Lecture 5

Question 1

Drawbacks of the Markowitz theory (2)

Answer 1

• Requires large number of estimates > scope for errors

- No guidelines for forecasting security risk premiums provided > essential to construct efficient frontier

Question 2

Success of the portfolio selection rule depends on

Answer 2

Quality of the input list

Question 3

Input list (2)

Answer 3

• Estimated expected returns

- Variances

Question 4

Market risk =

Answer 4

Unexpected changes that impact the whole market and cannot be diversified away

Question 5

Beta measures

Answer 5

The systematic risk

Question 6

Systematic risk =

Answer 6

How sensitive the security is to macroeconomic shocks

Question 7

Single-index model

Answer 7

Can set a rate of return on index securities as a proxy for m (common macroeconomic factor)

Question 8

Alpha =

Answer 8

Security’s expected excess return

Question 9

Market excess return =

Answer 9

0

Question 10

Slope coefficient =

Answer 10

Security beta > security’s sensitivity to index > amount by which security return increases/ decreases for every % increase/ decrease in return on index