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21 Cards in this Set

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Risk

The chance that some unfavorable event will occur.

Stand-Alone Risk

The risk an investor would face if he or she held only one asset.

Probability distributions

Listings of possible outcomes or events with a probability(chance of occurrence) assigned to each outcome.

Expected Rate of return

The rate of return expected to be realized from investments; the weighted average of the probability distribution of possible results.




Expected ending value-cost/cost

Standard Deviation

A statistical measure of the variability of a set of observations.




Used to quantify the tightness of a probability distribution.

Coefficient of Variation(CV)

The standardized measure of the risk per unit of return; calculated as the standard deviation divided by the expected return.




Standard Deviation/Expected Return




Most useful when the expected returns of two alternative investments are not the same.

Risk Aversion

Risk-averse investors dislike risk and require higher rates of return as an inducement to buy riskier securities.

Risk Premium(RP)

The difference between the expected rate of return on a given risky asset and that on a less risky asset.

Capital Asset Pricing Model(CAPM)

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 that reflects only the risk remaining after diversification.

Expected return on a portfolio

The weighted average of the expected returns on the assets held in the portfolio.

Realized Rates of return

Returns that were actually earned during some past period. Actual returns usually turn out to be different from expected returns except for riskless assets.

Correlation

The tendency of two variables to move together.

Correlation coefficient

A measure of the degree of relationship between two variables.




Measures the tendency of two variables to move together.




In reality, most stocks are positively correlated, but not perfectly; studies demonstrate it to be an average of 0.30 positive correlation.




Thus, combining stocks into portfolios reduces risk, but does not completely eliminate it.

Diversifiable Risk(Company specific or unsystematic risk)

That part of a security's risk associated with random events; it can be eliminated by proper diversification.

Market Risk(nondiversifiable, systematic, or beta risk)

The risk that remains in a portfolio after diversification has eliminated all company specific risk.

Market Portfolio

A portfolio consisting of all stocks.

Relevant Risk

The risk that remains once a stock is in a diversified portfolio is its contribution to the portfolio's market risk.





Beta Coefficient, b

A metric that shows the extent to which a given stock's return move up and down with the stock market. Beta measures market risk.

Average Stock's Beta, bA

By definition bA=1 because an average-risk stock is one that tends to move up and down in step with the general market.

Market Risk Premium, RPm

The additional return over the risk-free rate needed to compensate investors for assuming an average amount of risk.

Security Market Line(SML) Equation

An equation that shows the relationship between risk as measured by beta and the required rates of return on individual securities.