FIN 411 Ch 6 Vocab

active portfolio

The portfolio formed by optimally combining analyzed stocks.

alpha

A stock’s expected excess return beyond that consistent with its beta and the market’s excess return.

beta

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

efficient frontier

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

excess return

Rate of return in excess of the risk-free rate.

Diversifiable risk

Risk that can be eliminated by diversification.

firm-specific risk

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

index model

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

information ratio

Ratio of alpha to the standard deviation of the residual.

investment opportunity set

Set of available portfolio risk-return combinations.

market risk

Risk factors common to the whole economy.

nondiversifiable risk

Risk factors common to the whole economy.

nonsystematic risk

Risk that can be eliminated by diversification.

optimal risky portfolio

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

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.

separation property

The property that implies portfolio choice can be separated into two independent tasks: (1) determination of the optimal risky portfolio, which is a purely technical problem, and (2) the personal choice of the best mix of the risky portfolio and the risk-free asset.

systematic risk

Risk factors common to the whole economy.

unique risk

Risk that can be eliminated by diversification.