4 Risk and Return Free Online FlashCards

How do return and risk differ?

Return is the income and change in value an investment produces; risk is the uncertainty that its actual return will differ from what was expected.

What does holding-period return include?

Holding-period return includes both income and the change in price: $R=\frac{P_1-P_0+D}{P_0}$, where $P_0$ and $P_1$ are beginning and ending prices, and $D$ is income received.

What happens to $\$100$ after a $50\%$ gain and then a $50\%$ loss?

A $50\%$ gain followed by a $50\%$ loss leaves $\$100$ at $\$75$, because the loss applies to the increased value.

How is expected return calculated from possible outcomes?

Expected return is the probability-weighted average of possible returns: $E(R)=\sum_i p_iR_i$, where $p_i$ is the probability of outcome $i$.

How is a portfolio’s return calculated?

Portfolio return is the weighted average of its assets’ returns: $R_p=\sum_{i=1}^{n}w_iR_i$, where the portfolio weights sum to $1$.

How can correlation affect diversification benefits?

When asset returns are less than perfectly correlated, combining them can reduce portfolio volatility. Lower correlation generally offers more potential for risk reduction, all else equal.

What is unsystematic risk?

Unsystematic risk is concentrated in a company or narrow industry, such as a product failure or management problem. Diversification can reduce much of it.

What is a risk premium?

A risk premium is expected return above the return on a relatively low-risk benchmark, offered as compensation for bearing risk.

What does beta measure, and what does it not measure?

Beta measures how an asset’s returns have tended to move with the market: $1$ indicates market-level sensitivity, above $1$ greater sensitivity, and below $1$ lower sensitivity. It is not total volatility.

What does the arithmetic average of returns measure?

The arithmetic average is the sum of the periodic returns divided by the number of periods; it summarizes the average one-period return.

What does the geometric average of returns represent?

The geometric average is the constant per-period rate that would produce the same compounded ending value. It is generally more informative for long-run compound growth.

What does standard deviation measure in investment returns?

Standard deviation is the square root of variance and measures how widely returns vary around their average. It is expressed in the same units as returns.