Investments Ch. 3- Risk & Return

Front 1

Arithmetic return

Back 1

Simple average

Add up returns divide by number of returns

Front 2

Geometric return

Back 2

Calculates average return assuming all earnings remain invested

Same as IRR

When returns don’t vary yr to yr it is same as arithmetic mean, if they do arithmetic will always be greater

Front 3

Geometric return formula/ calculation

Back 3

Returns: 45%, -10%, -25%, 30%

[1.45x.90x.75x1.30] ^1/4 -1= 0.062

4 returns = 1/4 power

Front 4

After-tax return

Back 4

Realized taxable return X (1-marginal income tax rate)

8% corp, 30% tax rate

.08X (1-.30)=

.08 x .70= 5.6%

Front 5

Systematic risks

Back 5

Can not be avoided

Purchasing power

Reinvestment rate

Interest Rate

Market Risk

Exchange Rate

Front 6

Standard deviation and beta

Back 6

Std: includes systematic and unsystematic risk

Beta: measures systematic risk

Front 7

Variance

Back 7

Std deviation squared

Higher variance = higher risk

Front 8

Skewness

Back 8

Measure of lack of symmetry for a data set

Positive: mean greater than median

Front 9

Kurtosis

Back 9

Measure of whether data are heavily tailed or light tailed

Leptokurtic: high peak, fat tails

Platykurtic: low peak, thin tails

Front 10

Correlation coefficient

Back 10

Determines level of diversification in portfolio

+1= perfect positive

+.50 = positive relationship

0= no relationship

-.50= negative relationship

-1 = perfect negative relationship

Front 11

Covariance

Back 11

A measure of how much 2 assets move together

Not as intuitive as CC

Not constrained to -1 & 1 like CC

Front 12

Covariance formula

Back 12

Std dev asset A x std dev asset B x correlation between both assets

Front 13

Semivariance

Back 13

Only takes into consideration of volatility below the mean return

Front 14

Coefficient of Determination

Back 14

R^2

Provides % variation in portfolio returns that is explained by the variation in benchmark returns, range is 0 to 1.00

Ex: Yankees baseball team 43% or R^2 .43 which means 43% of change in one variable is explained by changes in the other (height & weight)

Front 15

Coefficient of Variation (CV)

Back 15

Securities return relative to its risk

Std deviation divided by expected return

Fails to adjust for risk-free rate of return

Front 16

Dollar weighted return vs Time weighted return

Back 16

Dollar looks at the investors return

Time looks at the investments return

Use IRR to calculate both

Front 17

Annualized return

Back 17

Same as compound rate of return & assumes cash flow are reinvested at same rate

Ex: 3% quarterly return

(1.03^4) -1= .01255= 12.55%

Ex: 6% semiannual return

(1.06^2)-1= 0.1236= 12.36%

Front 18

Effective Annual Rate of Return

Back 18

(1+ ann rate/# of pd)^# of pd-1

Ex: 7% compound weekly

(1+ .07/52)^52-1=

(1.0013)^ 52 - 1= .07246= 7.25%

Front 19

Beta calculation

Back 19

Std dev of port X correlation divided by std dev of market

Front 20

Diversification

Back 20

Comparing the variability of a portfolio is returned to the market indicates Diversification

Front 21

Weighted average return

Back 21

They combined return of a portfolio

Front 22

Adjusted for correlation

Back 22

The combine standard deviation of a portfolio is the weighted average

Front 23

The Four Cs

Back 23

Back (Definition)