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Chapter 6 Finance 362
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Terms in this set (15)
Holding-period return (historical or realized rate of return)
the rate of return earned on an investment, which equals the dollar gain divided by the amount invested.
Expected rate of return
The arithmetic mean or average of all possible outcomes where those outcome are weighted by the probability that each will occur.
Risk
potential variability in future cash flows.
Standard deviation
a statistical measure of the spread of a probability distribution calculated by squaring the difference between each outcome and its expected value, weighting each value by its probability, summing over all possible outcomes, and taking the square root of his sum.
Unsystematic 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 diversifible risk.
Systematic risk
the risk to 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. This risk of a project from the viewpoint of a well diversified shareholder. This measure takes into account that some of the projects risk will be diversified away as the project.
Characteristic line
The line of best fit through a series of return for a firm's stock relative to the market's return. The slope of the line, frequently called beta, represents the average movement of the firm's stock returns in response to a movement in the market's returns.
Beta
the relationship between an investment's returns and the market's returns. This is a measure of the investment's nondiversifiable risk.
Portfolio beta
the relationship between a portfolio's returns and the market returns. It is a measure of the portfolio's nondiversifiable risk.
Asset Allocation
Identifying and selecting the asset classes appropriate for a specific investment portfolio and determining the proportions of those assets within the portfolio.
Required rate of return
minimum rate of return necessary to attract an investor to purchase or hold a security.
Risk free rate of return
the rate of return on risk free investments. This interest rates on short term US government securities are commonly used to measure this rate.
Risk premium
the additional return expected for assuming risk.
Capital asset pricing model
an equation stating that the expected rate of return on an investment (in this case a stock) is a function of 1the risk free rate 2 the investments systematic risk, and the 3 expected risk premium for the market portfolio of all risky securities.
Security market line
the return line that reflects the attitude of investors regarding the minimum acceptable return for a given level of systematic risk associated with a security.
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