Modern PortfolionTheory

Question 0

What is Beta

Answer 0

Beta is a measure of volatility or sistematic risk of an investment or portfolio in comparison to the market as a whole. You can think of it as a tendency of an investment’s return to respond to swings in the market. By definition, the market has a Beta of 1

Question 1

Explain Alpha

Answer 1

Alpha is the measure of an investment’s performance on a risk adjusted basis. It takes the volatility of a security and compares its risk-adjusted performance to a benchmark index. The excess return of the investment relative to the return of it’s benchmark is its “alpha”

Question 2

What is R-squared?

Answer 2

R-squared is the return that can be explained by the return of the benchmark. A performance between 85 and 100, has a performance record that is closely correlated to the index.

Question 3

Standard Deviation

Answer 3

Standard deviation measures the dispersion of data from its mean. Measures the volatility of the return of a security. A volatile stock would have a high standard deviation. In a mutual fund, it tells us how much the return of a fund is deviating from the expected returns based on its historical performance.

Question 4

Sharpe Ratio

Answer 4

Measures the risk adjusted performance. The Sharpe ratio tells investors whether an investments returns are due to smart investing, or a result of excess risk.

Question 5

CAPM formula:

Answer 5

Capital Asset Pricing Model formula is

Expected Return = Risk Free rt + Beta(Mkt rt - RF rt)

Question 6

CML formula:

Answer 6

Capital Market Line:

CML=Rf + [(Standard Dev of P)(Rm - Rf) / (Standard Dev of Mkt)]

Question 7

Expected Return =

Answer 7

Is the weighted average of the expected returns of the component securities.

E(Rp)= W1E(R1) + W2E(R2) + … WnE(Rn)

Question 8

Efficiency of a portfolio is

Answer 8

The highest return for a given level of risk

Question 9

What is APT?

Answer 9

Arbitrage Pricing Theory is an alternative to CAPM. APT assumes there are multiple sources of risk and that mean variance optimization may not represent the ideal portfolio for an investor.
E(Rj) = Rfree + Bn1 (Risk Premium1) + Bn2 (Risk Premium2) + …

Question 10

SML

Answer 10

Security Market Line is the relationship between risk and return for the individual asset = CAPM
Risk is measured in terms of Beta coefficient

Question 11

Define the Real Rate of Return

Answer 11

Is that rate of return that is above inflation

Real rate = [(1+ Nominal rate / 1+ Inflation rate) -1]*100

Question 12

Simple interest

Answer 12

I = PrincipalRateTimePeriod(n)

Question 13

Future Value formula

Answer 13

FV = PV*(1+r)^n

Question 14

Present Value Formula:

Answer 14

PV = FV / (1+r)^n

Question 15

What is the rule of 72?

Answer 15

It is a quick estimate of the time it will take for an investment to double.
72 / r = time it will take to double
72 / n = the rate it will take to double

Question 16

What is the FV of an Annuity Due?

Answer 16

An investor deposits money on a periodic basis at the beginning of each period. The future compounding value is called Future Value of Annuity Due - FVAD.

FVAD = (1+r) [ ((1+r)^n-1)/r)*(initial deposit)

Question 17

Formula for future value of an ordinary annuity

Answer 17

Ordinary annuity receives its contribution at the end of the period. The formula is:
FVOA = (((1+r)^n)-1) / r) + (initial deposit)

Question 18

What is the present value of an annuity due?

Answer 18

PVAD = (1+r) [(1-(1/(1+r)^n)*(Initial Deposit) / r]

Question 19

Formula for Present Value of an Ordinary Annuity:

Answer 19

PVOA = [(1-(1/(1+r)^n) / r) * (init dep)]

Question 20

The effective rate of interest is:

Answer 20

Effective Rate = ((1+ Periodic Rate)^m) - 1

Question 21

What is the equity risk premium?

Answer 21

The equity risk premium is the rate above the risk free rate :
Equity Premium = Rm - Rf

Question 22

What is rhe formula for a taxable equivalent yield?

Answer 22

Taxable equivalent Yield = Tax free yield / (1- tax bracket)

Question 23

Net Present Value Calculation:

Answer 23

Determines if a project is viable or not. To be viable the NPV must be > 0
The formula is:
NPV = CF0 + CF1/(1+r)^1 + CF2/(1+r)^2 + … CFn/(1+r)^n

Question 24

What is the importance of an IPS?

Answer 24

An Investment Policy Statement contributes to the

Question 25

What is the importance of an IPS?

Answer 25

An Investment Policy Statement improves the communication with the client, establishes a dramework for decision making, and sets a disciplined approach to investment management.

Question 26

Arithmetic mean

Answer 26

Is the sum of the observations divided by the number of observations. Consequently, it ignores the effect of compounding

Question 27

Geometric mean

Answer 27

The proxess by which money today (PV) grows to a larger amount (FV) over time, is called compounding.

Question 28

What is UPMIFA

Answer 28

Uniform Management of Institutionl Funds Act. Along with the UMIFA are the core bodies of regulation for Endowments and Charities.

Question 29

What is one important element of the UPIA?

Answer 29

The Uniform Prudent Investor Act allows for the use of methodologies established by MPT. Performance can be measured on the whole portfolio and not on individual assets, allowing for the use of commodities and futures.