Diversification Flashcards
What two factors do investors consider when forming portfolios?
Expected return (mean) and risk (standard deviation).
What is the ideal position for an asset in mean-standard deviation space?
The top-left corner (high expected return, low risk).
What is the benefit of diversifying between two international equity markets?
Diversification can reduce risk, depending on the correlation between assets.
What determines the benefit of diversification?
The correlation coefficient between assets—the lower the correlation, the greater the benefit.
What does the Efficient Frontier represent?
The set of portfolios that offer the highest expected return for a given level of risk.
What is the Capital Market Line (CML)?
A line showing the optimal risk-return tradeoff when combining a risk-free asset with a risky portfolio.
What is the Tangency Portfolio?
The optimal risky portfolio that maximizes the Sharpe ratio.
What does the Sharpe Ratio measure?
The reward-to-risk tradeoff of an investment.
Why do investors use the Sharpe Ratio?
To compare investment performance across different assets.
How do investors allocate between risk-free and risky assets?
They decide on a mix based on their risk aversion, balancing safety with potential returns.
What does the Two-Fund Separation Theorem state?
All investors should hold some combination of the risk-free asset and the tangency portfolio.
What is the “Market Portfolio”?
The portfolio containing all investable assets worldwide, including stocks, bonds, real estate, and commodities.
Why do investors hesitate to invest internationally?
Due to transaction costs, management costs, lack of local knowledge, taxation, and political risks.
Why are emerging markets attractive to investors?
They may have inefficiencies that allow for potential excess returns.
What are some benefits of Bitcoin investment?
Store of value, limited supply (21 million max), potential diversification.
What are the risks of investing in Bitcoin?
High volatility, difficulty in determining fair value, regulatory uncertainty.
What did Platanakis and Urquhart (2020) find about Bitcoin in portfolios?
Portfolios with Bitcoin performed better than traditional stock-bond portfolios, despite increased volatility.
