19 terms

FNCE 3101-Systematic Risk

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Portfolio Expected Return
percentage of dollar value of overall portfolio held in each individual investment
Portfolio Return
computed as a weighted average of returns on each individual investment
Expected Portfolio Return
computed as a weighted average but using expected return of each assets rather than actual (realized) return
Portfolio Volatility
Computed as standard deviation of portfolio returns. one measure of risk
may be less volatile than individual stocks due to diversification benefits, however, some risk will always remain (systematic)
The amount of risk eliminated depends on...
whether the stocks face similar risks and move together (comove)

*more similar return pattern = less diversification
Correlation
a measure ranging from -1 to 1 that reflects the tendancey of 2 things (2 stock returns) to move together (or opposite)
+1
perfect positive correlation -> always move together
0
uncorrelated -> no tendancy to move in the same or opposite directions
-1
perfect negative correlation -> always move opposite
low correlation =
greater diversification benefit
correlation between the return on stock A (Ra) and stock B (Rb) is:
corr (Ra, Rb) = cov(Ra, Rb)/ SD(Ra)-SD(Rb)
covariance
a measure ranging from -∞ to ∞ that reflects the tendency of 2 things to move together or opposite. Correlation is just covariance scaled to be between -1 and 1 and not have units
Covariance =
(Ra-R-bar(a))(Rb-R-bar(b))
Market Portfolio
the portfolio of all shares outstanding of every security
-contains only systematic risk since all firm specific risk is diversified away
Market Portfolio Proxy
a portfolio whose return tracks the true market portfolio. Indexes are typically used
Stock Index
indicator that reports the value of a particular set of securities
-Most well known: dow jones industrial average (DJIA), S&P 500, NASDAQ Composite
-Most used as market proxy S&P 500
Measuring Systematic Risk-Intuition
If a systematic/market-wide event happens, the market portfolio will change (possibly a lot). If an individual stock's return doesn't change much during this time, it must have low systematic risk (low exposure to systematic events(
Stocks with returns highly correlated with the market portfolio returns must..
have high systematic risk
A stock whose returns move opposite the market's...
would reduce a portfolio's systematic risk when added, because it would do well when negative events occur (a stock that does well in recessions should have low systematic risk)
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