FIN 370 Ch 1-8 terms
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real assets
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assets used to produce goods and services
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financial assets
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claims on real assets or the income generated by them
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fixed income (debt) securities
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pay a specified cash flow over a specific period
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agency problems
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conflicts of interest between managers and stockholders
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asset allocation
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allocation of an investment portfolio across broad asset classes
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security selection
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choice of specific securities within each asset class
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security analysis
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analysis of the value of securities
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risk-return trade-off
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assets with higher expected returns entail greater risk
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passive management
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buying and holding a diversified portfolio without attempting to identify mispriced securities
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active management
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attempting to identify mispriced securities or to forecast broad market trends
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financial intermediaries
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institutions that connect borrowers and lenders by accepting funds from lenders and loaning funds to borrowers
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investment companies
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firms managing funds for investors. an investment company may manage several mutual funds
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investment banker
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firms specializing in the sale of new securities to the public, typically by underwriting the issue
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primary market
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market in which new issues of securities are offered to the public
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secondary market
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previously issued securities are traded among investors
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equity
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an ownership share in a corporation
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venture capital
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money invested to finance a new firm
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private equity
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investments in companies that are not traded on a stock exchange
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securitization
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pooling loans into standardized securities backed by these loans, which can then be traded like any other security
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systemic risk
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risk of breakdown in the financial system
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investment
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commitment of current resources in the expectation of deriving greater resources in the future
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derivative securities
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securities providing payoffs that depend on the values of other assets
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money market
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include short term, highly liquid and relatively low risk debt instruments
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treasury bills
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short term government securities issued at a discount from face value and returning the face amount at maturity
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certificate of deposit
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a bank time deposit
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commercial paper
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short term unsecured debt issued by large corporations
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bankers acceptance
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order to a bank by a customer to pay a sum of money at a future date
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eurodollars
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dollar denominated deposits at foreign banks or foreign branches of American banks
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repurchase agreements
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short term sales of government securities with an agreement to repurchase the securities at a higher price
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federal funds
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funds in the accounts of commercial banks at the Federal Reserve Bank
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LIBOR
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lending rate among banks in the London market
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treasury notes or bonds
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debt obligations of the federal government with original maturities of one year or more
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municipal bonds
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tax-exempt bonds issued by state and local governments
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corporate bonds
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long-term debt issued by private corporations typically paying semiannual coupons and returning the face value of the bond at maturity
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common stocks
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ownership shares in a publicly held corporation. shareholders have voting rights and may receive dividends
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preferred stock
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nonvoting shares in a corporation, usually paying a fixed stream of dividends
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price-weighted average
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average computed by adding the prices of the stocks and dividing by a divisor
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market value-weighted index
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index return equals the weighted average of the returns of each component security, with weights proportional to outstanding market value
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equally weighted index
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index computed from a simple average of returns
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derivative asset
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security with a payoff that depends on the prices of other securities
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call option
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right to buy an asset at a specified price on or before a specified expiration date
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put option
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right to sell an asset at a specified exercise price on or before a specified expiration date
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futures contract
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obliges traders to purchase or sell an asset at an agreed upon price at a specified future date
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primary market ch 3
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market for new issues of securities
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secondary market ch 4
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market for already-existing securities
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private placement
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primary offerings in which shares are sold directly to a small group of institutional or wealthy investors
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initial public offering
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first sale of stock by a formerly private company
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underwriters
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purchase securities from the issuing company and resell them to the public
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prospectus
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description of the firm and the security it is issuing
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dealer markets
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markets in which traders specializing in particular assets buy and sell for their own accounts
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auction market
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market where all traders meet at one place to buy or sell an asset
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bid price
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the price at which a dealer or other trader is willing to purchase a security
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ask price
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the price at which a dealer or other trader will sell a security
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bid-ask spread
