Exam 2 - Chapter 7 [SLIDES] Flashcards
However, I cannot tell you anything yet for individual asset even if you tell me the STD of the individual asset. Why?
Since it has diversified able risk
Decomposition risk
- decompose in 2 risk:
- Non diversified
2. Diversified
Now we know every investor holds the market portfolio M in equilibrium. Thus, not one takes any __________ ____
Diversifiable
However, STD’s of individual risky assets contain ______ _________
Diversifiable risk
Any pairs of risky is ______ correlated
Positively
Diversification effect exists -> each individual risky asset must be subject to a ________ ________
Diversifiable risk
The two conditions that has to be satisfied for empirical results
- Any pari of risky assets is postieively correlated
2. Diversification effects exists each individual risky asset must be subject to diversifiable risk
Unsystematic risk is what type of ris k
Diversifiable risk
What is systemic risk
What type of risk
Non diversified risk
Equilibrium (one major assumption) (learn all this)
Homogenous
Limitation of cml line
Combines a diversified portfolio
Another names for systematic risk
Non-diversifiable risk
Market risk
Systematic/non-diversifiable/market risk:
Risk related to the systematic or macro economic factors
Unsystematic/diversifiable/unique/firm specific risk:
Risk not related to the macro factor or market index
Another name for unsystematic risk
Diversifiable/unique/firm specific risk
No one takes _______ risk in equilibrium
Unsystematic risk
You want the equilibrium return because:
To know future cash flows and the price of the stock
Market portfolio beta
1
Equilbirium relationship between
Return and risk in terms of beta for any asset or portfolio
Only what type of risk matters
Systematic risk
Systematic risk is used for what
Expected rate of return
Expect return on asset i =
Risk free rate + risk premium
Risk premium on asset i =
Market risk premium x beta
Beta of market portfolio =
1
Beta of risk-free asset =
0
Beta
Beta is a measure of non-diversifiable risk relative to market portfolio risk
Alpha must be ____ if the model is correct and the market is in equilibrium
0
If the regression results shows non-zero alpha value, the data indicates that the asset exhibited _______ during the data period
Mispriced
If alpha is higher, we get a higher ________ ________ because _____ is higher
Sharpe ratio; u (expected return)
You want a ______ Sharpe Ratio
Higher
If you are an investor you’re looking for a positive or negative alpha ?
Positive alpha
Positive alpha is _______
Underpriced
Negative alpha price is ______
Overpriced
If you want a positive alpha you want a _____ price
Lower
You need same _______ for CAPM Model
Horizons
The CAPM is “false” based on the _____________
Validity of its assumptions
THE CAPM could still be a useful predictor of ________ ________
Expected returns (Empirical returns)
(CAPM) there may be a huge measurably issue because the market portfolio is ________
Unobservable
(CAPM) ______ may not. Be constant over time
Beta
As a theory the CAPM is _______
Untestable
However, the _______ of the CAPM is testable
Practicality
Even if the CAPM is “False” the markets can still be “_______”
Efficient
Therefore the CAPM is _____ and _____ understood
Used and well
The ______ we learn from the CAPM are still entirely valid
Principles
Investors should ______
Diversify
Systematic risk is the risk that _____
Matters
A well diversified risky portfolio can be suitable for
a wide range of investors
Difference in risk tolerances can be handled by changing the ______ _____ decisions in the complete portfolio
Asset allocation
Single pricing model is to measure ______
Systematic risk
