Asset Management Final Exam Review
Time value of money (tvm) - answer-money is more valuable today than tomorrow
-to forego consumption today, you need to be enticed; you need to be compensated for
delayed gratification (return on your investment)
equity - answer ownership interest in a firm; sometimes used interchangeably with
common stock or net worth
-(stocks, real estate, etc.)
-value comes from earnings paid to equity owners and future growth of the business
debt - answer-bonds, loans, etc.
-value comes from amount to be repaid (principal + interest)
normal distribution - answer a distribution corresponding to the shape of the normal
(bell) curve
-math makes it so you always get this if you are adding up averages
standard deviation - answera measure of the degree of dispersion of a distribution; the
square root of the variance
-probability of various events occurring
-68, 95, 99 %
systematic risk - answerthe degree to which a specific asset's return is affected by
political, economic, demographic, or social events and trends; also, the degree to which
an asset's return is affected by the investment market as a whole
-inherent in the system; can't be avoided
-inflation, interest rates, market risk (political unrest, economic cycles, etc.)
non-systematic risk - answerrisk not related to general market movements; diversifiable
-specific to a firm or sector; not rewarded
-default (credit) risk, country or sector risk, management, technology, competition
,beta - answera parameter in the CAPM and APM models that relates stock or portfolio
performance to market performance
-how to measure systematic risk
-a measure of the volatility of a security in comparison to the market as a whole
-if less than 1= stock is less volatile than the market
-if more than 1= stock is more volatile than the market
B<0 - answerasset generally moves in the opposite direction as compared to the index;
a short position in a stock
B=0 - answermovement of the asset is uncorrelated with the movement of the
benchmark; fixed-income asset whose growth is unrelated to the movement of the stock
market
0 <B< 1 - answermovement of the asset is generally in the same direction as the
benchmark, but less susceptible to day-to-day fluctuations; large-cap value stocks
B=1 - answermovement of the asset is generally in the same direction as, and exhibits
similar volatility of the benchmark; index fund
B>1 - answermovement of the asset is generally in the same direction as, but more than
the movement of the benchmark; stocks which are very strongly influenced by day-to-
day market news, or by the general health of the economy
capital asset pricing model (CAPM) - answerthe theoretical model that seeks to explain
returns as a function of the relationship between risk-free rate, market risk premium,
and beta
-expected returns must be higher for risky assets
Rf + B(Rm-Rf)= expected return
modern portfolio theory - answerthe combination of CAPM, efficient market hypothesis
(EMH), and related theoretical models of security market pricing and performance
Jensen's alpha - answera risk-adjusted measure of stock or portfolio performance; the
difference between the actual return to a stock or portfolio and the return that would
have been expected, based on CAPM
-a= asset return - CAPM
-a= Rfund - (Rf + B(Rm-Rf))
-positive= beat the market
, -negative= underperform the market
sharpe ratio - answera measure of risk-adjusted performance of an asset, calculated as
the ratio of asset's rate of return minus the risk-free rate divided by the asset's standard
deviation
-allows us to compare the efficiency of different portfolios
treynor ratio - answera measure of risk-adjusted performance of an asset calculated as
the ratio of the asset's rate of return minus the risk-free rate divided by the asset's beta
correlation coefficient - answera measure of the comovement tendency of two variables,
such as the returns of two securities
-combining assets with less than perfect correlation will improve risk/return
characteristics of the portfolio
-ranges from -1 to +1
0=independent
efficient frontier - answera set of portfolios, each of which offers the highest expected
return for a given risk and the smallest risk for a given expected return
-the mix that provides the most return at each given level of risk
capital market line - answerthe line formed by combinations of the risk-free asset and
the market portfolio
-optimal risky portfolio will be a combination of all risky assets
-all combinations of investment in risk-free asset and market portfolio
-all combinations have the same (maximum) sharpe ratio
-slope of line= the sharpe ratio of the market portfolio
implications of MPT and CAPM - answer-investors should diversify to minimize
unsystematic risk
-systematic risk is the risk that is rewarded
-all positions on the capital market line have the same maximum sharpe ratio
-optimal household portfolio= expected utility maximizing allocation between Rf and
market portfolio
Time value of money (tvm) - answer-money is more valuable today than tomorrow
-to forego consumption today, you need to be enticed; you need to be compensated for
delayed gratification (return on your investment)
equity - answer ownership interest in a firm; sometimes used interchangeably with
common stock or net worth
-(stocks, real estate, etc.)