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the difference between the bid and asked prices
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limit buy (sell) order
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an order specifying a price at which an investor is willing to buy or sell a security
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stop order
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trade is not to be executed unless stock hits a price limit
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over-the-counter market
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informal network of brokers and dealers who negotiate sales of securities
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NASDAQ stock market
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computer-linked price quotation and trade execution system
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electronic communication networks
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computer networks that allow direct trading without the need for market makers
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specialist
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trader who makes a market in the shares of one or more firms and who maintains a fair and orderly market by dealing personally in the market
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stock exchanges
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secondary markets where already issued securities are bought and sold by members
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latency
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the time it takes to accept, process, and deliver a trading order
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algorithmic trading
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use of computer programs to make rapid trading decisions
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high-frequency trading
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subset of algorithmic trading that relies on computer programs to make very rapid trading decisions
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blocks
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large transactions in which at least 10,000 shares of stock are bought or sold
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dark pools
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electronic trading networks where participants can anonymously buy or sell large blocks of securities
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margin
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describes securities purchased with money borrowed in part from a broker. margin is the net worth of the investor's account
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short sales
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sale of shares not owned by the investor but borrowed through a broker and later purchased to replace the loan
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inside information
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nonpublic knowledge about a corporation possessed by corporate officers, major owners, or other individuals with privileged access to information about the firm
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investment companies ch 4
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financial intermediaries that invest the funds of individual investors in securities or other assets
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net asset value
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assets minus liabilities expressed on a per-share basis
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unit investment trusts
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money pooled from many investors that is invested in a portfolio fixed for the life of the fund
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open end fund
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fund that issues or redeems its shares at net asset value
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closed end fund
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shares may not be redeemed but instead are traded at prices that can differ from net asset value
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load
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sales commission charged on a mutual fund
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hedge fund
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private investment pool, open to wealthy or institutional investors, that is exempt from SEC regulation and can therefore pursue more speculative policies than mutual funds
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funds of funds
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mutual funds that primarily invest in shares of other mutual funds
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12b-1 fees
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annual fees charged by a mutual fund to pay for marketing and distribution costs
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soft dollars
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the value of research services that brokerage houses provide free of charge in exchange for the investment manager's business
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turnover
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the ratio of the trading activity of a portfolio to the assets of the portfolio
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exchange-traded funds
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offshoots of mutual funds that allow investors to trade index portfolios
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holding-period return
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rate of return over a given investment period
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arithmetic average
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the sum of returns in each period divided by the number of periods
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geometric average
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the single per-period return that gives the same cumulative performance as the sequence of actual returns
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dollar-weighted average return
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internal rate of return on an investment
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scenario analysis
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process of devising a list of possible economic scenarios and specifying the likelihood of each one, as well as the HPR that will be realized in each case
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probability distribution
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list of possible outcomes with associated probabilities
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expected return
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the mean value of the distribution of HPR
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variance
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expected value of the squared deviation from the mean
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standard deviation
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the square root of the variance
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value at risk
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measure of downside risk. the worst loss that will be suffered with a give probability, often 5%
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kurtosis
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measure of the fatness of the tails of a probability distribution relative to that of a normal distribution. indicates likelihood of extreme outcomes
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skew
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measure of the asymmetry of a probability distribution
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risk-free rate
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rate of return that can be earned with certainity
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risk premium
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expected return in excess of that on risk-free securities
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excess return
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rate of return in excess of the risk-free rate
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risk aversion
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reluctance to accept risk
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price of risk
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the ratio of portfolio risk premium to variance
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sharpe (reward to volatility) ratio
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ratio of portfolio risk premium to standard deviation
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mean-variance analysis
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ranking portfolios by their Sharpe ratios
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inflation rate
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the rate at which prices are rising, measured as the rate of increase of the CPI
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nominal interest rate
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interest rate in terms of nominal (not adjusted for purchasing power) dollars
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real interest rate
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excess of the interest rate over the inflation rate. growth rate of purchasing power derived from an investment
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asset allocation
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portfolio choice among broad investment classes
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capital allocation
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choice between risky and risk-free assets
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complete portfolio
