Ch 11

Question 1

Two assumptions about investors

Answer 1

1. Investors prefer more return to less return

2. Investors prefers less risk to more risk

Question 2

Expected return

Answer 2

Average return on a risky asset expected in the future

Question 3

Risk premium

Answer 3

Difference between returns on a risky investment and a risk free investment

Question 4

Projected/ expected risk premium

Answer 4

Difference between the expected return on a risk investment and the certain return on a risk free investment

Question 5

Risk premium formula

Answer 5

Expected return (Rj) - risk free rate (Rf)

Question 6

Portfolio

Answer 6

Groups of assets suck as stocks and bonds held by and investor

Question 7

Portfolio weights

Answer 7

Percentage of a portfolios total value invested in a particular asset

Question 8

Standard deviation _____ as number of securities increases

Answer 8

Declines

Question 9

Diversification

Answer 9

The process of spreading an investment across assets and thereby forming a portfolio

Question 10

Principle of diversification

Answer 10

Says spreading an investment a cross many assets will eliminate some of the risk

Question 11

Diversifiable risk

Answer 11

Risk that can be eliminated by diversification

Question 12

Nondiversifiable risk

Answer 12

The minimum level of risk that cannot be eliminated by simply diversifying

Question 13

Time diversification fallacy

Answer 13

Although stocks are more volatile in any given hrs, over time this volatility cancels itself out

Question 14

Correlation

Answer 14

Extent to which the returns on two assets move together

Question 15

Positively correlated

Answer 15

Returns on two assets move up and down together

Question 16

Negatively correlated

Answer 16

Returns on two assets move opposite of each other

Question 17

Correlation coefficient

Answer 17

Ranges from -1 to 1, 1 is perfect positive correlation, 0 is incorrelated,

Question 18

Asset allocation

Answer 18

How an investor spreads portfolio dollars among assets

Question 19

Investment opportunity

Answer 19

Collection of possible risk-return combinations available from portfolios of individual assets

Question 20

Dominated/ inefficient portfolios

Answer 20

Given their level of risk, the expected return is inadequate compared to some other portfolio of equivalent risk

Question 21

Efficient Portfolio

Answer 21

A portfolio that offers the highest return for its level of risk

Question 22

Markowitz efficient frontier

Answer 22

Ten set of portfolios with the maximum return for a given standard deviation

Question 23

Primary reason Markowitz is not extended to large collections of individual assets

Answer 23

The inputs into the analysis are expected returns on assets, standard deviations on all assets, and correlations between every pair of assets

Question 24

Why is diversification important

Answer 24

Portfolios with many investments usually produce a more consistent and stable total return than portfolios with one investment