44 - Portfolio Risk and Return: Part 1

Question 1

LOS 44.a: Calculate and interpret Major Return Measures and describe their Appropriate uses

Holding Period Return

Answer 1

HPR - used to measure an investment’s return over a specific period.

Question 2

LOS 44.a: Calculate and interpret Major Return Measures and describe their Appropriate uses

• Money-weighted Rate of Return
• Gross Return
• Pretax Nominal Return

Answer 2

• Money-weighted Rate of Return - Is the IRR calculated by using the cash flows including Dividends.
• Gross Return - Total return after deducting commissions on trades and other costs necessary to generate returns, but before management and admin fees. Add M&A to get Net Return
• Pretax Nominal Return - Numerical precentage return on an investment, withoutconsidering the effects of taxes and inflation.

Question 3

LOS 44.b: Major Asset classes and their ranks from most to least risk

Answer 3

1. Small Cap Stocks
2. Large Cap Stocks
3. LT Corporate Bonds
4. LT Treasury Bonds
5. Treasury Bills

Question 4

LOS 44.c: Calculate and interpret mean, variance, and covariance/correlation

Answer 4

• Variance -
• Covariance - measures the extent to which two variables move together over time.
  
  • Positive movement - Assets move together
  • Negative Movement - Assets move opposite of each other
  • Zero - No linear relationship
• Correllation - measurement of co-movement that is bounded by -1 and +1

Question 5

LOS 44.d: Explain Risk aversion and its implications for portfolio selection

Answer 5

• Risk-averse - dislikes risk. Will hold risky assets if compesated
• Risk-seeking - risk loving.
• Risk-neutral - has no preference

Question 6

LOS 44.e: Calculate and interpret portfolio standard deviation

Answer 6

Var_portfolio=w₁²σ₁² + w₂²σ₂² + 2w₁w₂Cov₁₂

Allows to easily see the effect of the correlation of returns between the two assets on portfolio risk