Chapter 13 - Risk, Return and the Security Market Line (SML) Flashcards
(20 cards)
What is the expected return based on?
On the probability of a certain outcome.
What do Variance and standard deviation measure?
They measure the volatility of returns
State Probability ABC, Inc.
Boom 0.25 0.15
Normal 0.50 0.08
Slowdown 0.15 0.04
Recession 0.10 –0.03
Calculate:
What is the expected return?
What is the variance?
What is the standard deviation?
Expected return: sum(p(ER))
Boom:
Normal:
Slowdown:
Recession:
Variance: σ^2 = sum(p(Ri - E(R))^2
Standard deviation: Sqrt(σ^2)
What is a Portfolio?
An amalgamation or collection of assets
T/F: The risk and return profile of a stock in a portfolio affects the risk/return of the portfolio.
How is the risk/return profile of a portfolio assessed?
True
Through Standard Deviation (SD) and Expected Returns (ER) just like individual stocks.
What is the difference in the calculations of Expected Returns of individual stocks and a portfolio?
They are the same, but we account for the weight of each stock in a portfolio when calculating the ER of a portfolio.
What is a feasible set? And what is the efficient set?
The feasible set is all combinations of stocks that fit a certain risk/return profile. An efficient set is the group of stocks/assets that yield the highest return for a given risk profile, or provide the lowest risk for a given required return.
T/F. Is the variance and standard deviation of a portfolio calculated in the same way as individual stocks?
True
What are efficient markets a result of?
They are a result of people making investment decisions based on unexpected portion of announcements.
What is a systematic risk?
Macroeconomic factors affecting the entire market at once. For example, GDP, inflation, interest rates etc.
What is unsystematic risk?
Factors affecting a limited number or individual assets such as labour strikes.
What is the type of risk that can not be diversified away?
The systematic risk
How do you calculate total risk?
Total risk = Systematic risk + Unsystematic risk
How do you calculate total return?
Total return = Expected return + Systematic return + Unsystematic return
What is the formula for calculating the beta of a portfolio
Portfolio Beta = Sum(weight(beta)) of all assets in that portfolio
What is the formula for the reward-risk ratio?
Reward-risk ratio = (E(RA) – Rf)/(Beta(A) – 0)
What does the Security Market Line represent?
It represents a market equilibrium where the risk-return profiles of all assets is equal to that of the market.
The slope of the SML is the reward-to-risk ratio:
(E(RM) – Rf)/Beta(M)
Beta for the market is always equal to one.
What is the formula of the CAPM?
The capital asset pricing model(CAPM) defines
the relationship between risk and return
E(RA) = Rf + BetaA(E(RM) – Rf
What is the Arbitrage Pricing Theory?
God knows
Consider an asset with a beta of 1.2, a risk-free
rate of 5% and a market return of 13%.
− What is the reward-to-risk ratio in equilibrium?
− What is the expected return on the asset?
− What is the reward-to-risk ratio in equilibrium?
8(%)
− What is the expected return on the asset?
14.6%