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Portfolio Management > Course 5,6,7 > Flashcards

Course 5,6,7 Flashcards

1
Q

What are the 3 interpretation of risk aversion constant a?

A
  • Risk averse: The higher the A is > 0, the more averse the individual is.
  • Risk neutral A=0
  • Risk seeker: A is low and. < 0
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2
Q

What are the 2 steps to define the complete portfolio under 1 Rf and 1 risky asset?

A

1) Define the range of capital allocation possibilities (CAL)
2) Determine the optimal choice for an investor.

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3
Q

What is the Capital Allocation Line (CAL)?

A
  • It represents all possible complete portfolios combinations
  • The slope of the CAL is the sharpe ratio
  • The slope represents how much addition return do we get from a 1% increase in standard deviation
  • The investor must choose the point where the CAL line is tangeant to an indifference curve
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4
Q

What happens if y* > 1?

A

The investor need to borrow, if not the investor is lending.

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5
Q

What is Amin when Rl <Rb?

A

It is the minimum level of risk aversion from which an investor will want to invest at the risk-free rate

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6
Q

What is Amax when Rl <Rb?

A

It is the level of maximum risk aversion below which an investor will want to borrow and make investments in the risky portfolio

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7
Q

What happens if A>Amin

A

The investor will combine P1 with Rl

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8
Q

What happens if A<Amax

A

The investor will combine P2 with Rb

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9
Q

What happens if Amin<A<Amax?

A

The investor chooses according to his risk aversion, a portfolio on the efficient frontier, acting as if there were no risk-free rates.

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10
Q

What are we doing as an investment strategy if borrowing is not allowed?

A

1) We identify the P1 tangency portfolio with the risk-free investment rate Rf.
2) We determine Amin
- If A>Amin, the investor will want to lend, we will choose the optimal portfolio (P1 and Rl) on the CAL
- If A<Amax, the investor will want to borrow but is not allowed. To counter that, the investor will have to choose the optimal risky portfolio by pretending that there is no risk-free rate.

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11
Q

What are we doing as an investment strategy if buying on margin is limited?

A

The investor whose risk aversion is very low will have to be satisfied with the maximum borrowing allowed by the investing in the P2 portfolio.

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12
Q

What are we doing as an investment strategy if short sales are not allowed?

A
  • Short sales only affect risky securities
  • The fact that investors cannot short sell, limits thes scope of the curve representing all investment opportunities in the universe of risky assets.
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13
Q

What are we doing as an investment strategy if we have investment bounds?

A

Generally it leads to a reduction in the utility of the investor when they become effectively binding.

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14
Q

What is the investment decision in the portfolio choice?

A

Determination of risky tangency portfolio: The determination is purely technical and this portfolio if optimal for all investors regardless of their risk aversion.

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15
Q

What is the financing decision in the portfolio choice?

A

Allocation of capital between risk-free assets and the tangency portfolio: it depends on personal preference. Here the investor is the decision maker.

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16
Q

What is the capital market line?

A
  • It is a special case of the CAL.
  • The passive strategy avoids any direct or indirect security analysis.
  • A natural candidate for a passively held risky asset would be a well-diversified portfolio common stocks such as the S&P.
  • Basicly the CML results when using the market index as the risky portfolio.
  • The CML is specific to efficient portfolios.
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17
Q

What is skewness and its effects?

A
  • It is present when distribution is not symetrical
  • Negative skewness: long left tail (mean<median<mode)
  • Positive skewness: long right tail. what investors prefer. (mode<median<mean)
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18
Q

What are the type of kurtosis and their properties?

A
  • Normal distribution (mesokurtic): excess kurtosis = 0
  • Positive kurtosis (leptokurtic): high kurtosis, fat tails, observations of more frequent extreme events, increase asset’s risk not captured in a MV framework.
  • Negative kurtosis (platykurtic): observations of less frequent extreme events.
19
Q

What is semi-variance?

A

it measures the variability of returns that fall below a certain threshold (usually the mean or a specific target return). It only considers downside risk, which is relevant to investors focused on avoiding losses.

20
Q

What is relative semi-variance?

