FM chapter 6

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FM chapter 6
2010-11-04 01:21:59
FM chapter

FM chapter 6
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  1. Expected Return
    investment generates come in the form of cash flows (isn't accounting profits)
  2. Risk
    potential variability in future cash flows. wider the range of possible events that occur, greater the risk
  3. stock publishing company is more
    risky but offers the potential of a higher payoff (compared to treasury)
  4. Standard Deviation
    one way to measure risk. it measure volatility or riskiness of portfolio returns
  5. risk and return have _ relationship
  6. what kind of stock provides a reasonable hedge against inflation
    common stocks
  7. portfolio
    combining several assets
  8. total risk of porfolio is due to two types of risk
    • systematic (market risk): risk that affects all firms (tax rates)
    • unsystematic (company unique risk): risk that affects only a specific firm
  9. diversification
    creating a portfolio of stocks
  10. main motive for holding multiple stocks
    reduce the overall risk exposure
  11. degree of reduction depends on the correlation among assets
    if two stocks are perfectly positively correlated, diversification has no effect on risk

    if two stocks are perfectly negatively correlated, the portfolio is perfectly diversified (want this one)
  12. characterstic line
    line of best fit for all the stock returns relative to returns of company
  13. slope of the characteristic line
    measures average relationship between a stock's returns and those of the company's return
  14. the slope is called
  15. beta
    • risk that remains for a company even after we have diversified our portfolio-
    • stock with beta of 0 = no systematic risk
    • stock with beta 1 = systematic risk = to typical stock in marketplace
    • stock beta > 1 has sytematic risk greater than "typical stock"
  16. most stocks have betas between
    .60 and 1.60
  17. portfolio beta indicates
    change on average of the portfolio for every 1% change in the gneral market
  18. the market rewards
    diversification b/c it brings lower risk without sacrificing expected returns and we can increase expected returns w/o having to assume more risk
  19. asset allocation
    diversifying among different kinds of asset types; have to do it today and decision made today will be the payoff in the future
  20. direct relationship between risk and return
    move from all stock portfolio to a mix of stocks and bonds to an all bond portolio, both risk and return decline
  21. increase hold period then
    risk declines
  22. investor's required rate of return
    minimum rate of return necessary to attrack an investor to purchase or hold a security (opportunity cost)
  23. risk free rate
    RROR or discount rate for risk-less investments and measured by U.S. treasury bill rate
  24. Risk Premium
    additional return we must expect to recieve for assuming risk; level risk increases we demand additional expected returns
  25. CAPM provides
    thinking about the return that an investor should require on an investment, given the asset's systematic or market risk
  26. security market linke is a
    graphic representation of the CAPM- line shows the appropriate RROR for a given stock's systematic risk