Intro to finance 4

16 flashcards · Other · by Daniel F.

1. Expected rate of return E(R)

   not anticipated outcome mathematical expected outcome

2. standard deviation of E(R)

   risk what is the probability that the E(R) will not be what we calculated on average (68%) my possible rate of return will differ from E(R) in the one sigma range 95% of the time in the 2 sigma range

3. Expected rate of return of portfolio E(Rp)

   same as weighted average of the returns of the equities

4. standard deviation of return of portfolio E(Rp)

   NOT the same at the weighted average of std dev of the equities returns of the securities do not move equally

5. increase in diversification leads to? because?

   to deceased risk because securities dont move equally

6. systematic risk vs unsystematic risk

   systematic risk a risk that influences a large number of assets, we cannot eliminate it non-diversifiable risk / market risk e.g. interest rate increase, energy costs increase, core inflation increase unsystematic risk a risk that affect at most a small number of assets. unique risk / asset-specific risk

7. risk premium

   assume risk free investment Rf offers 4% (e.g. government securities) the amount of risk you take is how much you deviate from Rf Risk premium = R(Rs) - Rf -> the additional risk, should be measured with systematic risk

8. market risk premium

   To calculate the market risk premium that only contains systematic risk: How much more the market earns than risk free rate

9. Expected return of an individual risky security - Capital asset pricing model (CAPM)

   Market risk premium is given information B is the risk level of the security B = 0 -> E(R) is as risky as Rf B = 1 -> E(R) is as risky as E(Rm) B > 1 -> E(R) is riskier than market

10. Reward risk ratio in the Capital asset pricing model (CAPM)

    E(RA)−RFβA\frac{E(R_A)-R_F}{\beta_A}βA​E(RA​)−RF​​ usually every portfolio is on the line and has the risk to reward ratio portfolio not on the line tend to move to the line e.g. Portfolio C is above the line, provides higher return at the same risk expected rate of return must drop price of C will increase

11. Payback period

    the number of years for an investment the recover its initial cost

12. what project should we accept

    independent projects: choose any project less than benchmark mutually exclusive: determine which one is better and select it

13. How to calculate payback period of long term investment

    I see the present value of years and roughly how many years it takes I calculate how much is missing to get back the initial investment after x whole years I add x up with the ratio of missing cash / present value of x+1 Problem: doesn't take all cashflows into account

14. Take NPV of long term investment

    Cash outflow of P0 - NPV of cash inflows Problem: doesnt indicate if it is high value or low value

15. Internal rate of return of long term investment

    IRR is a discount rate that makes the net present value (NPV) of all cash flows equal to zero higher is usually better Problem: could conflict with NPV

16. cross over rate of long term investment

    subtract all years from each other take irr