Portfolio Management: Portfolio Risk & Return Flashcards
(32 cards)
Capital allocation line
CAL) A graph line that describes the combinations of expected return and standard deviation of return available to an investor from combining the optimal portfolio of risky assets with the risk-free asset.
Correlation coefficient
A number between −1 and +1 that measures the consistency or tendency for two investments to act in a similar way. It is used to determine the effect on portfolio risk when two assets are combined.
Global minimum-variance portfolio
The portfolio on the minimum-variance frontier with the smallest variance of return.
Indifference curve
A curve representing all the combinations of two goods or attributes such that the consumer is entirely indifferent among them.
Internal rate of return
(IRR) The discount rate that makes net present value equal 0; the discount rate that makes the present value of an investment’s costs (outflows) equal to the present value of the investment’s benefits (inflows).
Leverage
In the context of corporate finance, leverage refers to the use of fixed costs within a company’s cost structure. Fixed costs that are operating costs (such as depreciation or rent) create operating leverage. Fixed costs that are financial costs (such as interest expense) create financial leverage.
Liquidity
The ability to purchase or sell an asset quickly and easily at a price close to fair market value. The ability to meet short-term obligations using assets that are the most readily converted into cash.
Markowitz efficient frontier
The graph of the set of portfolios offering the maximum expected return for their level of risk (standard deviation of return).
Minimum-variance portfolio
The portfolio with the minimum variance for each given level of expected return.
Risk averse
The assumption that an investor will choose the least risky alternative.
Risk aversion
The degree of an investor’s inability and unwillingness to take risk.
Risk premium
An extra return expected by investors for bearing some specified risk.
Risk Tolerance
The amount of risk an investor is willing and able to bear to achieve an investment goal.
Skewness
A quantitative measure of skew (lack of symmetry); a synonym of skew.
Two-fund separation theorem
The theory that all investors regardless of taste, risk preferences, and initial wealth will hold a combination of two portfolios or funds: a risk-free asset and an optimal portfolio of risky assets.
Beta
A measure of the sensitivity of a given investment or portfolio to movements in the overall market.
Capital asset pricing model
(CAPM) An equation describing the expected return on any asset (or portfolio) as a linear function of its beta relative to the market portfolio.
Capital market line
(CML) The line with an intercept point equal to the risk-free rate that is tangent to the efficient frontier of risky assets; represents the efficient frontier when a risk-free asset is available for investment.
Homogeneity of expectations
The assumption that all investors have the same economic expectations and thus have the same expectations of prices, cash flows, and other investment characteristics
m2
A measure of what a portfolio would have returned if it had taken on the same total risk as the market index.
M2 Alpha
Difference between the risk-adjusted performance of the portfolio and the performance of the benchmark.
Market model
A regression equation that specifies a linear relationship between the return on a security (or portfolio) and the return on a broad market index.
Multi-factor model
A model that explains a variable in terms of the values of a set of factors.
Nonsystematic risk
Unique risk that is local or limited to a particular asset or industry that need not affect assets outside of that asset class.
