Markets and Institutions 2 part 1

Flashcards based on key vocabulary and concepts from the Markets and Institutions lecture notes.

Risk-return trade-off

Investors prefer investments with the highest expected return, but to achieve higher returns, one must accept higher investment risk.

Sharpe ratio

A measure that calculates risk-adjusted return, defined as the difference between the expected return of the investment and the risk-free rate divided by the standard deviation of the investment's return.

Risk aversion

A preference for certain outcomes where a risk-averse investor demands a premium for engaging in risky investments.

Diversification

A risk management strategy that involves mixing a variety of investments within a portfolio to reduce overall risk.

Market risk

Risk that arises from market-wide risk sources that cannot be eliminated through diversification, also called systematic risk.

Firm-specific risk

Risk that arises from factors specific to a company or industry, which can be mitigated through diversification.

Expected return

The average return anticipated on an investment over a specific period, taking into account all possible outcomes.

Volatility

A statistical measure of the dispersion of returns for a given security or market index; often referred to as risk.

Covariance

A measure of how much two random variables change together, can indicate the degree to which returns on two assets move in relation to each other.

No arbitrage

The principle stating that there should be no opportunities to earn risk-free profit by simultaneously buying and selling an asset in different markets.