Lecture 3

Question 1

To construct overall portfolio (2)

Answer 1

• Select composition of risky portfolio

- Decide how much to invest in portfolio, remainder goes into risk free

Question 2

Gamble =

Answer 2

Assumption of risk for enjoyment of risk itself

Question 3

Speculation =

Answer 3

Undertaken in spite of risk involved

Question 4

Investors should not have

Answer 4

Gambling/ speculative mindsets

Question 5

Investors assign utility score to portfolios based on

Answer 5

Expected risk and return

Question 6

Higher expected return =

Answer 6

Higher utility score

Question 7

Certainty equivalent rate of return =

Answer 7

Rate that the risk free investment would need to offer to provide same utility score as risky portfolios

Question 8

Utility score of risky portfolios can be interpreted as

Answer 8

Certainty equivalent rate of return

Question 9

Risk neutral investors (A = 0) judge risky prospects

Answer 9

Solely on expected rate of return

Question 10

Risk lover (A < 0)

Answer 10

Adjusted expected return upwards

Question 11

Investors are equally attracted to portfolios with

Answer 11

High risk and expected returns to portfolios with low risk and returns (both will lie on indifference curve)

Question 12

Indifference curve

Answer 12

Connects portfolio points with the same utility value

Question 13

Capital allocation line (CAL)

Answer 13

Depicts all risk-return combinations available to investors

Question 14

Slope of CAL =

Answer 14

Increase in expected return of complete portfolio per unit of additional standard deviation (incremental return per incremental risk)

Question 15

Slope of CAL (formula) =

Answer 15

Reward to volatility ratio / Sharpe ratio

Question 16

Investors chose allocation to risk asset that

Answer 16

Maximises utility function

Question 17

As allocation to risky asset increases

Answer 17

Expected return increases, volatility increases too, therefore utility can increase/ decrease

Question 18

Passive strategy =

Answer 18

Avoids direct/ indirect security analysis, hold investments for long periods of time

Question 19

Passive strategy benefits from

Answer 19

Free-rider effect

Question 20

Passive strategy must..

Answer 20

Invest in two passive portfolios:

• Risk free
• Common stocks that mimic market index

Question 21

Capital allocation line representing passive strategy =

Answer 21

Capital market line