fin management chapter 6

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fin management chapter 6
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2010-12-14 21:30:18
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financial management chapter 6
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  1. expected benefits or returns
    an investment generates comes in the form of cash flows (used to measure returns- no acct profits)
  2. expected cash flow is the weighted average of the
    possible cash flows outcomes
  3. Risk
    potential variability in future cash flows
  4. wider the range of possible future events that can occur
    the greater the risk
  5. returns on CS is more
    risky than returns from investing in savings acct in a bank
  6. stock is more risky but
    also offers the potential of a higher payoff than a treasury bill
  7. standard deviation
    measure risk. measures volatility or riskiness of portfolio returns
  8. direct relationship between risk and
    return (concerning rates of return)
  9. only common stocks provide a
    reasonable hedge against inflation (concerning rates of return)
  10. portfolio
    combining several assets
  11. 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
  12. only nonsystematic risk can
    be reduced or eliminated through effective diversification
  13. 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
  14. if two stocks are perfectly positively correlated diversification has
    no effect on risk
  15. if two stocks are perfectly negatively correlated
    the portfolio is perfectly diversified
  16. when making a portfolio we should pick securities/assets that have
    negative or low positive correlation to attain diversification benefits
  17. googles has relatively ____ compared to S&P500
    higher risk
  18. characteristic line
    is the "line of best fit" for all the stock returns relative to returns of S&P500
  19. slope of characteristic line (.68)
    measures avg relationship between a stock's returns and those of the S&P500 index returns--slope is called beta
  20. beta is measuring
    the firm's market risk
  21. beta
    risk that remains for a company even after we have diversified our portfolio
  22. 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
  23. portfolio beta
    % change on avg of the portfolio for ever 1% change in the general market
  24. market rewards
    risk diversification, through effective risk diversification lower risk without sacrificing expected returns ad increase expected returns without having to assume more risk
  25. 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
  26. asset allocation: direct relationship between
    risk and return and holding period matters
  27. asset allocation:as we increase the holding period
    risk declines
  28. investor's required rate of return
    minimum rate of return necessary to attract an investor to purchase or hold a security
  29. Risk-Free rate
    required rate of return or discount rate for risk-less investments
  30. risk free rate is typically measured
    by US treasury bill rate
  31. risk premium
    additional return we must expect to receive for assuming risk
  32. as level of risk increases we will
    demand additional expected returns
  33. 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
  34. 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

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