A

It compares the downside risk of a portfolio to a benchmark. It focuses on returns that fall below the returns of a reference benchmark (such as the market or another portfolio).

21
Q

What is the value at risk?

A
  • It measures the probability of underperforming by providing a statistical measure of downside risk.
  • It is the minimum loss that can occur over a defined period of a given confidence level.
22
Q

What are the parameters of the CaR?

A
  • Holding period: depends on the needs and variations analyzed
  • Confidence level: it is how often the portfolio should stay within VaR limits
23
Q

Why do we use VaR?

A
  • to compare and evaluate the performance of different portfolios. Build a portfolio with target VaR to limit losses.
  • it required assumptions about the distribution of returns
24
Q

Describe the parametric method used to estimate the VaR.

A

VaR = mean - quantile * std. dev

25
Q

What are the 3 ways to estimate variance?

A

Parametric, historical approach, monte carlo simulation

26
Q

What does fat-tailed distribution does on VaR and ES?

A

It result in extreme values of VaR and ES resulting in smaller allocations

27
Q

What is the post-modern portfolio theory (PMPT)?

A

It is a methodology used for portfolio optimization that utilizes the downside risk of returns.

28
Q

What are the main practical problems in Markowitz?

A
  • It requires a huge number of estimates.
  • We don’t have any guideline to the forecasting of the security risk premium.
  • The MVO framework is highly sensitive to estimation errors.
  • The results can lead to undesirable allocation.
29
Q

What is the expected shortfall (ES) risk?

A

refers to the probability that the return of a portfolio will fall below a specified target or threshold, such as a desired minimum return or a liability that needs to be covered. It is particularly relevant for investors concerned with avoiding outcomes that are worse than their financial goals or obligations.

30
Q

What are the main behavioural assumptions of the CAPM?

A
  • All investors in the market are rational (risk averse and utility-maximizing)
  • Investors plan for the same single holding period
  • Investors have homogeneous expectations or beliefs.
31
Q

What are the market structure assumptions of the CAPM?

A
  • Markets are frictionless
  • Investors can borrow or lend at a common risk-free rate
  • All investments are infinitively divisible
  • Investors are price takers
32
Q

Why do we use the CAPM?

A

It estimates what should be the expected return of any risky asset/portfolio given the level of systematic risk.

33
Q

What is the systematic risk?

A
  • Systematic risk is the only relevant risk measure (beta)
34
Q

What is beta?

A

It is a measure of how sensitive an asset’s return is to the market as a whole.

35
Q

What are the implication of the CAPM?

A
  • All investors have the same efficient frontier regardless of their level of risk aversion (A)
  • All investor will hold the same porfolio of risky assets “m”, the market portfolio
  • Only the systematic risk of individual securities is remunerated by the market (beta)
36
Q

What is the comportement of stock below or above the SML?

A

A stock above the SML is undervalued (we buy it), a stock below is overvalues (we short it)

37
Q

What is the description of the SML?

A

It is described as the “expected return, beta” space

38
Q

What is the adjusted beta?

A
  • It estimates a security’s future beta. It is an historical beta adjusted to reflect the tendency of beta to be mean-reverting.
  • It is 1/3 + 2/3 * Beta_raw
  • An alternative could also be the APT
39
Q

What is the zero-beta CAPM by Black?

A
  • They have a zero beta and can therefore replace the portfolio for SML.
  • The return is comparable to the return on risk-free assets in the CAPM relationship.
  • It outperforms the CAPM
39
Q

Describe the single index model.

A

It describe excess return (on the formule sheet) the bars on top of variables are the excess returns relative to the risk-free rate.

39
Q

How many estimates does it take for 50 stocks for SIM and markowitz?

A
  • SIM it takes 152 estimates
  • Markowitz is takes 1325 estimates
40
Q

How can stock variability can be decomposed?

A
  • Market risk (systematic): largely due to macroeconomic events
  • Firm-specific effect (idiosyncratic)
40
Q

What are the 3 main assumption for APT?

A
  • A factor model describes asset returns
  • With a large pool of assests, investors can form well-diversified portfolio that eliminate asset-specific risk.
  • No arbitrage opportunities exist among well-diversified portfolios.

Portfolio Management (2 decks)

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