Speculation

The assumption of considerable investment risk to

obtain commensurate gain; undertaken in spite of the
risk invovled because one receives a favorable risk-
return trade-off

Gamble
To bet or wager on an uncertain outcome; the
assumption of risk for no purpose but enjoyment fo
the risk itself

Fair Game
A risky investment with a risk premium of zero

Heterogeneous Expectations
Investors on each side of a financial position see
themselves as speculating rather than gambling

Risk Averse
Investors that reject investment portfolios that are fair
games or worse. A risk averse investor penalizes the
expected rate of return of a risky portfolio by a certain
percentage to account for the risk involved

Utility
the amount of satisfaction one gets from a good or
service

Certainty Equivalent Rate
The rate that risk-free investments would need to offer
to provide the same utility score as the risky portfolio.
It is the rate that, if earned with certainty, would
provide a utility score equivalent to that of the
portfolio in question

Risk Neutral
A=0, judge risky prospects solely by their expected
rates of return. The level of risk is irrelevant to the risk
neutral investor, meaning that there is no penalty for
risk. For this investor a portfolio's certainty equivalent
rate is simply its E(r)

Risk Lover
A<0, happy to engage in fair games and gambles; this
investor adjusts the E(r) upward to take into account
the "fun" of confronting the prospect's risk


Mean-Variance (M-V) Criterion
Higher than or equal to
E(r) AND Lower than or equal to standard deviation

Indifference Curve
Connects all portfolio points with the same utility
value

Capital Allocation
A process of how businesses divide their financial
resources and other sources of capital to different
processes, people and projects. Overall, it is
management's goal to optimize capital allocation so
that it generates as much wealth as possible for its
shareholders.

Price-Indexed Bond
The only risk-free asset in real terms. Even a default-
free perfectly indexed bond is subject to interest rate
risk, because real interest rates change unpredictably
through time.

Risk-Free Asset
It is common to view Treasury bills as "the" risk-free
asset because their short-term nature makers their
values insensitive to interest rate fluctuations.
Inflation uncertainty over the course of a few weeks or
months is negligible compared with the uncertainty of
stock market returns.

Investment Opportunity Set
The set of feasible expected return and standard
deviation pairs of all portfolios resulting from different
values of y (weights)

Capital Allocation Line
A line that depicts all the risk-return combinations
available to investors. The slope of the CAL equals the
increase in the expected return of the complete
portfolio per unit of additional standard deviation -
incremental return per incremental risk.

Reward-to-Volatility Ratio
The name of the slope of the CAL. The slope of the
CAL equals the increase in the expected return of the
complete portfolio per unit of additional standard
deviation - incremental return per incremental risk.
Also called the Sharpe Ratio.


Investor's Borrowing Cost
Nongovernment investors cannot borrow at the risk-
free rate. The risk of the borrower's default causes
lenders to demand higher interest rates on loans.

Buy on margin
Borrowing to invest in the risky portfolio when you
have a margin account with a broker. Margin
purchases may not exceed 50% of the purchase value.