5. Portfolio Mathmatics

Question 1

Covariance

Answer 1

A measure of the co-movement (linear association) between two random variables.

Question 2

Expected return on the portfolio

Answer 2

Denoted as (E (Rp)). The weighted average of the expected returns (R1 to Rn) on the component securities using their respective weights (w1 to wn).

Question 3

Independent

Answer 3

With reference to events, the property that the occurrence of one event does not affect the probability of another event occurring. With reference to two random variables X and Y, they are independent if and only if P(X,Y) = P(X)P(Y).

Question 4

Joint probability function

Answer 4

A function giving the probability of joint occurrences of values of stated random variables.

Question 5

Mean–variance analysis

Answer 5

An approach to portfolio analysis using expected means, variances, and covariances of asset returns.

Question 6

Safety-first rules

Answer 6

Rules for portfolio selection that focus on the risk that portfolio value or portfolio return will fall below some minimum acceptable level over some time horizon.

Question 7

Scenario analysis

Answer 7

A variation of the valuation process combining a base case with alternative outcomes, allowing the incorporation of more favorable or adverse scenarios in the valuation process.

Question 8

Shortfall risk

Answer 8

The risk that portfolio value or portfolio return will fall below some minimum acceptable level over some time horizon.

Question 9

Stress testing

Answer 9

A specific type of scenario analysis that estimates losses in rare and extremely unfavorable combinations of events or scenarios.

Question 10

Value at risk

Answer 10

A money measure of the maximum value of losses expected during a specified time period at a given level of probability.