Term
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Definition
-refers to the fact that individuals prefer less risk to more risk
-a risk averse individual will only accept more risk if it is accompanies by a higher return |
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Term
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Definition
| -investor is equally satisfied at any risk/return combinations along this curve |
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Term
| variance of returns for an individual security |
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Definition
σ2= ∑Pi[Ri-E(R)]2
p= probablity of Ri occuring
Ri= return |
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Term
covariance
*based on historical data instead of E(R)
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Definition
∑{[Rt,1 -R1][Rt,2 -R2]}
n-1
n= number of returns
Rt,1= return on asset 1 in period t
Rt,2= return on asset 2 in period t
R1= mean return on asset 1
R2= mean return on asset 2
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Term
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Definition
ρ1,2= Cov1,2
σ1σ2
Cov1,2= ρ1,2σ1σ2
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Term
| standard deviation of two-asset portfolios |
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Definition
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Term
| 4 steps in portfolio management process |
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Definition
1) Write a policy statement: Specifies investor's goals, constraints, and risk
2) Develop an investment strategy: Based on policy statement and current and project financial and economic conditions
3) Implement the plan: construct portfolio and allocate assets
4) Monitor and Update: Update investor policy statement and monitor market. Rebalance portfolio if needed. |
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Term
| Purpose of the policy statement |
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Definition
| Impose investment discipline on the client and the portfolio manager |
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Term
| Investment objectives must be stated in terms of... |
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Definition
both risk and return
*stating only in terms of return may expose the client to inappropriate, high-risk strategies |
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Term
| Return objectives should consider... |
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Definition
| current income needs, capital appreciation, capital preservation, and total returns |
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Term
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Definition
objective of earning a return at least equal to the inflation rate with little or no chance of loss
*appropriate when funds are needed in the short-term |
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Term
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Definition
objective of earning a nominal return that exceeds the rate of inflation. Goal is to increase purchasing power of initial investment.
*appropriate when funds are for retirement |
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Term
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Definition
primary purpose is to produce income as opposed to capital appreciation
*appropriate when client needs to supplement other sources of income to meet living expenses or some planned spending need. |
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Term
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Definition
objective of having the portfolio grow in value to meet a future need through both capital gains and the reinvestment of current income.
*less risky than capital appreciation, riskier than income objective
*appropriate for investor w/ long-term horizon and moderate risk tolerance |
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Term
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Definition
| ability to quickly convert investments into cash at a price close to fair market value |
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Term
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Definition
refers to the time between making the investment and needing the funds.
*there is a relationship between time horizon, liquidity needs, and risk aversion (shorter time horizon means more risk b/c ability to overcome ST drop his harder) |
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Term
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Definition
| important b/c after-tax returns are what investors should be worried about |
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Term
| legal and regulatory factors |
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Definition
| more a concern for institutional clients, but still applies to individuals. (ex. penalty for early withdrawal on retirement fund) |
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