Chapter 6: Finance

systematic risk (market risk or nondiversifiable risk) (1)

(1) the risk related to an investment return that cannot be eliminated through diversification. Systematic risk results from factors that affect all stocks. Also called market risk or nondiversifiable risk. (2) The risk of a project from the viewpoint of a well-diversified shareholder. This measure takes into account that some of the project's risk will be diversified away as the project is combined with the firm's other projects, and, in addition, some of the remaining risk will be diversified away by shareholders as they combine this stock with other stocks in their portfolios.

Monthly holding-period return

(end of month price - beginning of month price)/ beginning of month price

Interpreting Beta

Beta is the risk that remains for a company even after we have diversified our portfolio. -A stock with a Beta of 0 has no systematic risk -A stock with a Beta of 1 has systematic risk equal to the "typical" stock in the marketplace

Examples of portfolio:

Investing in multiple financial assets (stocks - $6000, bonds - $3000, T-bills - $1000)

Portfolio

Portfolio refers to combining several assets.

Total risk of portfolio is due to two types of risk:

Systematic (or market risk)

The main motive for holding multiple assets or creating a portfolio of stocks:

is to reduce the overall risk exposure.

beta slope

measures the average relationship between a stock's returns and those of the S&P 500 Index Returns

Systematic (or market risk)

risk that affects all firms (ex.: tax rate changes, war)

Unsystematic (or company-unique risk)

risk that affects only a specific firm (ex.: labor strikes, CEO change) --Only unsystematic risk can be reduced or eliminated through effective diversification.

Systematic risk

risk that is inherent in the macro economy and cannot be eliminated through diversification (caused by global markets)

Average Holding Period Return

sum of all monthly returns/ number of monthly returns

Characteristic Line

the line of "best fit" through a series of returns for a firm's stock relative to returns of s&p 500

unsystematic risk (company-unique risk or diversifiable risk)

the risk related to an investment return that can be eliminated through diversification. Unsystematic risk is the result of factors that are unique to the particular firm. Also called company unique risk or diversifiable risk.