Principles of Investments

Review Sheet

Exam 1

Chapter 1Investment: Background and Issues

• Understand the primary differences between real assets and financial assets.
• What is asset allocation, and how is it accomplished?
• Understand what it means for the financial markets to be efficient. What are the implications for investors?
• What is the difference between active portfolio management and passive portfolio management? Which of these management techniques should be used if the markets are efficient?
• How do financial markets that operate efficiently help increase a country's standard of living?
• What are the "players" in the financial markets? What role does each "player" accomplish?

Chapter 3Securities Markets

• Understand how firms issue securities. What are the basic characteristics of initial public offerings (IPOs)?
• Understand how securities are traded. What different types of markets, and trading mechanisms exist in the financial markets?
• Understand margin selling and short selling. Be able to compute the return that is earned when an investor buys on margin.
• Understand the difference between the dealer's bid price and the dealer's asked price.
• What organization(s) regulate the securities markets?

Chapter 5Risk and Return: Past and Prologue

• Be able to compute a holding period return (HPR).
• Understand how the arithmetic average, the geometric average, and the dollar-weighted average are computed. How do they differ from each other?
• What is the excess return on an investment? How is the excess return related to the risk associated with an investment?
• Be able to compute the expected return and standard deviation of an investment.
• What is risk aversion?
• How is a complete portfolio defined? What role does the complete portfolio play in the construction of a capital allocation line (CAL)?
• What is the Sharpe ratio? How is it computed? What information does it provide to investors?

Chapter 6Efficient Diversification

• Be able to compute the mean and variance of a portfolio.
• Be able to compute the covariance and correlation of returns between two investments. Understand what the value of a correlation coefficient means with regard to the ability to combine investments to achieve diversification.
• What is the mean-variance criterion? How does the mean-variance criterion determine the efficient frontier (set of risky assets)?
• Understand the separation property (theory). Why is the concept of the separation property important for investors?
• Understand the difference among total risk associated with an investment, its systematic risk, and its unsystematic risk. Why is knowledge of these risks important to investors?
• What is the beta coefficient, , for an investment? How is determined?
• Understand the information that provides investors.
• Understand diversification. When constructing a two-asset portfolio, what should an investor do to achieve the best diversification?