covariance matrix
A display of the covariances between all possible pairs of a set of variables.
efficient portfolio
Portfolio providing the maximum return for the level of risk
industry effect
The tendency of firms sharing a similar line of business to experience similar movements in their earnings or stock prices.
markowitz model
Any portfolio construction technique using the full covariance matrix is called ______
minimum variance
The combination of assets from a security universe that has lower variance than any other possible combination.
multi-index model
A theoretical representation of market prices in which price effects other than those from systematic risk are included.
single-index model
A model of security price behavior that compares all securities to a single benchmark
arbitrage pricing theory (APT)
A pricing theory based on the absence of arbitrage and the notion that a security's expected return comes from a number of economic factors.
borrowing portfolio
In the context of the capital market line, an efficient portfolio that involves purchasing the market portfolio on margin.
capital asset pricing model (CAPM)
A theoretical model measuring the expected return of an asset in terms of its beta and the expected return on a broad market index.
capital market line (CML)
A line drawn in expected return/standard deviation space from the risk-free rate to the market portfolio.
corner portfolio
A portfolio generated by the Markowitz full covariance model, in which a new security enters the portfolio or an existing security leaves as portfolio risk changes.
dominance
The characteristic an investment alternative has when its risk and return characteristics are preferable to the alternatives.
efficient frontier
The collection of dominant portfolios for given levels of risk or return.
equity risk premium
The difference in the average return between stocks and some measure of the risk-free rate, usually either the Treasury bill rate or Treasury bond rate.
lending portfolio
In the context of the capital market line, an efficient portfolio that is partially invested in the riskless interest rate.
market model
A regression model relating the past series of excess returns on an investment to the past series of excess returns on a market index. The ______ is often used to estimate beta for the Capital Asset Pricing Model.
market portfolio
A theoretical construct of the Markowitz full covariance model that represents the tangent point of a line from the risk-free rate to the efficient frontier for risky securities.
market price of risk
Measures the cost of expected return in terms of risk. The slope of the SML.
markowitz diversification
Diversification designed to exploit the covariances of the portfolio components.
minimum variance portfolio
The combination of assets from a security universe that has lower variance than any other possible combination.
naive diversification
A method of achieving a reduction of portfolio risk by investing in
several securities without particular regard for the individual security characteristics.
quadratic programming
An extension of linear programming in which the objective function contains a second-order term.
security market line (SML)
A plot of the expected returns of securities against their betas.
stochastic dominance
A theory of dominance based on the likelihood of realizing an outcome below a certain level. Regardless of the level chosen, the less the likelihood of earning less than this amount, the better.
superfluous diversification
Holding more securities than are reasonably required to reduce unsystematic risk to a practical minimum.
systematic risk
The variance of a security's returns that stems from overall market movements and is measured by beta.
total risk
The sum of systematic and unsystematic risk.
unsystematic risk
Diversifiable risk that is unique to a particular company.
absolute purchasing power parity
The fact that, because of the law of one price, equivalent assets in different countries should sell for the same price after adjusting for currency differences. "Law of one price
american depository receipts (ADRs)
Securities that are actually receipts representing shares of stock that are held on the holder's behalf in a bank in the country of origin.
country risk
An aspect of the risk assessment of foreign investments, particularly involving a measurement of political risk in a particular country.
cover
The process of eliminating an existing investment position by taking an offsetting trade.
covered interest arbitrage
A sequence of actions in the currency markets, currency forward markets, and different money markets that results in a riskless profit because of these markets being out of equilibrium.
economic exposure
A type of exposure that measures the risk that the value of a security will decline due to an unexpected change in relative foreign exchange rates.
emerging market
An imprecise term referring to a country without a mature stock market or exchange mechanism.
eurobond
A debt agreement that is denominated in a currency other than that of the country in which it is held.
foreign bond
A debt agreement that is denominated in the local currency but
issued by a foreign corporation.
foreign currency option
A listed option giving the holder the right to buy or sell a specified quantity of foreign currency.
foreign exchange risk
The chance of loss due to adverse fluctuations in exchange rates between national currencies.
forward rate
A contractual rate between a commercial bank and a client for the future delivery of a specified quantity of foreign currency; the ______ is normally quoted on the basis of one, two, three, six, and twelve months.
futures contract
A legal, transferable, standardized contract that represents a promise to buy or sell a quantity of a standardized commodity by a predetermined delivery date.
hedging
The act of transferring unwanted risk to another market participant who is willing to bear it.
inflation premium
The rapidity with which prices are rising; it measures how rapidly the money standard is losing its purchasing power.
interest rate parity
The theory that in the absence of market imperfections, international foreign currency exchange rates reflect differentials in the relative national interest rates.
macro risk
An element of political risk that describes government action that affects all foreign firms in a particular industry.
micro risk
A risk that refers to the direction of politically motivated changes in the business environment of selected fields of business activity, or to foreign enterprises with specific characteristics.
political risk
Risk that arises from the potential for foreign governments to interfere with the operation of a company or with the free flow of investment capital or profits across international boundaries.
portfolio investment
Foreign investment via the securities markets; also known as financial investment.
purchasing power parity (PPP)
The phenomenon in international finance whereby relative exchange rates reflect differences in the relative purchasing power of a currency in the two countries.
real investment
An investment in physical assets rather than securities, especially with international investments.
real rate
Theoretically, the rate of return investors demand for giving up the current use of funds.
relative purchasing power parity
The condition in which changes in exchange rates stem from changes in countries' inflation rates.
risk premium
The component of interest rates that is toughest to measure; It is the component of interest rates that reflects compensation for risk to risk-adverse investors
spot rate
The current exchange rate for two currencies; the rate that is posted on signs at international airports and in banking centers. The spot rate changes daily.
transaction exposure
The chance of loss associated with the purchase or sale of goods due to changes in the exchange rate between two currencies.
translation exposure
Exposure that stems from the holding of foreign assets and liabilities that are denominated in currencies other than U.S. dollars.
security universe
the collection of all possible investments