Term
| What is the relationship between the present value of an ordinary annuity and an annuity due? |
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Definition
| PV(Annuity Due) = PV(Ordinary Annuity)(1+r) |
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Term
| What happens to the present value of a sum when interest rates rise? |
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Definition
| The present value declines. |
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Term
| What happens to the future value of a sum when interest rates fall? |
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Definition
| The future value declines |
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Term
| If the cash flows of a project are discounted by the IRR, what is the net present value of the project? |
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Definition
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Term
| Under what conditions can a project have multiple IRRs? |
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Definition
| If there are multiple sign changes |
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Term
| Can IRRs ever be negative? |
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Definition
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Term
If NPV and IRR provide contradictory information about a project, which
should be used? |
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Definition
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Term
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Definition
| Volatility is the standard deviation of the returns to an asset |
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Term
| What is the relationship between covariance and correlation? |
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Definition
| Correlation equals covariance divided by the product of standard deviations |
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Term
| What is a disadvantage of the covariance measure? |
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Definition
| No upper or lower limit and is affected by all units |
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Term
| What does diversification refer to? |
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Definition
Diversification refers to the reduction of risk in a portfolio by holding
assets with low or negative correlations |
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Term
| What is the investment opportunity set? |
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Definition
| The set of all possible portfolios available to an investor |
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Term
| What is the efficient frontier? |
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Definition
The set of all portfolios which have the highest expected return for a given
level of risk |
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Term
| What is the significance of the minimum variance portfolio? |
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Definition
The minimum variance portfolio is the least risky portfolio available to
investors; it forms the lower boundary of the efficient frontier |
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Term
For a portfolio consisting of two assets with a correlation of one, what is the
shape of the investment opportunity set? |
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Definition
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Term
For a portfolio consisting of two assets with a correlation of negative one, what
is the shape of the investment opportunity set? |
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Definition
| Two straight lines; one with a positive slope, and one with a negative slope |
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Term
| What does the beta of a stock measure? |
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Definition
| it shows how sensitive a stock is to market risk |
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Term
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Definition
Beta equals the covariance between the excess returns to a stock and the
market portfolio divided by the variance of the excess returns to the market
portfolio |
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Term
| What is the excess return to a stock? |
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Definition
| This is the return to a stock minus the risk-free rate of interest |
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Term
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Definition
| This is the expected excess return to a stock |
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Term
| What is the beta of a risk-free asset? |
|
Definition
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Term
| What is the beta of the market portfolio? |
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Definition
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Term
| What is required for a stock to have a negative beta? |
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Definition
| The stock’s returns are negatively correlated with the market portfolio |
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Term
| What type of risk is reduced or eliminated in a well-diversified portfolio? |
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Definition
| Non-systematic (firm-specific) risk is eliminated |
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Term
| What are two assumptions of the CAPM model? |
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Definition
all investors choose to be on the efficient frontier
all investors have identical expectations |
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Term
| What is true of a risk-averse investor? |
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Definition
| They will place most or all funds in the risk free asset |
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Term
| What is the CAPM equation? |
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Definition
| E(ri) = rf + βi[E(rM) – rf] |
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Term
| What does the Capital Market Line (CML) show? |
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Definition
The CML shows the relationship between standard deviation and expected
return |
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Term
| What is the intercept of the CML? |
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Definition
| The intercept is the risk-free rate |
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Term
| What is the slope of the CML? |
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Definition
| The slope is the Sharpe Ratio of the Market Portfolio |
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Term
| What does the Security Market Line (SML) show? |
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Definition
| The SML shows the relationship between beta and expected return |
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Term
| What is the intercept of the SML? |
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Definition
| The intercept of the SML is the risk-free rate |
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Term
| What is the slope of the SML? |
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Definition
| The slope of the SML is the risk premium of the market portfolio |
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Term
| What is one important implication of the CAPM? |
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Definition
One important implication is that all investors will choose a combination
of the risk-free asset and the market portfolio |
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