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Flashcards in Study Unit 5 Deck (39)
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1

ROI

Amnt rec'd-Amnt invested

2

Rate of return

ROI/Amnt invested

3

Systematic risk

mkt risk (undiversifiable risk)
risk faced by all firms
changes in economy as a whole (inflation, business cycle)
all investments affected

4

Unsystematic risk

unique risk or company risk
determined by industry, products, customer loyalty, degree of leverage, mgt competence,

diversifiable risk

5

Types of investment risk

credit default
liquidity
maturity (interest rate)
inflation
political
exchange
business
country
principal

6

Credit default

risk borrower will default and won't pay principal or interest; gauge by using credit-rating agencies

7

Liquidity

security can't be sold on short notice for MV

8

Maturity risk

interest rate risk
risk an investment security will fluctuate n value bet date of issue and date of maturity
longer the date of maturity, higher the risk

9

Political risk

probability of loss from actions of govts (tax law changes, environmental regs)

10

Exchange rate risk

risk of loss bc of fluctuation in relative value of foreign currency

11

business risk

operation risk
risk of earning fluctuations before interest and taxes or in operating income when firm doesn't use debt
-risk inherent in its ops that excludes financial risk (risk to shareholders from use of financial leverage)
-depends on demand variability, sales price variability, input price variability, amnt of op leverge

12

Country risk

overall risk of investing in a foreign country

13

principal risk

risk of losing the amnt invested

14

risk averse

utility of gain doesn't outweigh dis utility of potential loss of the same amnt

15

risk neutral

investors adopts expected value approach bc they regard utility of gain as = to dis utility of a loss of same amnt

16

risk seeking

optimistic attitude toward risk
utility of gain as exceeding dis utility of loss of same amnt

17

risk premium

excess of investment's expected RoR over risk free interest rate (interest rate on safest investment, rate on US T bill)

T bill holder only exposed to inflation risk; mkt rate of interest = risk free rate of interest + inflation premium

18

required rate of return

return that takes into account all investment risks that relate to specific security

Real risk free rate + inflation premium=risk free rate
risk free rate+ liquidity risk premium + default risk premium+ maturity risk premium= required rate of return

19

Debt securities

income bonds pay return only if issuer is profitable
debentures are unsecured
mtg bonds are secured by real property
T bonds backed by US govt

20

Precious metal

risky b/c of volatility
when high inflation, currency loses purchasing power & may be safe investment

21

Probability distribution

set of all possible outcomes for decision
discrete b/c outcomes are limited

22

expected rate of return

investment determined using an expected value calculation
avg of possible outcomes weighted wrt probabilities
Ex RoR= sum (possible rate of return * probability)

23

Risk

chance actual return differs from expected
risk=std dev (variance) of investment's return
std dev= sq rt[sum(possible rate of return-expected rate of return)^2 * probability]= sq rt (variance)

24

Coefficient of variation

measures risk per unit of return
CV=std dev/expected rate of return
lower the ratio better the risk return tradeoff

25

Diversification
expected portfolio return
portfolio risk

weighted avg of returns on indiv securities

less than a simple avg of the std deviations of component securities; benefit of diversification

benefits decrease when more than 20-30 different securities are held

26

coefficient of correlation

measures degree to which any 2 variables (prices) are related
-range from 1.0 to -1.0
-perfect positive (1.0) means variables move together
-perfect negative (-1.0) mans variables move opposite
-normal range of 2 random stocks is .5 -.7

27

CAPM

quantifies req ROE security by relating security's level of risk to avg return available in the mkt (portfolio)
based on idea investor is compensated in 2 ways (time value of $ and risk)
-time value is risk free rate
-risk component consists of market risk premium (Rm-Rf) and beta

28

market risk premium

return provided by mkt over and above risk free rate
varies in direct proportion to beta

29

beta

measure of security's risk
-effect of indiv security on volatility measured by sensitivity to movements of overall mkt
-beta of mkt=1, beta of US treasury = 0

30

security risk premium

beta(Rm-Rf)