Chapter 4
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Nominal Risk Free Rate
Monetary reward for postponing consumption (TBill Return)

Real Risk Free Rate of Return
Return without chance of default or volatility.

Inflation
Increase in the cost of goods and services over time.

Required Risk Premium
Necessary compensation for risk taking.

Total Return
The sum of dividends, interest income, and capital gains or capital losses.

Arithmetic Average Return
Sum of investment returns divided by number of periods or securities.

Geometric Mean Return
Compound rate of return earned on investment.

Nominal Return
Gross investment profit expressed as a percentage.

Real Return
Investment return after inflation.

Standard Deviation
Common risk measure.

Coefficient of Variation
Relative risk reward measure.

Covariance
Absolute measure of comovement that varies between plus and minus infinity.

Correlation
Measure of comovement that varies between 1 and +1.

Investment Horizon
Holding Period.

Market Risk
General fluctuation in stock and bond prices.

Firm Specific Risk
Chance that problems with an individual company will reduce the value of investment.

Valuation Risk
Chance of loss due to relatively high stock prices.

Reversion to the Mean
Tendency of stock and bond returns to return toward long term averages.

Interest Rate Risk
Chance of loss in the value of fixed income investments following a rise in interest rates.

Credit Risk
Chance of loss due to issuer default.

Investment Portfolio
Collection of securities that together provide an investor with an attractive trade off between risk and return.

Portfolio Theory
Concept of making security choices based on portfolio expected returns and risks.

Expected Return
Anticipated profit over some relevant holding period.

Risk
Return volatility; usually measured by the standard deviation of returns.

Probability Distribution
Apportionment of likely occurrences

Utility
Positive benefit.


Risk Averse
Characterized by desire to avoid risk.

Zero Risk Portfolio
Constant return portfolio.

Efficient Portfolio
Portfolio with maximum expected return for a given level of risk or with minimum risk for a given expected return.

Efficient Frontier
Collection of all efficient portfolios

Optimal Portfolio
Collection of securities that provides an investor with the highest level of expected utility.


House Money Effect
Propensity to take risky gambles after winning some money.

Mental Accounting
Thinking about money and investing using individual categories instead of a unified perspective.