Lecture 4 - Portfolio theory

Question 1

What are the two conflicting objectives of portfolio theory?

Answer 1

1. Have what you need when you need it
2. take advantage of opportunities to increase wealth

Question 2

What is the main aim of modern portfolio theory?

Answer 2

optimal portfolio structure to have the highest expected return at a given level of risk

Question 3

What is the Fama-French Three factor model?

Answer 3

An alternative to CAPM
Says returns are predicted by:
1. size (small highest)
2. High book to market best
3. Beta

Question 4

Critiques of Fama-French

Answer 4

1. The returns are the result of higher risk exposure
2. The model results in irrational preferences for large firms with low book to market ratios

Question 5

What is the practical use for CAPM?

Answer 5

Useful in showing investors the risk relationships between assets

Useful to view risk of a company relative to their portfolio