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entire portfolio including risky and risk-free assets
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capital allocation line
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plot of risk-return combinations available by varying portfolio between a risk-free asset and a risky portfolio
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passive strategy
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investment policy that avoids security analysis
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capital market line
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the capital allocation line using the market index portfolio as the risky asset
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market risk/systematic risk/non-diversifiable risk
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risk factors common to the whole economy
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unique risk/firm-specific risk/nonsystematic risk/diversifiable risk
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risk that can be eliminated by diversification
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investment opportunity set
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set of available portfolio risk-return combinations
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optimal risky portfolio
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the best combination of risky assets to be mixed with safe assets to form the complete portfolio
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efficient frontier
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graph representing a set of portfolios that maximizes expected return at each level of portfolio risk
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separation property
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the property that implies portfolio choice can be separated into two independent tasks: 1) determination of the optimal risky portfolio 2) the personal choice of the best mix of the risky portfolio and the risk-free asset
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index model
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model that relates stock returns to returns on both a broad market index and firm specific factors
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excess return ch 6
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rate of return in excess of the risk-free rate
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beta
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the sensitivity of a security's returns to the market factor
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firm specific/residual risk
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component of return variance that is independent of the market factor
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alpha
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stock's expected return beyond that induced by the market index; its expected excess return when the market's excess return is 0
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security characteristic line
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plot of a security's predicted excess return from the excess return of the market
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information ratio
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ratio of alpha to the standard deviation of the residual
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active portfolio
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portfolio formed by optimally combining analyzed stocks
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capital asset pricing model
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model that relates the required rate of return on a security to its systematic risk as measured by beta
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market portfolio
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portfolio for which each security is held in proportion to its total market value
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mutual fund theorem
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states that all investors desire the same portfolio of risky assets and can be satisfied by a single mutual fund composed of that portfolio
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expected return-beta relationship
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implication of the CAPM that security risk premiums will be proportional to the beta
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security market line
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graphical representation of the expected return-beta relationship of the CAPM
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alpha ch 7
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abnormal rate of return on a security in excess of what would be predicted by an equilibrium model such as the CAPM
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security characteristic line ch 7
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a plot of a security's expected excess return over the risk-free rate as a function of the excess return on the market
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multifactor models
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models of security returns that respond to several systematic factors
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arbitrage
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creation of riskless profits made possible by relative mispricing among securities
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arbitrage pricing theory
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theory of risk-return relationships derived from no-arbitrage considerations in large capital markets
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well-diversified portfolio
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portfolio sufficiently diversified that nonsystematic risk is negligible
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arbitrage portfolio
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zero-net investment, risk-free portfolio with a positive return
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factor portfolio
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a well-diversified portfolio constructed to have a beta of 1 on one factor and a beta of zero on any other factor
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random walk
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the notion that stock price changes are random and unpredictable
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efficient market hypothesis
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hypothesis that prices of securities fully reflect available information about securities
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weak-form EMH
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assertion that stock prices already reflect all info contained in the history of past trading
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semistrong-form EMH
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the assertion that stock prices already reflect all publicly available info
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strong-form EMH
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the assertion that stock prices reflect all relevant info, including inside information
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technical analysis
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research on recurrent and predictable stock price patterns and on proxies for buy or sell pressure in the market
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resistance level
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price level above which it is supposedly unlikely for a stock or stock index to rise
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support level
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price level below which it is supposedly unlikely for a stock or stock index to fall.
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fundamental analysis
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research on determinants of stock value
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passive investment strategy
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buying a well-diversified portfolio without attempting to search out mispriced securities
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index fund
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a mutual fund holding shares in proportion to their representation in a market index such as the S&P 500
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momentum effect
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the tendency of poorly performing stocks and well-performing stocks in one period to continue that abnormal performance in following periods
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reversal effect
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the tendency of poorly performing stocks and well-performing stocks in one period to experience reversals in the following period
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anomalies
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patterns of returns that seem to contradict the efficient market hypothesis
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P/E effect
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portfolios of low P/E stocks have exhibited higher average risk-adjusted returns that high P/E stocks
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small-firm effect
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stocks of small firms have earned abnormal returns, primarily in the month of Jan
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neglected-firm effect returns
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tendency of investments in stock of less well-known firms to generate abnormal returns
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book-to-market effect
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the tendency for investments in shares of firms with high ratios of book value to market value to generate abnormal returns
