Determining the Optimal Portfolio Flashcards
what is the simplest way to control risk in the portfolio
change the fraction invested in risk free assets versus the fraction invested in risky assets
where does the capital allocation line meet the efficient frontier
the tangency point
the tangency point gives us what type of slope for the CAL
highest possible slope
the tangency point is what point on the efficient frontier
the highest possible return to risk ratio
what 3 factors should determine the optimal portfolio for an investor
- The efficient frontier of all risky assets
- The Capital Allocation Line
- Investor’s indifference curves
what can the slope of the indifference curve tell us
about risk aversion
with more risk, a person would want more return
which is the optimal portfolio in relation to where CAL and indifference curves intersect
highest possible indifference curve that intersects with the CAL
does everyone have the same optimal portfolio
no because everyone has different expectations
Features of an Investment Policy Statement
- Risk Objectives
- Return Objectives
- Liquidity Objectives
- Time Horizon Objectives
- Tax Concerns
- Legal and Regulatory Factors
- Unique Conditions
what is absolute risk aversion
no loss of capital
or lose no more than a certian % of cpaital
how is capital at risk stated
in probability terms - VALUE AT RISK
eg 95% probability of a loss no more than 13% in a 12 month period
what is a relative risk objective
relate risk to a benchmark eg s&p or LIBOR
or in realtion to a liabilty
what is an example of risk relative to a liability
trying to meet pension payments as they come due
two types of risk objectives
relative
absolute
what two things impact risk tolerance
willingness to take risk
ability to bear risk
what affects willingness to take risk
personality type
confidence
independent thinking
what affects ability to bear risk
time horizon
expected income
wealth relative to liabilities
what are the two types of return objectives
absolute
relative
two types of absolute return objectives
nominal and real
what are relative return objectives
claim to outperform the benchmark, or other portfolio managers
why does being realistic come into account when considering return objective
given the risk you are taking, you have to be realistic with return objectives
investors usually want to be told what type of return rate when investing
real rate
know the numbers
fund managers usually give what type of return objectives
relative
why do fund managers have to consider liquidity
will withdrawls ve needed at short notice
example of a fund where liquidity needs are more predictable
pension
what is one of the least liquid assets
real estate
you cannot sell overnight
transaction costs needed to turn real estate into cash
what type of funds are less predictible in terms of liquidity
insurance companies
claim need to be paid - how much to keep in liquid assets
what do we need to consider when it comes to time horizon objectives
when will the funds be withdrawn
what taxes might the investor consider
income tax
capital gains tax
pension funds are tax exempt
examples of legal and regulatory factors they might need to consider
insider trading is illegal
restrictions on short sales
restriction in some countries of amount of assets held overseas
restriction in quality of assets (no junk assets)
examples of unique conditions that may effect investment decision
ehtical values eg no child labour
religion eg no gambling
person preferences eg environmental sustainability
does a longer time horizon mean more or less ability to bear risk
more
more time to recover
what should a person avoid investing in to diversify
their own industry that they work in
home market
