fin management chapter 6

an investment generates comes in the form of cash flows (used to measure returns- no acct profits)

possible cash flows outcomes

potential variability in future cash flows

the greater the risk

risky than returns from investing in savings acct in a bank

also offers the potential of a higher payoff than a treasury bill

measure risk. measures volatility or riskiness of portfolio returns

return (concerning rates of return)

reasonable hedge against inflation (concerning rates of return)

combining several assets

• systematic risk (market risk) risk that affects all firms
• unsystematic risk (company unique risk) risk that affects only a specfic firm

be reduced or eliminated through effective diversification

reduce the overall risk exposure. Degree of reduction depends on the correlation among the assets

no effect on risk

the portfolio is perfectly diversified

negative or low positive correlation to attain diversification benefits

higher risk

is the "line of best fit" for all the stock returns relative to returns of S&P500

measures avg relationship between a stock's returns and those of the S&P500 index returns--slope is called beta

the firm's market risk

risk that remains for a company even after we have diversified our portfolio

• 0: no systematic risk
• 1: equal to the "typical" stock in the marketplace
• >1: greater systematic risk than the typical stock

most between .60 and 1.60

% change on avg of the portfolio for ever 1% change in the general market

risk diversification, through effective risk diversification lower risk without sacrificing expected returns ad increase expected returns without having to assume more risk

diversifying among different kinds of asset types...decision has to be made TODAY, payoff in the future will depend on the mix chosen

risk and return and holding period matters

risk declines

minimum rate of return necessary to attract an investor to purchase or hold a security

required rate of return or discount rate for risk-less investments

by US treasury bill rate

additional return we must expect to receive for assuming risk

demand additional expected returns

thinking about the return that an investor should require on an investment, given the asset's systematic or market risk

graphic representation of the CAPM, where the line shows the appropriate required rate of return for a given stock's systematic risk