Lecture 5 Flashcards
(20 cards)
Holding period return
End of period price + dividend / beginning of period price
- 1
= Pt + Divt / P0 -1q
Maturity premium
Extra average return from investing in long versus short term treasury securities
Risk premium m
Expected return in excess of risk free return as compensation for risk
Risk =
Uncertainty
How can risk be measured
Variance = average value of squared deviations from mean. A mean of volatility
Standard Deviation = square root of variance, also a measure of volatility
The higher the expected return…
The higher the risk
Diversification
Strategy designed to reduce risk by spreading a portfolio across many investments
unique risk
Risk factor affecting only that firm
Also called diversifiable and firm specific risk
Market risk
Economy wide sources of risk that affect the overall stock market
Also called systematic or undiverisfiable risk
Total risk =
Market risk plus unique risk
Portfolio =
Collection of financial assets characterised by portfolio weighted that sum to 1
Portfolios expected weight of return
Weighted sum of each assets rate of return
Expected return of portfolio =
Sum of the weights of asset multiplied by there expected rate of return
Reasons why returns don’t move together
Each asset has uniqueness
Correlation coefficient
Measure the strength and direction of linear relationship between two variables
What happens to portfolio risk as correlation decreases
Risk decreases but returns remain the same
When is the benefit of diversification maximised
When rho is equal to -1
What happens to price A and B when risk decreases
Prices A and B move in opposite directions
How can firm specific risk be reduced
Increase number o investments in portfolio
What is an efficient portfolio
Provides highest expected return for given level of risk
And
provides the least risk for a given level of expected return;
