RSM332 Final Exam

5 Pages
249 Views
Unlock Document

Department
Rotman Commerce
Course
RSM332H1
Professor
Jennifer So
Semester
Fall

Description
Risk and Return  Risk is defined as the "possibility of incurring harm."  Ex post returns: returns past or historical returns  Ex ante returns: returns future or expected returns  Return on investment compromises of income yield and capital gain (or loss) yield  Income yield: the return earned by investors as a periodic cash flow (interest, dividends)  CF1/P0  Capital gain (or loss): appreciation (or deprecation) in the price of the asset from some starting price  (P1 - P0) / P0  Paper losses: capital losses that people do not accept as losses until they actually sell and realize them  Mark to market: carrying securities at the current market value regardless of whether they are sold  Measuring average returns  Arithmetic mean or average: sum of all returns divided by the total number of observations  Appropriate when trying to estimate typical return for a given period  Geometric mean: the average or compound growth rate over multiple periods  Determining "true" average rate of return over multiple periods  Standard deviation: a measure of risk over all the observations; the square root of the variance  Expected returns is the sum of the probabilities of most likely returns under various scenarios Measuring risk  Standard deviation formula  Expressed as a percentage  Ex ante standard deviation sum of Prob * (return - expected)^2  Variance: the standard deviation squared Risk premium is the additional return above the risk-free rate resulting from bearing risk  Compensation for additional risk  Sometimes called excess return Expected return and risk for portfolios  Portfolio: a collection of securities, such as stocks and bonds, that are combined and considered a single asset  Modern portfolio theory (MPT): the theory that securities should be managed within a portfolio rather than individually, to create risk-reduction gains; also stipulates that investors should diversify their investments so as not to be unnecessary exposed to a single negative event  Expected return of portfolio is the weighted average of the expected returns on each individual securities  Standard deviation of portfolio  covariance: statistical measure of the correlation of the fluctuations of the annual rates of return of different investments  Strength or magnitude  Correlation coefficient: a statistical measure that identifies how security returns move in relation to one another  +1 = 1 perfect positive correlation, -1 = -1 perfect negative correlation  Lower correlation, lower the standard deviation  Diversification: process of investing funds across several securities, which results in reduced risk  Random or naïve diversification: the act of randomly buying securities without regard to relevant investment characteristics, such as company size, industry classification, and so on  Benefit does not continue indefinitely, marginal risk reduction decrease  Total risk = market + unique  Unique (non-systematic) or diversifiable risk: the company-specific part of total risk that is eliminated by diversification  Market (systematic) or non-diversifiable risk: the systematic part of total risk, directly influenced by overall movements in the general market or economy that cannot be eliminated by diversification Portfolio theory  Efficient frontier  3 security portfolio variance (page 317)  Modern portfolio theory  Assumptions  Investors are rational decision-makers  Investors are risk averse, which means they like expected returns and dislike risk and therefore require compensation to assume additional risk  Investor preferences are based on a portfolio's expected return and risk  Minimum variance frontier: the curve produced when determining the expected return-risk combinations available to investors from a given set of securities by allowing portfolio weights to vary  Attainable portfolios: portfolios that may be constructed by combining the underlying securities  Dominated portfolio: inefficient, lower expected rate of return for same risk as others  Efficient frontier: set of efficient portfolios  Efficient portfolios: those portfolios that offer the highest expected return for a given level of risk, or offer the lowest risk for a given expected return  Minimum variance portfolio (MVP): a portfolio that lies on the efficient frontier and has the minimum amount of portfolio risk available from any possible combination of available securities  Portfolio with lowest possible risk and therefore defines the lowest expected return we should be willing to accept  Alternate way to find weight in 8A and find efficient frontier  Introduction of risk-free borrowing and lending  Insurance premium: payment to get out of a risk situation  Tangent portfolio: the risky portfolio on the efficient frontier whose tangent line cuts the vertical axis at the risk-free rate  The tangent line from Rf to this portfolio is known as the Capital Market Line (CML)  With RF and risky assets, we would never invest in any portfolio that is NOT on the CML  New (or super) efficient frontier: portfolios composed of the risk-free rate and the tangent portfolio that offer the highest expected rate of return for any given level of risk  Borrow RF and invest everything in M  Short position: a negative position in an asset; the investor achieves a short position by borrowing part of the asset's purchase price from the stockbroker  Separation theorem: the theory that investment decision (how to construct the portfolio of risky assets) is separate from the financing decision (how much should be invested or borrowed at the risk-free rate)  Market portfolio: a portfolio that contains all risk securities in the market  Everyone will choose to invest in the same risky market portfolio CAPM  Capital asset pricing model: a pricing model that uses one factor, beta, to relate expected returns to risk  Assumptions  All investors have identical expectations  No transaction costs and can borrow/end at risk free RoR  Same one period time horizon  N
More Less

Related notes for RSM332H1

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit