Finance final 9-13

Variance and standard deviation:

-are both measures of dispersion -both measure the volatility of asset returns -greater volatility-> greater uncertainty

We need to ask ourselves the following questions when evaluating capital budgeting decision rules:

1. Does the decision rule adjust for the time value of money 2. Does the decision rule adjust for risk 3. Does the decision rule provide information on whether we are creating value for the firm

standard deviation

A common method used to measure the risk of a probability distribution; it is the positive square rooot of the variance

portfolio

A group of assets such as stocks and bonds held by An investor - an assets's risk and return are important in how they affect the risk and return of the portfolio -the risk-return trade off for a portfolio is measured by the expected return and standard deviation for the portfolio

Variance

A method to measure the variability of returns; it is the average squared differences between the actual return and the average return

Harmonic Mean

A type of weighted mean computed by averaging the reciprocals of the observations, then taking the reciprocal of that average.

The decision rule for NPV is:

Invest if = NPV > 0 Do not invest if = NPV < 0

Internal Rate of Return (IRR)

The discount rate that makes net present value equal 0; the discount rate that makes the present value of an investment's costs (outflows) equal to the present value of the investment's benefits (inflows).

Payback Period

The number of years required to recover the original investment in a project

Net Present Value (NPV)

The present value of an investment's cash inflows (benefits) minus the present value of its cash outflows (costs)

Standard deviation is a measure of which one of the following?

Volatility

When using economic probabilities to compute the expected return on a stock, the result is:

a mathematical expectation based on a weighted average and not a guaranteed outcome.

The internal rate of return is defined as the:

discount rate which causes the net present value of a project to equal zero.

Given a well-diversified stock portfolio, the variance of the portfolio:

may be less than the variance of the least risky stock in the portfolio.

The length of time a firm must wait to recoup the money it has invested in a project is called the:

payback period.

Buchi owns several financial instruments: stocks issued by seven different companies, plus bonds issued by four different companies. Her investments are best described as a(n):

portfolio

To calculate the expected risk premium on a stock, one must subtract the ________ from the stock's expected return.

risk-free rate

principal of diversification

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

geometric average return

the average compound return earned per year over a multiyear period

A project has a net present value of zero. Given this information:

the project's cash inflows equal its cash outflows in current dollar terms.

arithmetic average return

the return earned in an average year over a multiyear period