A. Portfolio Approach to Investing

Question 1

Portfolio Approach

Answer 1

“evaluating individual securities in rela- tion to their contribution to the investment characteristics of the whole portfolio. “

Question 2

to avoid disaster (attributed to a single security)

Answer 2

“The portfolio approach provides investors with a way to reduce the risk associated with their wealth without necessarily decreasing their expected rate of return.”

Question 3

To Reduce Risk

Answer 3

“portfolios also generally offer equivalent expected returns with lower over- all volatility of returns—as represented by a measure such as standard deviation.”

Question 4

Diversification Ratio

Answer 4

“calculated as the ratio of the standard deviation of the equally weighted portfolio to the standard deviation of the randomly selected security. “

“The diversification ratio of the portfolio’s standard deviation to the individual asset’s stan- dard deviation measures the risk reduction benefits of a simple portfolio construction method, equal weighting”

A ‘greater portfolio effect’ means a lower diversification ratio

Question 5

Composition for the Risk, Return trade-off

Answer 5

“observe the trade-offs between portfolio volatility of returns and expected return (for short, their risk–return trade-offs). “

Question 6

Not necessarily downside Protection

Answer 6

“the co-movement or correlation pattern of the securities’ returns in the portfolio can change in a manner unfavorable to the investor. We use historical return data from a set of global indices to show the impact of chan”

“although portfolio diversification generally does reduce risk, it does not necessarily provide the same level of risk reduction during times of severe market turmoil as it does when the economy and markets are operating ‘normally’. In fact, if the economy or markets fail totally (which has happened numerous times around the world), then diversification is a false promise.”

Question 7

Modern Port. Theory

Answer 7

“modern portfolio theory (MPT). The main conclusion of MPT is that investors should not only hold portfolios but should also focus on how individual securities in the portfolios are related to one another. “

Question 8

MPT

Answer 8

Markowitz: Reduce risk through diversification but it can’t reduce market risk

during turmoil correlations increase

Diversification Benefit: Diversification Ratio: Reduce risk via equal weights (which isnt the best) Single SD/Portfolio SD

Question 9

Portfolios are most likely to provide (Risk Reduction)

Answer 9

Risk Reduction: “Combining assets into a portfolio should reduce the portfolio’s volatility”

“However, the portfolio approach does not necessarily provide downside protection or eliminate all risk.”