Intermediate Investments Chapter 6 Book Vocab

Market, Systematic, Nondiversifiable Risk

Risk factors common to the whole economy.

unique risk, firm-specific risk, unsystematic risk, diversifiable risk

Risk that can be eliminated by diversification.

Variance

The probability-weighted average of the squared deviations of actual returns from the expected return.

Correlation Coefficient

The covariance divided by the product of the standard deviations of the returns on each fund.

Investment Opportunity Set

Set of available portfolio risk-return combinations.

Optimal Risky Portfolio

The best combination of risky assets to be mixed with safe assets when forming the complete portfolio.

Risk Premium

Expected excess return over the risk-free rate.

The slope of the CAL

Sharpe Ratio

Efficient Frontier

Graph representing a set of portfolios that maximizes expected return at each level of portfolio volatility.

Separation Property

The property that implies portfolio choice can be separated into two independent tasks

Index Model

Model that relates stock returns to returns on both a broad market index and firm-specific factors.

Alpha

The expected rate of return on a security in excess of what would be predicted by an equilibrium model such as the CAPM.

Beta

The sensitivity of a security’s return to the return on the market index.

Beta measures

Systematic risk

Firm-specific (or residual) risk

Component of return variance that is independent of the market factor.

Security Characteristic Line (SCL)

Plot of a security’s predicted excess return given the excess return of the market.

Risk Pooling

Pooling together many independent sources of risk