Lecture Four

Question 1

What is portfolio

Answer 1

Refers to any collection of financial assets e.g. stocks, bonds, cash

characterized by their mean, variances and covariances of their returns

Question 2

Who are portfolios usually held by

Answer 2

Individual investors, managed by financial professionals, hedge funds or other financial intributions

Question 3

What is hedge fund

Answer 3

an investment instrument with pooled funds that is managed to outperform average market returns

Question 4

How are portfolios characterized by?

Answer 4

potential risk and return

Question 5

what is there always in risk and return

Answer 5

a trade off

= u will get into an investment that will u pay u a high return if the risk is also high

Question 6

What do we aim for in terms of risk and return

Answer 6

aim to minimize the risk/maximise the return

Question 7

what is the portfolio expected return

Answer 7

simply a weighted average of the expected returns on individual assets

Question 8

What is the equation for the portfolio expected return

Answer 8

the same as normal return:

new-old
———— x100
old

Question 9

What is usually used to work out where to invest

Answer 9

gets the prices for an assert and u work out the return of the investment to determine where u invest

Question 10

What essentially is the expected return

Answer 10

The mean

Question 11

How to work out the expected return using asset 1&asset 2

Answer 11

= weight of asset 1 x mean of asset1 + weight of asset2 x mean of asset2

Question 12

Are weights always going to be equal

Answer 12

No, not going to invest equally bc ur not going to invest the same for every assets
- Its based on probabilities of observing different values

=weights will be different

Question 13

What is the variance of portfolio

Answer 13

simply the weighted average of variances and covariances

Question 14

what is the symbol and name for variance

Answer 14

σ^2 -sigma squared

Question 15

How to work out the variance

Answer 15

-the variance of the first asset x squared weight + the variance of the second asset x squared asset of the second weight + 2 x the weight x the covariance

Question 16

What effect does a negative correlation have on the variance portfolio =-1

Answer 16

decreasing the variance of the portfolio (negative = pushing it down)

Question 17

What effect does a positive correlation have on the variance portfolio =1

Answer 17

increasing the variance of the portfolio (positive= pushing it up)

Question 18

What if the covariance is between -1 or 1

Answer 18

• not perfectly either side
  =u are decreasing the portfolio variance - controlling the risk - combining money into diff assets
  -not just investing in one asset = spreading risk

Question 19

How to work out the standard deviation of the portflio

Answer 19

Square root of the variance

Question 20

are we sure for what the risk will be for a portfolio

Answer 20

The concept of risk in a portfolio of assets relates to the stylized
fact that the return from a portfolio is not constant over time.
Thus, at each point in time we are not sure about what the return
on a portfolio is going to be.

Question 21

What is diversification

Answer 21

Process of combining assets in a portfolio to reduce total risk without sacrificing portfolio return

-investing in diff assets to reduce risk

Question 22

What risks are companies exposed to

Answer 22

-every company has a risk specific to the company
-every company is exposed to the market risk

Question 23

What risk does the diversification get rid of?

Answer 23

-diversify the risk that is specific to the company

Question 24

What does a correlation of 1 mean for the variance of the -diversify the risk that is specific to the company portfolio

Answer 24

correlation is 1 = 1 never decrease variance of portfolio

Question 25

What does a correlation of -1 mean for the variance of the -diversify the risk that is specific to the company portfolio

Answer 25

-correlation is -1 = portfolio variance = 0 , no risk

Question 26

What if two values are negative

Answer 26

-two values are negative - variance is always lower

Question 27

Is -1 correlation common

Answer 27

ever find correlation that is exactly -1, bc theres always risk/ always exposed to a certain risk

Question 28

What happens to correlation when there is a global risk?

Answer 28

-when theres global risk = all move in the same direction
=correlation in bad times, ALWAYS increase SIGNIFICANTLY
-always exposed to losing large amounts of £

Question 29

some changes of global risk

Answer 29

shifts in exchange rates, new regulations, protectionism, debt crises, and political unrest.

Question 30

how can diversification affect the variance in the equation

Answer 30

N is the uncorrolated assets:
the variance will turn into 1/N^2 *variance + 1

-the 1/n indicates that the assets are divided and spread across the variance -SPREADING RISK

=e.g. if n = 1000000000, variance will be closer to 0
-ASSUMING variance Is same for ALL assets

Question 31

What does MVP stand for

Answer 31

Minimum Variance Portfolio

Question 32

What is the MVP

Answer 32

is a collection of non-correlated, volatile securities that has the lowest possible risk (variance) among all portfolios of risky assets

A portfolio with the lowest risk (variance) among all portfolios of risky assets

Question 33

What is the objective of the MVP

Answer 33

to find the weights that will render a portfolio with the lowest possible variance

Question 34

What is used for the MVP

Answer 34

return patterns and correlations

Question 35

what is the relationship for the portfolio expected returns compared to the portfolio variance

Answer 35

Ex return is a linear combination of two assets and weights
But portfolio variance is not

Question 38

What is the relationship between variance and expected return for the variance

Answer 38

the lower the variance = the lower the expected return

Question 39

Where is the MVP

Answer 39

The lowest point -can be the one on the curve
on the curved angle on a risk/return diagram

=guaranteed smallest variance