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Holding Period Return (single period):

HPR tells us what we earned, but investments are based on what we EXPECT to earn

Expected Return:

The weighted average of the possible returns

Nominal Dollar:

The dollar in your wallet, or bank account

Real Dollar:

Refers to purchasing power

Nominal interest rate:

Growth rate of your money

Real interest rate:

Growth rate of your purchasing power

Inflation rate:

The general decline in what a dollar can purchase

Equilibrium Nominal Rate of Interest:

As the inflation rate increases, investors will demand higher nominal rates of return

Nominal rate =

real rate + inflation forecast

Risk Premium:

Difference between the expected RoR and the risk-free rate

Excess Return:

Difference between the actual RoR and the risk-free rate

Variance (σ^2):

Measures the dispersion of possible outcomes around expected return

Higher variance:

Implies a higher dispersion of possible outcomes; more uncertainty

Geometric Average Return:

Used to compute the average compound return of an investment over multiple periods

The geometric average will be:

Less than the arithmetic average unless all the returns are equal

Arithmetic average is an:

Overly optimistic estimate of future returns for long horizons

The geometric average is an:

Overly pessimistic estimate of future returns for short horizons

Forecasting Return:

To achieve a more accurate estimate of expected returns, one can use Blume's formula

Value at Risk (VaR):

What is the worse loss that an investment will suffer, given a probability (often 5%)

Non-Normal Distributions:

When distributions are non-normal we need to consider more than mean and variance

Distribution Characteristics: Mean:

Most likely outcome

The spread of possible outcomes

Distribution Characteristics: Variance or Standard Deviation:

Distribution Characteristics: Skewness:

How asymmetrical is the distribution

Distribution Characteristics: Kurtosis:

Flat or "Peakie;" which means that it compares the frequency of extreme values to that of the normal distribution

Dollar-weighted average return:

Is the internal rate of return of the project, which is the interest rate that sets the present value of the cash flows realized on the portfolio

Scenario analysis:

Process of devising a list of possible economic scenarios and specifying the likelihood of each one, as well as the HPR that will be realized in each case

Probability distribution:

List of possible outcomes with associated probabilities

Expected Return Definition:

The mean value of the distribution of HPR

Variance Definition:

The expected value of the squared deviation from the mean

Skew Definition:

Measure of the asymmetry of a probability distribution

Risk-free Rate:

The rate of return that can be earned with certainty

Risk Premium Definition:

An expected return in excess of that on risk-free securities

Risk Aversion:

Reluctance to accept risk

Price of Risk:

The ratio of portfolio risk premium to variance

Mean-variance Analysis:

Ranking portfolios by their Sharpe ratios

Inflation Rate Definition

The rate at which prices are rising, measured as the rate of increase of the CPI

Nominal Interest Rate Definition:

The interest rate in terms of nominal (not adjusted for purchasing power) dollars

Asset Allocation:

Portfolio choice among broad investment classes

Capital Allocation:

The choice between risky and risk-free assets

Complete Portfolio:

The entire portfolio including risky and risk-free assets

Capital Allocation Line (CAL):

Plot of risk-return combinations available by varying portfolio allocation between a risk-free asset and a risky portfolio

Passive Investment Strategy:

Based on the premise that securities are fairly priced, and it avoids the costs involved in undertaking security analysis

Capital Market Line (CML):

The capital allocation line using the market index portfolio as the risky asset

Speculators expect a risk-return trade-off

Speculation is undertaken despite the risk because:

Also called the time-weighted average return

The geometric average rate of return is _______:

Treasury securities are free of default risk

Treasury securities are commonly regarded as risk-free assets because _______:

Securities are fairly priced

A passive investment strategy is based on the premise that _______:

The Real Interest Rate

The excess of the interest rate over the inflation rate is called:

What is the "technical" part of capital allocation?

Finding the available combinations of risk and return is the ''technical" part of capital allocation; it deals only with the opportunities available to investors

The 1930s and 1940s show us:

that very volatile levels of unexpected inflation can play havoc with

Diversified sample of

Until 1969, the "World Portfolio" of stocks was constructed from a:

Inflation rate

The rate of change of the price level, usually measured as a percentage change per year

The complete portfolio is:

The overall portfolio composed of the risk-free asset and the risky portfolio and it includes the investor's wealth

Real Interest Rate

The growth rate of purchasing power derived from an investment is the:

The complete portfolio includes:

The entire investor's wealth

What is the Capital Market Line?

The capital allocation line provided by one-month T-bills and a broad index of common stocks; A passive strategy using the broad stock market index as the risk portfolio generates an investment opportunity set tha…

A nominal interest rate

The interest rate in terms of "non adjusted for purchasing power" dollars is called:

Weighted-average of returns in all possible outcomes

In scenario analysis, the HPR is calculated by computing:

Annual percentage rate (APR) is always:

Less than or equal to effective annual rate