Chapter 6 Flashcards
What is diversification in portfolio risk?
Diversification is the process of allocating investments among various financial instruments, industries, and other categories to reduce risk.
What is market risk?
Market risk is the undiversifiable or systematic risk that affects the entire market.
What is firm-specific risk?
Firm-specific risk is the diversifiable or unsystematic risk that affects a particular company.
What is the formula for expected return (E(R))?
E(R) = ΣwR
Where w is the weight and R is the return of each asset.
How is variance calculated?
Variance (σ²) = Σ[Rᵢ - E(R)]² / n-1
Where Rᵢ is the return of each asset and E(R) is the expected return.
What is our risk measure?
Varience
What does a correlation of 1.0 indicate?
Two assets are perfectly positively correlated.
What does a correlation of -1.0 indicate?
A correlation of -1.0 indicates that two assets are perfectly negatively correlated.
What is the formula for portfolio variance?
σ²ₚ = Σwᵢ²σ²ᵢ + ΣΣwᵢwⱼCov(Rᵢ, Rⱼ)
Where w is the weight and Cov is the covariance between assets.
What is the efficient frontier?
The efficient frontier is the subset of all portfolios that offer the highest expected return for a given level of risk.
What is the market portfolio (M)?
The market portfolio (M) is the best portfolio of risky assets, containing all securities with weights equal to their relative market values.
What is the risk premium on the market?
The risk premium on the market depends on the average risk aversion of all market participants.
What is the relationship between individual security risk premium and market?
The risk premium on an individual security is a function of its covariance with the market.
