Introduction to Portfolio Theory

Question 1

Relationship between Risk and Return

Answer 1

Positive correlation; lower risk, lower reward

Question 2

Systematic Risk

Answer 2

Risk inherent to the entire market or to the entire market segment.

Question 3

Idiosyncratic Risk

Answer 3

Risk specific to an asset or small group of assets (no correlation with market risk).

Question 4

Covariance

Answer 4

A measure of how the returns on two risky assets change in relation to each other.

Question 5

Normalized Covariance (Correlation)

Answer 5

Aka Correlation,

Correlation = [cov(X,Y)/SD_X*SD_Y]

Note: If correlation is -1 all risk can be eliminated, but as long as correlation is not 1 some risk can be eliminated.