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Chapter 4&5 - Exam II Review(Chapters 4 5 Chapter 4...

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Exam II Review (Chapters 4 & 5) Chapter 4: Key Concepts The Concept of Return A. Components of Return 1. Current Income 2. Capital Gains (or Losses) B. Why Return Is Important 1. Historical Performance 2. Expected Return C. Level of Return 1. Internal Characteristics 2. External Forces D. Historical Returns and Expected Returns Measuring Return A. Real, Risk-Free, and Required Returns B. Holding Period Return 1. Understanding Return Components 2. Computing the Holding Period Return (HPR)
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3. Using the HPR in Investment Decisions C. Yield: The Internal Rate of Return Risk: The Other Side of the Coin A. Sources of Risk 1. Business Risk 2. Financial Risk 3. Purchasing Power Risk 4. Interest Rate Risk 5. Liquidity Risk 6. Tax Risk 7. Market Risk 8. Event Risk B. Risk of a Single Asset 1. Standard Deviation: An Absolute Measure of Risk 2. Coefficient of Variation: A Relative Measure of Risk 3. Historical Returns and Risk, Expected Returns and Risk 1. Returns are rewards for investing. The components of total return are current income and capital gains (or losses) . Current income is income received in cash or near-cash, whereas capital gains refers to income that is attributed to an increase—realized or unrealized—in the value of the investment. 2. Expected return motivates a person to invest in a particular vehicle. Expectations of returns are based on the past returns of that vehicle or the probability distribution of possible returns. Measuring the historical return of a particular investment reveals its average return as well as the trend of its returns 3. Yield , also called the internal rate of return (IRR) , represents the annual rate of return earned on a long-term investment. A satisfactory investment is one that has a yield equal to or greater than the appropriate discount rate.
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4. The concept of risk . The possible sources of risk include business risk, financial risk, purchasing power risk, interest rate risk, liquidity risk, tax risk, market risk, and event risk. The basic types of risk include diversifiable, nondiversifiable, and total. The standard deviation is a measure of absolute total risk. Chapter 5: Key Concepts I. Principles of Portfolio Planning A. Portfolio Objectives B. Portfolio Return and Standard Deviation C. Correlation and Diversification 1. Correlation 2. Diversification 3. Impact on Risk and Return D. International Diversification 1. Effectiveness of International Diversification 2. Methods for International Diversification 3. Benefits of International Diversification II. The Capital Asset Price Model (CAPM) A. Components of Risk B. Beta: A Popular Measure of Risk 1. Deriving Beta 2. Interpreting Beta 3. Applying Beta C. The CAPM: Using Beta to Estimate Return 1. The Equation
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2. Historical Risk Premiums 3. The Graph: The Security Market Line (SML) III. Traditional Versus Modern Portfolio Theory A. The Traditional Approach B. Modern Portfolio Theory 1. The Efficient Frontier 2. Portfolio Betas a. Risk Diversification b. Calculating Portfolio Betas c. Using Portfolio Betas d. Interpreting Portfolio Betas 3. The Risk-Return Tradeoff: C.
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