
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Define: unsystematic risk |
Risks which influence a small number of assets (or risks unique to the asset itself). |
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What does unanticipated risk consists of? |
Systematic and unsystematic risks. |
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Define: principle of diversification |
The process of reducing diversifiable risk by spreading the investment across multiple assets. |
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How does diversification virtually reduce unsystematic risk? |
As the number of assets in a portfolio grow, the unsystematic risks of each one tends to be relatively small and cancel each other out. |
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How is the risk of an investment measured? |
By its standard deviation. |
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Why can't systematic risk not be diversified away? |
By definition, systematic risk affects most assets of the market. Therefore, increasing the number of assets in a portfolio does not decrease this. |
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Define: systematic risk principle. Why is this so? |
The reward for bearing risk (expected return) depends only on the systematic risk of an investment. The rationale is because the unsystematic risk can be reduced simply by diversifying (at no cost). |
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What is the measurement for an investment's systematic risk?
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The Beta Coefficient. |
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Define: Beta Coefficient |
The amount of systematic risk present in a particular risky asset relative to that of an average one. |
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Define: Security Market Line |
The positively sloped straight line regarding the relationship between expected return and beta. |
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Define: market efficiency |
Markets at the same time period reflect all public available information. |
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What are the different types of efficiencies of markets? |
Weak, semistrong and strong. |
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How is Beta calculated? |
The slope of an investment compared to that of a broad market index. |
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How is the expected return of an asset calculated? CAPM*
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Risk Free rate + Beta Coefficient*Risk Premium |
