Lecture 8 - Portfolio Analysis Flashcards
What is capital allocation?
The choice between risky and risk free assets.
What is asset allocation?
Portfolio choice among broad investment classes (e.g. US stocks, international stocks and long term bonds).
What is security selection?
Selection of individual assets within each asset class.
What is a risk free asset?
The most common are Treasury bills as they are insensitive to interest rate fluctuations. Treasury bonds are still affected by inflation. Price indexed government bonds (e.g. TIPS). Money market instruments are effectively risk free. Risk of CDs and commercial paper is minor compared to most assets.
What is the most basic allocation choice?
The choice of how much of the portfolio to place in risk free money market securities versus other risky asset classes.
How do you optimise allocation?
Maximise the slope of the Capital Allocation Line (CAL) for any possible portfolio, P.
What is sharpe ratio?
The risk premium in excess of risk free rate, divided by the standard deviation. The portfolio that maximises the sharpe ratio is the solution to the asset allocation problem.
