Finance chapter 6

what is the relevant variable the financial manager uses to measure returns cash flow
holding-period return the rate of return earned on an investment which equals the dollar gain divided by the amount invested
expected rate of return the arithmetic mean of all possible outcomes where those outcomes are weighted by the probability that each will occur
expected cash flow cf in state 1 x probability in state 1 + cf in state 2 x probability in state 2
holding-period dollar gain price at the end of the period + cash distribution (dividend) – price at the beginning of the period
risk potential variability in future cash flows
how do we quantify risk by computing the variance in the possible investment returns and its square root, standard deviation
the more risky an investment the what the SD higher
four aspects of a return to look at nominal average r, SD, the real average r, the risk premium
what does the SD of a return measure the volatility or riskiness of returns
what is the real average annual rate of return the nominal return less the inflation rate
what does the risk premium represent the additional return received beyond the risk-free rate
if we diversify our investments across different securities what happens to risk declines
company-unique risk the risk related to an investment return that can be eliminated through diversification
what is company-unique risk result of factors that are unique to the particular firm
market risk the risk related to an investment return that cannot be eliminated through diversification
monthly holding returns formula price at the end of the month – price at the beginning of the month all over price at the beginning of the month
financial return the total financial gain or loss of an asset over a given period
expected returns average of the possible rates of returns
risk aversion the tendency of investors to avoid risky investments
risk tolerance the extent to which an investor is willing to accept more risk in exchange for the possibility of a high return

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