Finance Exam 2
None of the Above is NEVER the answer
NOTES 9/28/2006
Value Assets: Investments and capital budgeting
Value = PV of Benefits
Risk Analysis- Definition of risk: Relative measure of the degree of variability of possible outcomes over time.
Utility Theory and Risk Aversion
Are the people risk seekers or risk averters? Las Vega lottery vs. insurance and diversifying
The utility curve measures wealth on X axis and utility on Y axis.
The only thing that changed was the width of the distribution, not the probability of winning or losing
Methods for describing the risk of an asset held in isolation
1)
Standard deviation: absolute measure of risk variability “average goof”
2) Coefficient of Variation (v): relative variance, risk/return.
SD (o) is expressed in absolute terms in order to evaluate the dispersion of outcomes with different x’s the coefficient of
variation is used.
NOTES 10/3/2006
Return in a Portfolio
The expected return on a portfolio is simply the weighted average expected return on the individual securities in the portfolio.
Risk in a Portfolio
The expected stated deviation of a portfolio is generally LESS than the weighted average SD’s of the individual securities.
Diversification- Lowers risk as long as assets don’t move perfectly together.
EXAMPLE: Sunglasses, Umbrellas, and Suntan lotion during the sunny/rainy seasons.
Sunglasses and suntan lotion are systematic because they move together.
Since sunglasses and umbrellas move oppositely, the risk is diversified.
Mathematical Formula for the Standard Deviation of a Portfolio (Eliminating Risk)
Row AB is the correlation coefficient between assets A and B.
It allows for the elimination of risk.
The key for diversification is the coefficient correlation, ranging from 0 to 1.
NOTES 10/10/2006
Dow Jones Industrial Average- Average of 30 big stocks reached it’s all-time peak.
If you can value an asset, you can make a good decision.
Risk in a Portfolio:
If things move together, they don’t eliminate risk.
If they do not move together, they eliminate risk.
1)
Unsystematic Risk (Diversifiable or company-specific risk)- Risk that CAN be eliminated through random diversification.
Unsystematically unique, so it can be diversified and eliminated.

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