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Concepts of Investment > Midterm #2 > Flashcards

Midterm #2 Flashcards

1
Q

2 Types of Risk

A

Firm Specific
Macroeconomic

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2
Q

Covariance

A

measures the extent to which the returns on any two assets vary in tandem

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3
Q

Index Model

A

statistical model designed to estimate the two risk components of a security or portfolio

practicability is key

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3
Q

alpha

A

measures the excess return (or underperformance) of a stock or portfolio relative to a benchmark index, after accounting for market-related risk (Beta). It reflects the value added (or lost) by the asset manager or stock independent of the market

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4
Q

+ alpha

A

outperformed

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5
Q

Beta

A

measures the sensitivity of a stock or portfolio’s returns to the returns of the market. It represents the level of systematic risk (market risk) associated with an asset.

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6
Q

Beta < 1

A

less volatile than the market

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7
Q

Beta = 1

A

in line with market

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8
Q

Beta > 1

A

more volatile than the market
tech stocks

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9
Q

CAPM
Capital Asset Pricing Model

A

model that produces a precise relationship between the risk of an asset and its expected return

provides a benchmark rate of return

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10
Q

Investors only differ

A

in risk aversion

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11
Q

Market Portfolio

A

the sum of the portfolios of all investors

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12
Q

Alpha and Single Index

A

is the stock’s return not explained by the market

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12
Q

Risk Aversion

A

does not matter for finding the optimal risk portfolio

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13
Q

Passive Indexing Strategy

A

obtain efficient portfolio by simply holding the market portfolio

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13
Q

Optimal Risky Portfolio of All Investors

A

is the same

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14
Q

CAPM provides

A

a baseline for providing securities

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15
Q

Alpha =

A

expected return - fair return

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16
Q

Expected Returns should

A

be directed related to beta

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17
Q

CAPM deals with

A

MARKET not investor

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18
Q

Firm Specific Stocks are

A

independent of market movements

so independent of alpha

19
Q

Alpha and Stocks

A

doesn’t necessarily mean higher firm-specific shocks—it means the stock has a higher expected return UNRELATED to the market.

20
Q

Systematic Risk and Beta

A

Firm-specific shocks are unsystematic risk, and their standard deviation is independent of beta.

21
Q

Expected Value of Firm Specific Stocks

A

is zero because they are random and unpredictable. Over time, the positive and negative deviations cancel out

22
Q

While the stocks have the same alpha, beta, and firm-specific standard deviation

A

their returns are not always the same

23
Q

Diversification and Beta

A

Diversification does not lower beta

it reduces unsystematic risk

24
Q

Diversification and Alpha

A

does not increase Beta

it reduces risk

25
Q

Diversification between Stocks

A

will yield a lower variance portfolio

26
Q

Systematic

A

market

26
Q

Unsystematic

A

unique to a specific company

27
Q

Low p value in sigle index model regression

A

stock’s true alpha is likely equal to zero

28
Q

Alpha = 0

A

in line with market

29
Q

Markowitz Portfolio

A

focuses on identifying the optimal risky portfolio by minimizing risk for a given level of expected return

more accurate compared to single index

30
Q

Single Index Model

A

simplifies portfolio construction by assuming that all stock returns are influenced by a single common factor

30
Q

If CAPM holds

A

zero alpha

31
Q

If CAPM holds what determines the stocks expected return

A

stock’s beta

32
Q

X Plot

A

market excess return

33
Q

Y Plot

A

stock’s excess return for that month

34
Q

When the point is to the right and below

A

shows that the market went up and the stock went down

35
Q

What is the Beta on the Graph?

A

the slope of the line

36
Q

Each Dot

A

is a 1 month return

37
Q

Where is Alpha?

A

the intercept

38
Q

Expected on the Graph

A

is the distance between the slope and the plot

39
Q

When the plot is more spread out

A

it has more firm specific risk

40
Q

Market Portfolio in the CAPM

A

has a beta of 1

41
Q

In Single Index Model the expected value of firm specific stocks is

A

0

42
Q

Beta of 1.2

A

expected return will be higher than the market return

43
Q

Diversification in the Single Index Model

A

reduces firm specific risk

DOES NOT eliminate systematic risk

44
Q

CAPM Beta of 0 =

A

Risk Free Rate

45
Q

Alpha in Index Model

A

is expected excess return after controlling for systematic risk

Concepts of Investment (3 decks)

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