Lecture 6 Flashcards

1
Q

Is there a positive relationship between volatility and average returns for individual stocks

A

yes

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2
Q

What are the difference between larger stocks and smaller stocks

A

Larger stocks tend to have lower volatility

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3
Q

What is market risk (systematic or non diversifiable)

A

It’s the risk that comes from the whole market and sticks around even if you try really hard to spread your investments around.

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4
Q

Firm Specific risk (diversifiable or non systematic)

A

Risk that can be removed by diversification

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5
Q

What are the characteristics of firm specific risk

A
  • Projects may do better or be worse
  • Competition may be stronger or weaker
  • Entire sector may be affected
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6
Q

Characteristics of market risk

A
  • Exchange rate and political risk
  • Interest rate, inflation, news about economy
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7
Q

What are portfolio weights

A

Fraction of the total investment in the portfolio in each individual investment

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8
Q

What is portfolio return

A

Weighted average of returns on the investment in the portfolio

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9
Q

What is expected portfolio return

A

Weighted average of the expected return

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10
Q

What is the volatility of a two stock portfolio

A
  • Reduction of risk bc of diversification
  • Amount of risk eliminated depends on the degree where the stock face common risks and price movement
  • Finding the risk involve finding where the stock returns move together
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11
Q

What is the covariance of a portfolio

A

Expected product of the deviations of two returns from their means

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12
Q

What happens when the covariance is positive

A

Stocks move together

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13
Q

What happens when the covariance is negative

A

Stocks move in opposite directions

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14
Q

What is correlation

A

Standardize measure for covariance

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15
Q

What happens when correlation is less than 1

A

SD of a portfolio will always be less than the weighted average of the asset SD

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16
Q

What is the minimum variance portfolio

A

Portfolio composed of risky assets that has the smallest standard devision and the portfolio with least risk

17
Q

Characteristics of risk reduction

A

R = 1; no risk
R= 0; Variance may be less than the standard deviation of either component asset
R = >1; Riskless hedge is possible

18
Q

What must be included in the portfolio of a risky asset

A

Return and risk

19
Q

What is the criteria to choose the optimal risky portfolio

A

Compare portfolios based on their expected returns and sd

20
Q

What is the mean variance frontier

A

Taking every possible combination of risky asset and find a portfolio that has the least SD

21
Q

What is efficient frontier

A
  • Best portfolios have the higher expected return for any sd and its the upper part of the curve
22
Q

What is the mean variance portfolio

A

The combination of individual securities that have the lowest variance

23
Q

Where do the efficient portfolio lie

A

Above the minimum variance portfolio

24
Q

What are the characteristics of short sale

A
  • Restrictions of weights = WA + WB = 1
  • This allows for negative proportions
  • Frontiers extend at both ends indefinitely
25
What happens when we expand our investment choices to include a risk free asset
Investment opportunity set increases
26
What yields the CAL
Risky free asset and a risky portfolio
27
What is the best CAL to achieve
Highest slope with our investment opportunity set which will ultimately intersect the efficient frontier of two risky assets at a tangency point
28
What does the best CAL involve
A portfolio that contains some allocation between the risk free asset and best risky asset portfolioW
29
What is the risky asset portfolio called
Optimal risky portfolio
30
What is the CML
Specific CAL where risk free rate = T-bill and optimal risky portfolio is given broad based index of common stocks known as the Market portfolio
31
What is the theory behind CML
Steepest of all CALs
32
What does the Two Fund Separation state
Portfolio choice can be divided into two independent tasks
33
What are the two independent tasks of the Two Fund Seperation
1. Identification of the optimal risky portfolio; demonstrating efficient diversification 2. Allocation choice between optimal risky portfolio and risk free rate; demonstrating different allocation for investors with different levels of risk aversion