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Financial Markets Theory > Lecture 5 > Flashcards

Lecture 5 Flashcards

1
Q

What does the risk free asset act as?

A

A benchmark rate of return

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2
Q

What must risky assets pay?

A

A risk premium relative to the risk free rate

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3
Q

What can the investor borrow at the risk free rate and what can they use it alongside/for?

A

Borrow funds
Use alongside existing funds
To invest in risky asset

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4
Q

Borrowing at risk free rate extends what? What is this called?

A

Extends the locus of feasible portfolios
Called the capital allocation line

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5
Q

Where is the optimal risky portfolio found at?

A

The point of tangency between the efficient frontier and the capital allocation line

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6
Q

What is the optimal portfolio called?

A

The mean-variance efficient portfolio

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7
Q

Any capital allocation line that is not _______ to the efficient frontier will either be impossible (if it’s ______) or inefficient (if it’s _________)

A
  1. Tangent
  2. Steeper
  3. Flatter
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8
Q

What is risk premium?

A

Extra return that the investor seek to hold a risky asset

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9
Q

How do you calculate the risk premium?

A

Market return - risk free rate

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10
Q

What is the premium for holding risky assets?

A

The amount of increased return that the investors receive to compensate them for increased risk

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11
Q

If the sharp ratio is 0.75, what does it imply?

A

That for each percentage point increase in the risk of a portfolio along the capital allocation line, the return rises by 0.75 percentage points

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12
Q

What is the reward-to-risk ratio called?

A

The Sharpe ratio

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13
Q

What is the riskiness of the MVEO portfolio and the risk premium dependant on?

A

The risk free rate of return

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14
Q

If the risk free rate were higher, and the same efficient frontier attainable then…

A

The Sharpe ratio would be lower
Mean variance efficient portfolio held by all investors will be more risky

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15
Q

Where must all assets be?

A

In the mean variance efficient portfolio

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16
Q

What two assets do all investors hold, and what does this mean?

A

The risk-free asset
Mean variance efficient portfolio
Albeit holding them in differing proportions in their portfolios

17
Q

For all available assets in the market to be purchased (the market to be in equilibrium)…

A

Each must be held in proportion to its weight in the market

18
Q

The MVEP includes all risky assets in proportion to ____________ (market capitalisation). It is therefore a ______________ version of itself and is known as the ____________

A
  1. Their weight in the market
  2. Scaled down
  3. Market portfolio
19
Q

Why do share prices fluctuate?

A
  1. They move with the market - market-related or systematic risk
  2. Idiosyncratic reasons - specific or unsystematic risk
20
Q

What is the line of best fit calculated using and what is it known as?

A

The mathematical procedure of regression to the mean
Known as the characteristic line for share i

21
Q

In a portfolio, the contribution of each share to the riskiness of the portfolio is…?

A

In proportion to its weight

22
Q

The sensitivity of the portfolio to the market is

A

The weighted average of the sensitivities of the constituent shares

23
Q

As the number of shares increases, the variance of the portfolio…?

A

Converges to the variance of the market

24
Q

Specific risk can be diversified away until…

A

Only market risk remains

25
Q

Rational, risk averse investors can do what to specific risk and therefore…?

A

Diversify away
Therefore specific risk does not hurt investors and they do not need to be compensated for it.

26
Q

What type of risk can’t investors diversify away, and what does this mean?

A

Market related risk
Means that they require a higher rate of return in order to accept the risk

27
Q

Bc the contribution that a share makes to the market risk of a portfolio is ______ to beta, the ______________ of a share must be ________ to its beta

A
  1. Proportional
  2. Risk premium
  3. Proportional

Financial Markets Theory (7 decks)

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