Porfolio Theory Flashcards
What are the aims of modern portfolio theory?
It focuses on mean-variance optimisation. Highest return for a given level of risk. And lowest risk for a given expected return.
How should investors optimise their portfolio?
They should base it on expected returns and volatility
What are the parts of the investment decision process?
Capital allocation - deciding risk-free vs risky assets in the portfolio
Asset allocation - within the portfolio, distributing wealth across bonds, stocks etc
Selection - within each asset, select individual assets/securities
What is the CAL and what does it show us?
The Capital Allocation Line represents all possible combinations of risk-free assets and risky portfolios
How does risk affect selection?
Different investors choose different allocations based on their risk aversion (A)
What are the investment strategies?
Passive and active
What is the Passive investment strategy?
Invest in market indices which are low cost with no security analysis. The CML represents the passive strategy CAL
What is the Active investment strategy?
Investor aims to outperform the market. It requires stock selection and market timing. It is high cost
What is the optimal risky portfolio selection?
Combining multiple risk assets into a single efficient portfolio.
What does efficient of a risky portfolio depend on?
Asset weights, Expected returns, standard deviation and correlation between assets
What does a positive p value in portfolio theory mean?
There is no risk reduction possible
What does Markowitz portfolio selection model tell us?
Identify risk-return combos available from risky assets. Done by drawing the minimum-variance frontier
Identify the portfolio by finding the weightings using the highest sharpe ratios. The steepest CAL means it dominates all alternative feasible lines
Choosing the appropriate proportions of the optimal complete portfolio by mixing risky and risk-free
What is Separation Property
The property that portfolio choice can be divided into two independent tasks: The determination of the optimal risky portfolio and the personal choice of the best mix of the optimal risky portfolio and the risk-free asset, which depends on a person’s degree of risk aversion.
