CLASS AUGUST 26

Question 1

STANDARD DEVIATION!! Very important

Answer 1

Be able to calculate
Measure of Total Risk
Be able to calculate with calculator

Question 2

COEFFICIENT OF VARIATION. Very important!!

Answer 2

Compares two assets with different averages
Swiss Army knife of diversification

The higher the CoV, the more risky the investment and less likely an investor is likely to achieve average return

Lower number is better (less risk for more return).
Standard deviation in numerator/return is denominator

Question 3

CORRELATION and CORRELATION COEFFICIENT

Answer 3

Measure movement of one security relative to that of another

CORRELATION COEFFICIENT IS R — it is a relative measure

Correlated = forest fires and ice cream

Correlation of +1 denotes two assets perfectly positively related

Correlation Coefficient gives us boundaries to work inside of

We want securities that are opposite

Question 4

COVARIANCE

Answer 4

Used

Question 5

BETA

Answer 5

Measures systematic risk (volatility)

Compared to S&P 500

Question 6

Rsq (Coefficient of Determination)

Answer 6

Measure of how much of the return is due to market

Square the CORRELATION COEFFICIENT

We don’t want unsystematic risk—we want an Rsq that approaches 100

Rsq more than .70, you can use Beta
Rsq is LESS than .70, you have to use Standard Deviation

Question 7

SYSTEMATIC vs UNSYSTEMATIC RISK

Answer 7

Systematic = market, undiversifiable, economy based risk
Purchasing power Reinvestment rate Interest rate Market Exchange rate

Unsystematic = is diversifiable, unique, company specific risk
      Accounting Business(specific company)** Country Default Executive Financial**(debt) Government (Regulation)

Question 8

MODERN PORTFOLIO THEORY

Answer 8

Outcome of MPT = Efficient Frontier

Indifference curve is a measure of utility

Question 9

CAPITAL MARKET LINE

Answer 9

Finding a Required Rate of return and the optimal portfolio

PART of CAPITAL ASSET PRICING MODEL (helps determine good from bad investment)

SML is better than CML because it uses BETA!!!

CAPM and SML are used interchangeably

SML = S M I L E. Formula =

Question 10

SECURITY MARKET LINE S M I L E

Answer 10

Practice the calculation!!!

Risk free rate + beta X risk premium (Risk premium = market rate - risk free rate)

Question 11

PORTFOLIO RISK

Answer 11

Standard deviation of a portfolio (very long formula!! There is a shortcut)
Portfolio deviation

Question 12

Portfolio Performance Measures

Answer 12

TREYNOR - - Beta (as denominator) and portfolio return - risk free (as numerator)
Relative measure with another Treynor—-Higher the better
Formula: rport - risk free/Beta of port

SHARPE - - Stand Dev of port as denominator
Relative measure with another Sharpe—-Higher the better
**Use this if you are not given Rsquared

JENSEN ALPHA - - absolute performance measure of fund management
Higher the better (better performance)
Long formula!!!!!

PLEASE EXCUSE MY DEAR AUNT SALLY
Parentheses - Exponents - multiply - divide - sum

Question 13

PORTFOLIO RETURNS

Answer 13

Holding Period Return
Selling price - purchase price +/- cash flows divided by Initial Equity
No time element involved
Take into account margin interest paid, see slide 66 (?)
60% initial margin, $20 per share, 10% margin interest, sold for $3,000 (100 shares)

Holding Period Return FORMULA is on Exam formula sheet

Question 14

PORTFOLIO RETURNS

Answer 14

Effective Annual Rate

EAR = (1+ i/n)power n - 1

Question 15

PORTFOLIO RETURNS contd

Answer 15

ARITHMETIC AVERAGE

Doesnt’ consider COMPOUNDING, simple average only

Question 16

PORTFOLIO RETURN — very important

Answer 16

GEOMETRIC AVERAGE!!!!!!!!!
   Present Value
   Future Value
   Years
   Payment 
   Interest ?

Question 17

PORTFOLIO RETURN

WEIGHTED AVERAGE RETURN and BETA!!!!

Answer 17

Either number of shares at various priced securities

Take number of shares of asset and multiply by price per share
Add up all shares at all prices
Then divide by number of securities

Current market value divided by total portfolio value multiplied by return of each security = weighted return