-value comes from earnings paid to equity owners and future growth of the business
debt - answer-bonds, loans, etc.
-value comes from amount to be repaid (principal + interest)
normal distribution - answer a distribution corresponding to the shape of the normal
(bell) curve
-math makes it so you always get this if you are adding up averages
standard deviation - answera measure of the degree of dispersion of a distribution; the
square root of the variance
-probability of various events occurring
-68, 95, 99 %
systematic risk - answerthe degree to which a specific asset's return is affected by
political, economic, demographic, or social events and trends; also, the degree to which
an asset's return is affected by the investment market as a whole
-inherent in the system; can't be avoided
-inflation, interest rates, market risk (political unrest, economic cycles, etc.)
non-systematic risk - answerrisk not related to general market movements; diversifiable
-specific to a firm or sector; not rewarded
-default (credit) risk, country or sector risk, management, technology, competition
,beta - answera parameter in the CAPM and APM models that relates stock or portfolio
performance to market performance
-how to measure systematic risk
-a measure of the volatility of a security in comparison to the market as a whole
-if less than 1= stock is less volatile than the market
-if more than 1= stock is more volatile than the market
B<0 - answerasset generally moves in the opposite direction as compared to the index;
a short position in a stock
B=0 - answermovement of the asset is uncorrelated with the movement of the
benchmark; fixed-income asset whose growth is unrelated to the movement of the stock
market
0 <B< 1 - answermovement of the asset is generally in the same direction as the
benchmark, but less susceptible to day-to-day fluctuations; large-cap value stocks
B=1 - answermovement of the asset is generally in the same direction as, and exhibits
similar volatility of the benchmark; index fund
B>1 - answermovement of the asset is generally in the same direction as, but more than
the movement of the benchmark; stocks which are very strongly influenced by day-to-
day market news, or by the general health of the economy
capital asset pricing model (CAPM) - answerthe theoretical model that seeks to explain
returns as a function of the relationship between risk-free rate, market risk premium,
and beta
-expected returns must be higher for risky assets
Rf + B(Rm-Rf)= expected return
modern portfolio theory - answerthe combination of CAPM, efficient market hypothesis
(EMH), and related theoretical models of security market pricing and performance
Jensen's alpha - answera risk-adjusted measure of stock or portfolio performance; the
difference between the actual return to a stock or portfolio and the return that would
have been expected, based on CAPM
-a= asset return - CAPM
-a= Rfund - (Rf + B(Rm-Rf))
-positive= beat the market
, -negative= underperform the market
sharpe ratio - answera measure of risk-adjusted performance of an asset, calculated as
the ratio of asset's rate of return minus the risk-free rate divided by the asset's standard
deviation
-allows us to compare the efficiency of different portfolios
treynor ratio - answera measure of risk-adjusted performance of an asset calculated as
the ratio of the asset's rate of return minus the risk-free rate divided by the asset's beta
correlation coefficient - answera measure of the comovement tendency of two variables,
such as the returns of two securities
-combining assets with less than perfect correlation will improve risk/return
characteristics of the portfolio
-ranges from -1 to +1
0=independent
efficient frontier - answera set of portfolios, each of which offers the highest expected
return for a given risk and the smallest risk for a given expected return
-the mix that provides the most return at each given level of risk
capital market line - answerthe line formed by combinations of the risk-free asset and
the market portfolio
-optimal risky portfolio will be a combination of all risky assets
-all combinations of investment in risk-free asset and market portfolio
-all combinations have the same (maximum) sharpe ratio
-slope of line= the sharpe ratio of the market portfolio
implications of MPT and CAPM - answer-investors should diversify to minimize
unsystematic risk
-systematic risk is the risk that is rewarded
-all positions on the capital market line have the same maximum sharpe ratio
-optimal household portfolio= expected utility maximizing allocation between Rf and
market portfolio
