Investments Ch 5-8

Question 1

Nominal Interest Rate

Answer 1

The interest rate in terms of nominal (not adjusted for purchasing power) dollars.

Question 2

Real Interest Rate

Answer 2

The growth rate of purchasing power; the excess of the interest rate over the inflation rate.

Question 3

Effective Annual Rate (EAR)

Answer 3

Interest rate annualized using compound rather than simple interest.

Question 4

Annual Percentage Rate (APR)

Answer 4

Interest rate is annualized using simple rather than compound interest.

Question 5

Dividend Yield

Answer 5

The rate of return provided by a stock’s dividend payments.

Question 6

Risk-Free Rate

Answer 6

The interest rate that can be earned with certainty by leaving money in risk-free assets such as T-bills, money market funds, or the bank.

Question 7

Risk Premium

Answer 7

An expected return in excess of that on risk-free securities. The premium provides compensation for the risk of an investment.

Question 8

Excess Return

Answer 8

Rate of return in excess of the risk-free rate.

Question 9

Risk-Averse

Answer 9

A risk-averse investor will consider risky portfolios only if they provide compensation for risk via a risk premium.

Question 10

Risk-Neutral

Answer 10

A risk-neutral investor finds the level of risk irrelevant and considers only the expected return of risk prospects.

Question 11

Risk lover

Answer 11

A risk lover is willing to accept lower expected return on prospects with higher amounts of risk.

Question 12

Value At Risk (VaR)

Answer 12

Measure of downside risk. The loss that will be incurred in the event of an extreme adverse price change with some given, typically low, probability.

Question 13

Kurtosis

Answer 13

Indicates probability of observing extreme high or low values.

Question 14

Expected Shortfall (ES)
or
Conditional Tail Expectation (CTE)

Answer 14

The expected loss on a security conditional on returns being in the left tail of the probability distribution.

Question 15

Sharpe Ratio

Answer 15

Reward-to-volatility ratio; ratio of portfolio excess return to standard deviation.

Question 16

Sortino Ratio

Answer 16

Excess return divided by lower partial standard deviation.

Question 17

Fair Game

Answer 17

An investment prospect that has a zero risk premium.

Question 18

Utility

Answer 18

The measure of welfare or satisfaction of an investor.

Question 19

Certainty Equivalent Rate

Answer 19

The rate that a risk-free investment would need to offer to provide the same utility score as the risky portfolio.

Question 20

Mean-Variance Criterion

Answer 20

The selection of portfolios based on the means and variances of their returns. The choice of the higher expected return portfolio for a given level of variance or the lower variance portfolio for a given expected return.

Question 21

Indifference Curve

Answer 21

A curve connecting all portfolios with the same utility according to their means and standard deviations.

Question 22

Capital Allocation Decision

Answer 22

The allocation of invested funds between risk-free assets versus the risky portfolio.

Question 23

Capital Allocation Line (CAL)

Answer 23

A graph showing all feasible risk-return combinations of a risky and risk-free asset.

Question 24

Capital Market Line (CML)

Answer 24

A capital allocation line provided by the market-index portfolio.

Question 25

Diversification

Answer 25

Spreading a portfolio over many investments to avoid excessive exposure to any one source of risk.

Question 26

Insurance Principle

Answer 26

The law of averages. The average outcome for many independent trials of an experiment will approach the expected value of the experiment.

Question 27

Systematic Risk, Market Risk, or Nondiversifiable Risk

Answer 27

Risk factors common to the whole economy.

Question 28

``` Nonsystematic risk, Unique Risk, Firm-Specific Risk, or Diversifiable Risk ```

Answer 28

Risk factors that can be eliminated by diversification.

Question 29

Portfolio Opportunity Set

Answer 29

The expected return-standard deviation pairs of all portfolios that can be constructed from a given set of assets.

Question 30

Optimal Risky Portfolio

Answer 30

An investor's best combination of risky assets to be mixed with safe assets to form the complete portfolio.

Question 31

Minimum-Variance Frontier

Answer 31

Graph of the lowest possible portfolio variance that is attainable for a given portfolio expected return.

Question 32

Efficient Frontier of Risky Assets

Answer 32

The portion of the minimum-variance frontier that lies above the global minimum-variance portfolio.

Question 33

Input List

Answer 33

List of parameters such as expected returns, variances, and covariances necessary to determine the optimal risky portfolio.

Question 34

Separation Property

Answer 34

The property that portfolio choice can be separated into two independent tasks: (1) determination of the optimal risky portfolio, which is a purely technical problem, and (2) the personal choice of the best mix of the risky portfolio and the risk-free asset.

Question 35

Risk Sharing

Answer 35

Sharing the risk of a portfolio of given size among many investors.

Question 36

Risk Pooling

Answer 36

Investing the portfolio in many risky assets.

Question 37

Single-Factor Model

Answer 37

A model of security returns that acknowledges only one common factor. A factor-model is a way of decomposing the factors that influence a security's rate of return into common and firm-specific influences.

Question 38

Single-Index Model

Answer 38

A model of stock returns that decomposes influences on returns into a systematic factor, as measured by the return on a broad market index, and firm-specific factors.

Question 39

Regression Equation

Answer 39

An equation that describes the average relationship between a dependent variable and a set of explanatory variables.

Question 40

Residuals

Answer 40

Parts of stock returns not explained by the explanatory variables (the market-index return). They measure the impact of firm-specific events during a particular period.

Question 41

Security Characteristic Line

Answer 41

A plot of the excess return on a security over the risk-free rate as a function of the excess return on the market.

Question 42

Scatter Diagram

Answer 42

Plot of returns of one security versus returns of another security. Each point represents on pair of returns for a given holding period.

Question 43

Information Ratio

Answer 43

Ratio of alpha to the standard deviation of diversifiable risk

Question 44

Tracking Portfolio

Answer 44

A portfolio constructed to have returns with the highest possible correlation with a systematic risk factor.