Term
|
Definition
| The total risk of an investment is measure by the variance or, more commonly, the standard deviation of its return |
|
|
Term
|
Definition
| The total return on an investment has two components: the expected return and the unexpected return. The unexpected return comes about because of unanticipated events. The risk from investing stems from the possibility of an unanticipated event. |
|
|
Term
| Systematic and Unsystematic risk: |
|
Definition
| Systematic also called market risk, are unanticipated events. Unsystematic unanticipated events that affect single assets. |
|
|
Term
| The Effect of Diversification: |
|
Definition
| Some, but not all, of the risk associated with a risky investment can be eliminated by diversification. The reason is that unsystematic risks, which are unique to individual assets, tend to wash out in a large portfolio, but systematic risks, which affect all of the assets in a portfolio to some extent, do not. |
|
|
Term
| The systematic risk principle and Beta: |
|
Definition
| Because unsystematic risk can be freely eliminated by diversification, the systematic risk principle states that the reward for bearing risk depends only on the level of systematic risk. The level of systematic risk in a particular asset, relative to the average, is given by the beta of that asset. |
|
|
Term
| The reward to risk ratio and the SLM Security Market Line: |
|
Definition
| In a well functioning market, this ratio is the same for every asset. As a result, when asset expected returns are plotted against asset betas, all asset plot on the same straight line, called the security market line. |
|
|
Term
| The Capital Asset Pricing Model(CAPM) |
|
Definition
| This is a capital asset pricing model (CAPM). The expected return on a risky asset thus has three components. The first is the pure time value of money, the second is the market risk premium and the third is the beta for that asset. |
|
|
