Investment Fundamentals Exam 2

Annual Percentage Rate (APR)

(per period rate x periods per year) Ignores compounding

The optimal risky portfolio can be identified by finding:

3 & 4 3= The tangency point of the capital market line and the efficient frontier 4=The line with the steepest slope that connects the risk free rate to the efficient frontier

Your investment has a 20% chance of earning a 30% rate of return, a 50% chance of earning a 10% rate of return, and a 30% chance of losing 6%. What is your expected return on this investment?

9.2% (watch for negatives)

The portfolio with the lowest standard deviation for any risk premium is called the _____.

Efficient frontier portfolio

Correlation

How related are they (-1:1)

Covariance

If they are related (- or +)

Which of the following statistics cannot be negative

Variance

Capital Allocation Line (CAL)

a graph showing all feasible risk-return combinations of a risky and risk-free asset

Skewness

a measure of the degree to which a distribution is asymmetrical. (-)= high prob of positive return; (+) high prob of negative return

Preferred Complete Portfolio

an efficient portfolio most preferred by an investor because its risk/reward characteristics approximate the investor's utility function. A portfolio that maximizes an investor's preferences with respect to return and risk.

Unique, Firm-specific, unsystematic, diversifiable risk

can be effectively eliminated by portfolio diversification.

Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always _________.

equal to 0

Efficient Frontier

graph representing a set of portfolios that maximizes expected return at each level of portfolio risk

Kurtosis

how flat or peaked a normal distribution is

On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie to the _____________ the current investment opportunity set.

left and above

An investor's degree of risk aversion will determine his or her ______.

optimal mix of the risk free asset and risky asset

Sharpe Ratio

ratio of portfolio risk premium to standard deviation

market (systematic), non diversifiable, risk

risk that cannot be removed by diversification

The plot of a security's excess return relative to the market's excess return is called the

security characteristic line

investment opportunity set

set of available portfolio risk-return combinations

Market risk is also called __________ and _________.

systematic risk; non-diversifiable risk

normal distribution curve

the bell-shaped curve that results from plotting continuous variation data on a graph. Mean =0; Standard Deviation = 1.

optimal portfolio

the best portfolio of securities for the investor's level of risk aversion

Capital Market Line (CML)

the capital allocation line using the market index portfolio as the risky asset

The term excess return refers to

the difference between the rate of return earned and the risk-free rate

The market risk premium is defined as

the difference between the return on an index fund and the return on Treasury bills

nominal interest rate

the interest rate as usually reported without a correction for the effects of inflation

real interest rate

the interest rate corrected for the effects of inflation

Effective Annual Rate (EAR)

the interest rate expressed as if it were compounded once per year. Includes compounding

Expected return

the return on a risky asset expected in the future

geometric average

the single per-period return that gives the same cumulative performance as the sequence of actual returns

arithmetic average

the sum of returns in each period divided by the number of periods

The expected rate of return of a portfolio of risky securities is

the weighted sum of the securities expected returns

Risk that can be eliminated through diversification is called ______ risk.

unique, firm specific, and diversifiable