Book 2_Port1_PORTFOLIO RISK AND RETURN_part2

Question 1

std of porfolio with risk-free asset

Answer 1

a risk-free asset has zero standard deviation and zero correlation of returns with a risky portfolio

Stdp = Wa x siga

Question 2

The capital allocation line (CAL)

Answer 2

the various combinations of a risky asset and the risk-free asset

Question 3

The capital market line (CML)

Answer 3

the combinations of the risky asset and the risk free asset in the specific case where the risky asset is the market portfolio
E(Rp)= Rf + sigpx[E(Rm) - Rf]/sigm

Question 4

Lending and borrowing portfolio

Answer 4

Assuming that investors can lend or borrow at risk-free rate
Lending: on the left, <100%
Borrowing: on the right, >100%

Question 5

Systematic (market) risk

Answer 5

• due to factors, such as GDP growth and interest rate changes, that affect the values of all risky securities
• cannot be reduced by diversification

Question 6

Unsystematic (firm-specific) risk

Answer 6

can be reduced by portfolio diversification

Question 7

A return generating model

Answer 7

an equation that estimates the expected return of an investment, based on a security’s exposure to one or more macroeconomic, fundamental, or statistical factors.

Question 8

the market model

Answer 8

The simplest return generating model
Ri = anpha + beta x Rm + ei
+ anpha = Rf x (1-beta)
+ ei: abnormal return on Asset i

Question 9

Beta calculation

Answer 9

beta = Cov(Ri, Rm)/(sigm)^2 = Pim(sigi/sigm)

Question 10

The capital asset pricing model (CAPM)

Answer 10

• Investors are risk averse, utility maximizing, and rational
• Markets are free of frictions like costs and taxes.
• All investors plan using the same time period.
• All investors have the same expectations of security returns.
• Investments are infinitely divisible.
• Prices are unaffected by an investor’s trades

Question 11

The security market line (SML)

Answer 11

a graphical representation of the CAPM that plots expected return versus beta for any security
E(Ri) = Rf + βi [E(Rm) − Rf ]

Question 12

Classify CML and SML

Answer 12

Both Y-axis is average return (Ep), but difference in X-axis
+ CML: sigp (total risk)
+ SML: betap (systematic risk)

Question 13

The CAPM

Answer 13

E(Ri) − Rf = βi [E(Rm) − Rf ]

Question 14

Determine under and over valued

Answer 14

CAPM calculates required rate of return
- Forecast rate > required rate: Above SML linn and Under valued (CAPM model is incorrect)
- Forecast rate < required rate: Below SML linn and Over valued

Question 15

The Sharpe ratio

Answer 15

measures excess return per unit of total risk (std) and is useful for comparing portfolios on a risk-adjusted basis.
= (Rp - Rf)/sigp

Question 16

M-squared alpha

Answer 16

• The extra return on Portfolio P* (adjust porfolio P to the market sigma by leverage or deleverage) above the market portfolio.
  M2 = Rf + sigM/sigP x (Rp - Rf) = Rf + sigM x Sharp Ratio

Question 17

The Treynor

Answer 17

measure measures a portfolio’s excess return per unit of systematic risk (beta)
= (Rp - Rf)/betap

Question 18

Jensen’s alpha

Answer 18

the difference between a portfolio’s return and the return of a portfolio on the SML that has the same beta
Jensen’s alpha = anphap = Rp - [Rf + betap(Rm- Rf)]

Question 19

Compare the ratio

Answer 19

• Sharp ratio and M2: based on total risk, using for one manager (not diversified)
• Treynor and Jensen: based on the systematic risk, using for many managers