financial management - chapter 5 vocab

Portfolio -- a collection, or group, of assets
risk -- the chance of financial loss or, more formally, the variability of returns associated with a given cost
return -- the total gain or loss experienced on an investment over a given period of time; calculated by dividing the assets Cash distributions during the period, plus change in value, by a its beginning of period investment value

Sources of risk
firm specific risks
business risk -- the chance at the firm will be unable to cover its operating costs. Level is driven I the firm's revenue stability and the structure of its operating costs (fixed versus variable)
financial risk -- the chance that the firm will be unable to cover its financial obligations. Level is driven by the predictability of the firms operating cash flows and its fixed cost financial obligations
shareholder specific risks
interest rate risk -- the chance that changes in interest rates will adversely affect the value of investment. Most investments lose value when the interest rate raises and increases in value when it falls
liquidity risk -- the chance that an investment cannot be easily liquidated at a reasonable price. Liquidity is significantly affected by the size and depth of the market in which an investment is customarily traded
market risk -- the chance that the value of investment will decline because of market factors that are independent of the investment (such as economic, political, and social event's). In general, the more a given investments value response to the market, the greater its risk; the less it responds, the smaller the risk
firm and shareholder risks
event risk -- the chance that a totally unexpected event will have a significant effect on the value of the firm or a specific investment. These infrequent events, such as government mandated withdrawal of a popular prescription drug, typically affect only a small group of firms or investment
exchange rate risk -- the exposure of future expected cash flows to fluctuations in the currency exchange rate. The greater the chance of undesirable exchange-rate fluctuations, the greater the risk of the cash flows and therefore the lower the value of the firm or investment
purchasing power risk -- the chance that changing price levels caused by inflation or deflation in the economy will adversely affect the firms or investments Cash flows and value. Typically, firms or investments with cash flows that move with general price levels have a little purchasing power risk, and those with cash flows that do not move with general price levels have a high purchasing power risk
tax risk -- the chance that on terrible changes in tax laws will occur. Firms and investments with values that are sensitive to tax law changes are more risky

Risk indifferent -- the attitude toward risk in which no change in return would be required for an increase in risk
risk averse -- the attitude toward risk in which an increase return would be required for an increase in risk
risk seeking -- the attitude toward risk in which a decreased return would be accepted for an increase in risk
sensitivity analysis -- an approach for assessing risk that uses several possible return estimates to obtain a sense of variability among outcomes
range -- a measure of an assets risk, which is found by subtracting the pessimistic outcome from the optimistic outcome
probability -- the chance that a given outcome will occur
probability distribution -- a model that releases of abilities to the associated outcomes
bar chart -- the simplest type of probability distribution; shows only a limited number of outcomes and associated probabilities for a given event
continuous probability distribution -- a probability distribution showing all the possible outcomes and associated probabilities for a given event
standard deviation -- the most common statistical indicator of an assets risk; it measures the dispersion around the expected value
expected value of return -- the most likely return on a given asset
normal probability distribution -- asymmetrical probability distribution to shape resembles a bell shaped curve
coefficient of variation (CV) -- a measure of relative dispersion that is useful in comparing the risks of assets with differing expected returns
efficient portfolio -- a portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return
correlation -- a statistical measure of the relationship between any two series of numbers representing data of any kind
positively correlated -- describes two series that move in the same direction
negatively correlated -- describes two series that move in opposite directions
correlation coefficient -- a measure of the degree of correlation between two series
perfectly positively correlated -- describes to positively correlated series that have a correlation coefficient of +1
perfectly negatively correlated -- describes to negatively correlated series that have a correlation coefficient of -1
uncorrelated -- describes two series that lack any interaction and therefore have a correlation coefficient close to zero
diversification -- combining negatively correlated assets to reduce, or diversify, risk
political risk -- risk that arises from the possibility that a host government will take actions harmful to foreign investors or that political turmoil in a country will endanger investments there
capital asset pricing model (CAPM) -- the basic theory that links risk and return for all assets
total risk -- the combination of a securities nondiversified risk and diversifiable risk
diversifiable risk -- the portion of an assets risk that is attributable to firm specific, random causes; can be eliminated through diversification. Also called unsystematic risk
beta coefficient (b) -- a relative measure of nondiversifiable risk. An index of the degree of movement of an assets returned in response to a change in the market return
market return -- the return on the market portfolio of all traded securities
risk-free rate of return -- the required return on a risk-free asset, typically a three-month U.S. Treasury bill
U.S. Treasury bills (T-bills) -- short-term IOUs issued by the U.S. Treasury; considered the risk-free assets
security market line (SML) -- the depiction of the capital asset pricing model (CAPM) as a graph that reflects the required return in the marketplace for each level of nondiversifiable risk (beta)
efficient market -- a market with the following characteristics: many small investors, all having the same information and expectations with respect to securities; no restrictions on investment, no taxes, and no transaction costs; and rational investors, who views securities similarly and are risk averse, preferring higher returns and lower risk