chapter 13 finance

Measuring Systematic Risk

Crucial determinant of an assets expected return, we need some way of measuring the level of systematic risk for different investments.

Portfolio

A group of assets such as stocks and bonds held by an investor.

Security Market Line (SML)

A positively sloped straight line displaying the relationship between expected return and beta.

Unsystematic Risk

A risk that affects a single asset or a small group of assets. -Unique to individual companies or assets.

Systematic Risk

A risk that influences a large number of assets, each to a greater or lesser extent also called market risk. -Uncertainties about general economic conditions -affect nearly all companies to some degree.

Systematic and Unsystematic Components of Returns

Breaking down the surprise portion (U) of the equation into systematic and unsystematic portions.

Portfolio Betas

If we had many assets in a portfolio, we would multiply each assets beta by its portfolio weight and then add the results to get the portfolios beta.

Principle of Diversification

Spreading an investment across a number of assets will eliminate some, but not all, of the risk.

Beta Coefficient

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset.

Capital Asset Pricing Model

The equation of the SML showing the relationship between expected return and beta.

Systematic Risk Principle

The expected return on a risky assets depends only on that assets systematic risk.

Portfolio Weight

The percentage of a portfolios total value that is invested in a particular asset.

Expected Return

The return on a risky asset expected in the future. -projected or expected risk premium is the difference between the expected return on a risky investment and the certain return on a risk free investment.

Market Risk Premium

The slope of the SML - the difference between expected return on a market portfolio and the risk free rate.