pt 2 risk and return

A collection of vocabulary flashcards related to key concepts in investor diversification and the fundamentals of finance.

Realized Returns

Total return earned over a particular period of time.

Average Annual Return

Average of realized returns for each year.

Variance of Returns

A measure of the variability of returns.

Standard Deviation

The square root of the variance, indicating volatility of returns.

95% Prediction Interval

The range of returns within which we are 95% confident that next period's return will lie.

Unsystematic Risk

Risk specific to a single firm that can be reduced through diversification.

Systematic Risk

Market-wide risks that affect all firms, generally not diversifiable.

Diversification

The reduction in unsystematic risk achieved by combining unrelated assets.

Correlation Coefficient

A statistical measure that describes the degree to which two securities move in relation to each other. +1 means almost exactly following

Risk Premium (RP)

The additional return required to compensate investors for the additional risk of an asset.

Efficient Portfolio

A portfolio that offers the highest expected return for a given level of risk.

Capital Asset Pricing Model (CAPM)

A model that describes the relationship between systemic risk and expected return for assets. converts risk measurement into required return

Opportunity Cost of Capital

The required return on projects that have similar risk.

Historical Volatility

A measure of how much the returns of an asset vary over time.

Correlation

A measure that describes the degree to which two assets move in relation to each other.

T-Bill Rate

The interest rate on short-term government bonds, used as the risk-free rate.

Portfolio Return

The expected return of a portfolio based on the weighted average of the individual asset returns.

Portfolio Risk

The risk associated with the collective performance of a portfolio.

Covariance

A measure of how two assets move together, used to calculate portfolio variance.

Systematic vs Unsystematic Risk

Systematic risk affects all companies while unsystematic risk is specific to individual firms.

Market Portfolio

A theoretical bundle of all possible investments in the market.

independent/unsystematic risk

like fires, affect one firm but not really others

common/market/systematic risk

recession, changes in tax law, new tech, affect everyone

diversification

reduces unsystematic risk, as you add more securities, get rid of firm specific risk