FI 4 Investing and Portfolio Diversification Flashcards
Standard deviation of two returns. what does a higher s.d. indicate?
Higher risk of not achieving expected return
Positive correlation - what does this mean?
Returns of two stocks are in-line with each other. When one increases, so does the other.
Negative correlation - what does this mean?
Returns of two stocks are opposite of each other. When one increases, the other decreases.
Zero correlation - what does this mean?
No relationship between the returns.
Correlation = 1 - what does this mean?
perfect relationship - no benefit to diversifying as both stocks have same rate of return
How to achieve portfolio integration? TO reduce risk?
Get negatively correlated portfolios - when one goes up, other goes down. Manages risk - less risky than the shares individually.
How to achieve portfolio integration? TO reduce risk?
Get negatively correlated portfolios - when one goes up, other goes down. Manages risk - less risky than the shares individually.
Two advantages of diversification?
Risk management and Portfolio Diversification
Define unsystematic risk
Unique to the security
Define systematic risk. How is this measured?
Market risk - not specific to the share. Beta.
CAPM formulas
The Capital Asset Pricing Model (CAPM) formula can be used to determine the return required on an investment.
Expected return = Risk-free return (RF) + Risk premium related to risk of investment
Expected return = Risk-free return (RF) + Beta (ß) × Market risk premium (RPM)
What does beta of 1.1 mean? 0.8?
10% more volatile than market portfolio. 80% as volatile.
Define sharpe ratio. What does this mean?
Assesses if returns are in line with the risks of portfolio. the higher the sharpe factor, the better a portfolio is at maximing risk-adjusted returns.
What factors should be taken into account before setting up a portfolio?
capital preservation annual income growth of capital liquidity time horizon income tax minimization
bottom-up vs top-down investing
bottom-up = looking at company
top-down - looking at macroeconomic environment
