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Basic Finance

Risk & Return

TermDefinition
Expected Return weighted avg of all possible returns, weighted by probability that each return will occur
Required return min return necessary to attract investor to buy/hold security
Standard Deviation measures return volatility, measure dispersion of possible outcomes (square root of the variance)
Beta Coefficient measures asset’s systematic risk, how individual stock’s returns vary w/ market returns
Beta = 1 asset has SAME systematic risk as overall market
Beta > 1 asset has MORE systematic risk than overall market
Beta < 1 asset has LESS systematic risk than overall market
Variance (measures volatility) avg squared deviation between actual returns & avg return (sigma squared)
Systematic Risk risk affects large number (non-diversifiable, market risk)
Unsystematic Risk risk affects small number (diversifiable, unique, idiosyncratic)
Diversification assets combined to cancel out unsystematic risks, (from diff sectors)
Total Risk = systematic risk + unsystematic risk
Security Market Line representation of market equilibrium between risk & return
SML slope market risk premium (reward-to-risk ratio)
CAPM defines relationship between risk & return (Capital Asset Pricing Model)
Historical Variance sum squared dev from mean / (number of observations - 1)
Total dollar return = investment income + capital gain (or loss) due to price change
Dividend Yield = income / beginning price
Capital Gains Yield = (end price - begin price)/ begin price
Total Percentage Return = Dividend Yield + Capital Gains Yield
Capital Asset Pricing Model defines relationship between risk & return
Risk Premium = expected return - risk free rate
Risk-Free Rate interest rate of short-term government bonds
EMH Efficient Market Hypothesis
Strong Form Efficiency prices reflect ALL info (public & private)
Semi-Strong Form Efficiency prices reflect PUBLIC info
Weak Form Efficiency reflect PAST market info (price & volume)
Created by: grpdish on 2006-10-22



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