chapter 6 3fb3 Flashcards
Q: What is speculation in investing?
A: Speculation involves taking considerable risk for a commensurate gain, where parties have heterogeneous expectations about the outcome.
Q: What is gambling in terms of risk-taking?
A: Gambling is a bet on an uncertain outcome for enjoyment, where parties assign the same probabilities to the possible outcomes.
Q: What is risk aversion in investing?
A: Risk aversion refers to the preference for risk-free or speculative prospects with positive risk premiums, avoiding risky investments without a sufficient potential gain.
Q: What assumption is made about each investor regarding competing portfolios?
A: Each investor is assumed to be able to assign a welfare or utility score to competing portfolios to evaluate and choose the one that maximizes their satisfaction.
Q: What assumption is made about each investor regarding competing portfolios?
A: Each investor is assumed to be able to assign a welfare or utility score to competing portfolios to evaluate and choose the one that maximizes their satisfaction.
Q: How are portfolios selected based on their returns?
A: Portfolios are selected based on the means and variance of their returns, either by choosing the highest expected return for a given level of variance or the lowest variance for a given expected return.
Q: Where do equally preferred portfolios lie on the mean-standard deviation plane?
A: Equally preferred portfolios lie on an indifferent curve in the mean-standard deviation plane, which connects all portfolio points with the same utility value.
Q: How can we estimate the levels of risk aversion of individual investors?
A: We can estimate risk aversion through questionnaires (varying degrees of complexity), observations of how portfolio composition changes over time, and by calculating the average degrees of risk aversion from groups of individuals.
Q: What is the most basic asset allocation choice?
A: The most basic asset allocation choice is the risk-free money market security.
Q: What is the simplest way to control risk in asset allocation?
A: The simplest way to control risk is by changing the ratio of risky vs. risk-free assets.
Q: Who can issue default-free securities?
A: Only governments can issue default-free securities.
Q: What conditions make a security risk-free with a guaranteed real return?
A: A security is risk-free with a guaranteed real return if its price is indexed and its maturity equals the investor’s holding period.
Q: What are considered risk-free assets in practice?
A: T-bills are viewed as the risk-free asset, and a broad range of money market instruments are considered effectively risk-free assets in practice.
Q: What does the investment opportunity set offer?
A: The investment opportunity set offers feasible expected return and standard deviation pairs of all portfolios resulting from different values of x and y
Flashcard 2:
Q: What is the Sharpe ratio (reward-to-volatility ratio)?
A: The Sharpe ratio is the ratio of excess return to portfolio standard deviation, used to assess the risk-adjusted return of a portfolio.
Q: What must the investor do within the investment opportunity set?
A: The investor must choose one optimal portfolio, C, from the set of feasible choices based on their risk-return preferences.
Q: What does a passive investment strategy avoid?
A: A passive strategy avoids any direct or indirect security analysis, relying on market forces to guide investment decisions.
