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expected benefits or returns
an investment generates comes in the form of cash flows (used to measure returns no acct profits)

expected cash flow is the weighted average of the
possible cash flows outcomes

Risk
potential variability in future cash flows

wider the range of possible future events that can occur
the greater the risk

returns on CS is more
risky than returns from investing in savings acct in a bank

stock is more risky but
also offers the potential of a higher payoff than a treasury bill

standard deviation
measure risk. measures volatility or riskiness of portfolio returns

direct relationship between risk and
return (concerning rates of return)

only common stocks provide a
reasonable hedge against inflation (concerning rates of return)

portfolio
combining several assets

total risk of portfolio is due to two types of risk
 systematic risk (market risk) risk that affects all firms
 unsystematic risk (company unique risk) risk that affects only a specfic firm

only nonsystematic risk can
be reduced or eliminated through effective diversification

main motive for holding multiple assets or creating a portfolio of stocks
reduce the overall risk exposure. Degree of reduction depends on the correlation among the 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

when making a portfolio we should pick securities/assets that have
negative or low positive correlation to attain diversification benefits

googles has relatively ____ compared to S&P500
higher risk

characteristic line
is the "line of best fit" for all the stock returns relative to returns of S&P500

slope of characteristic line (.68)
measures avg relationship between a stock's returns and those of the S&P500 index returnsslope is called beta

beta is measuring
the firm's market risk

beta
risk that remains for a company even after we have diversified our portfolio

stock with 0 beta
stock with 1 beta
stock with >1 beta
 0: no systematic risk
 1: equal to the "typical" stock in the marketplace
 >1: greater systematic risk than the typical stock
most between .60 and 1.60

portfolio beta
% change on avg of the portfolio for ever 1% change in the general market

market rewards
risk diversification, through effective risk diversification lower risk without sacrificing expected returns ad increase expected returns without having to assume more risk

asset allocation
diversifying among different kinds of asset types...decision has to be made TODAY, payoff in the future will depend on the mix chosen

asset allocation: direct relationship between
risk and return and holding period matters

asset allocation:as we increase the holding period
risk declines

investor's required rate of return
minimum rate of return necessary to attract an investor to purchase or hold a security

RiskFree rate
required rate of return or discount rate for riskless investments

risk free rate is typically measured
by US treasury bill rate

risk premium
additional return we must expect to receive for assuming risk

as level of risk increases we will
demand additional expected returns

capital asset pricing model (CAPM)
thinking about the return that an investor should require on an investment, given the asset's systematic or market risk

Security Market Price (SML)
graphic representation of the CAPM, where the line shows the appropriate required rate of return for a given stock's systematic risk

