FIN 301 Chapter 8 Notes

Expected Rate of Return

The anticipated profit or loss from an investment expressed as a percentage of the initial amount invested, factoring in the probabilities of all possible outcomes.

Variance

A measure of the dispersion of a set of values, showing how much individual values differ from the mean. It is used in finance to assess the risk of investment returns.

Portfolio Risk

The overall risk associated with a collection of investments, considering both the individual risks of each asset and how they interact with one another. Portfolio risk is crucial for effective asset allocation and risk management.

Diversification

A risk management strategy that involves spreading investments across various assets to reduce exposure to any single asset's risk. This approach can help stabilize returns and lower overall portfolio risk.

Sharpe Ratio

A measure used to assess the risk-adjusted performance of an investment, calculated by subtracting the risk-free rate from the investment's return and then dividing by its standard deviation. It helps investors understand how much excess return they are receiving for the additional volatility endured.

Mean-Variance Graph

qA graphical representation of the risk-return trade-off of a portfolio, plotting expected returns against portfolio risk, helping investors visualize the optimal asset allocation.

Minimum-Variance Portfolio

A portfolio that aims to achieve the lowest possible risk for a given level of expected return, determined through optimization techniques that take into account the correlations and variances of the asset returns.

Efficient Frontier

A curve that illustrates the set of optimal portfolios that offer the highest expected return for a defined level of risk, representing the best possible risk-return combinations available to investors.

Market Portfolio

A theoretical portfolio that includes all available assets in the market, weighted by their market values, representing the optimal risk-return profile.

Market Beta 

A measure of an asset's sensitivity to market movements, indicating how much the asset's price is expected to change in relation to a market index. A beta greater than 1 indicates higher volatility than the market, while a beta less than 1 indicates lower volatility.

Hedge Ratio

The ratio used to compare the amount of investment in an asset to the amount of investment in a hedge, often used to minimize risk.

Value Weighted

A method of calculating an index or portfolio return where each asset's weight is determined by its market capitalization relative to the total market capitalization of all assets in the index.

Asset Beta

A measure of an asset's risk in relation to the overall market, reflecting the expected change in the asset's price due to market movements.

Equity Beta

A measure of the risk of a stock or equity relative to the overall market, indicating how much the stock's price is expected to change in response to market movements.

Arithmetic Return

The average return of an investment calculated by summing the individual period returns and dividing by the number of periods. This return does not account for compounding.

Geometric Return

The average return on an investment over a specified period, calculated by multiplying the returns of each period and taking the nth root, where n is the number of periods.

CAGR

The Compound Annual Growth Rate (CAGR) is the rate at which an investment grows annually to reach a given end value, assuming the profits are reinvested at the end of each period.

Interference

The interaction of different investment strategies or patterns that can affect the overall performance of an investment portfolio.

Dilution

The reduction in ownership percentage of existing shareholders due to a company issuing new shares or securities.

Zero-Coupon Bond

A type of bond that does not pay interest during its life but is issued at a discount to its face value, with the full value paid at maturity.