Lesson 5 Risk, Return and Valuation

Risk Averse

The attitude toward risk in which investors require an increase return as compensation for an increase in risk

Risk Neutral

The attitude toward risk in which investors choose the investment with the higher return regardless of its risk

Risk Seeking

The attitude toward risk in which investors prefer investments with greater risk even if they have lower expected returns

Scenario Analysis

An approach for assessing risk that uses several possible alternative outcomes to obtain a sense of the variability among returns

Probability Distribution

A model that relates probabilities to the associated outcomes

Standard Deviation

The most common statistical indicator of an assets risk; it measures the dispersion around the expected value

Coefficient of Variation

A measure of relative dispersion that is useful in comparing the risk of assets with differing expected return

Total Risk

Combination of a security’s non diversifiable risk and diversifiable risk

Diversifiable Risk

Portion of an asset’s risk that is attributable to firm specific, random causes can be eliminated through diversification. Also called unsystematic system

Non Diversifiable Risk

The relevant portion of an asset’s risk attributable to market factors that affect all firms cannot be eliminated through diversification. Also called systematic risk

Beta Coefficient

A relative measure of non-diversifiable risk an index of the degree of an asset’s return in response to a change in the market return

Portfolio Beta

Beta of a portfolio can be easily estimated by using the betas of the individual assets it includes

Corporate Bond

Is a long term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms

Discount

The amount by which a bond sells below its par value

Premium

The amount by which a bond sells above its par value

Zero-Growth Model

An approach to dividend valuation that assumes a constant, non growing dividend stream

Constant-Growth (Gordon Growth) Model

A widely cited dividend valuation approach that assumes that dividends will grow at a constant rate, but a rate that is less than the required return

Variable-Growth Model

A dividend valuation approach that allows for a changes in the dividend growth rate

Free Cash Flow Valuation Model

A model that determines the value of an entire company