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Risk and Diversification definitions

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  • Diversification
    Holding a variety of investments to reduce exposure to risks unique to individual firms, while not eliminating risks affecting the entire market.
  • Firm-specific Risk
    Uncertainty impacting only one company, such as changes in its customer base or competition, which can be minimized by spreading investments.
  • Market Risk
    Uncertainty affecting all firms, often caused by events like recessions or wars, which cannot be avoided through spreading investments.
  • Rate of Return
    A measure calculated by dividing the income earned from an investment by its purchase price, reflecting profitability.
  • Risk-free Rate
    The return expected from an investment with virtually no chance of loss, commonly associated with US Treasury bills.
  • US Treasury Bills
    Government-issued securities considered to have minimal risk, often used as a benchmark for risk-free returns.
  • Dividends
    Payments made to shareholders from a company's profits, representing a portion of the income earned from owning stock.
  • Capital Gains
    Profits realized from selling an asset at a higher price than its purchase cost, contributing to investment income.
  • Interest
    Earnings received from lending money or holding bonds, forming part of the income from fixed-income investments.
  • Efficient Market Hypothesis
    A theory stating that asset prices reflect all available information, making future price movements unpredictable.
  • Informational Efficiency
    A condition where asset prices incorporate all publicly available data, ensuring that new information quickly affects values.
  • Random Walk
    A pattern describing unpredictable changes in asset prices, resulting from the arrival of unforeseen information.
  • Speculation
    The act of buying assets with the hope of profiting from price changes, often driven by expectations rather than fundamentals.
  • Bubble
    A situation where asset prices rise rapidly due to excessive demand, often followed by a sharp decline when reality sets in.
  • Market Equilibrium
    A state where asset prices balance supply and demand, influenced by rational and irrational behaviors in financial markets.