Portfolio Concepts

Question 0

Variance and stand dev of 2 asset portfolio

Answer 0

o^2 = w1^2o1^2 + w2^2o2^2 + 2w1w2p1,2o1o2

o = sqrt(o^2)

Question 1

Expected return for 2 asset portfolio

Answer 1

E(Rp) = w1E(R1) + w2E(R2)

Question 2

Calculate covariance

Answer 2

Cov(1,2) = p1,2o1o2

Question 3

What is the minimum variance frontier

Answer 3

Expected return variance combinations of the set of portfolios that have minimum variance for every given expected return

Question 4

Portfolios on the efficient frontier have the highest _________ at each given level of risk

Answer 4

Expected return

Question 5

Why are min var and efficient frontiers unstable? What is effect

Answer 5

Exp returns, variances, covariances change over time

May lead to large portfolio weighting areas

Question 6

What is portfolio diversification

Answer 6

Strategy of reducing risk by combining different types of assets into a portfolio

Question 7

Diversification benefits increase with _____ and ______

Answer 7

Decreases correlations

Increased number of assets

Question 8

Calc variance of equally weighted portfolio

Answer 8

O^2 = o^2 *((1 - p)/n + p)

Question 9

Variance of an equally weighted portfolio approaches average covariance as n gets large; this means…

Answer 9

1. Reducing risk via diversification can be achieved w/relatively few stocks
2. Higher average correlation => fewer stocks needed to reduce risk

Question 10

What is the capital allocation line

Answer 10

Line from risk free rate to tangency to efficient frontier

Question 11

Where does best risky portfolio lie

Answer 11

Point of tangency between CAL and efficient frontier

When combined with risky asset, optimal reward to risk ratio

Question 12

Sharpe ratio

Answer 12

o (std dev)

expected risk premium per unit risk

Question 13

CAL equation

Answer 13

E(Rc) = Rf+(E(Rt) - Rf)*oc
———
o (std dev)

Combo of risk free asset and efficient asset

Question 14

Things to remember about CAL

Answer 14

If risk free available, combine to risky portfolio to increase returns
Intercept = rf
Slope = Sharpe ratio 
Use to assess risk at target return
Diff asset expectations = diff CALs

Question 15

Market portfolio is tangency portfolio CML equation:

Answer 15

E(Rc) = Rf+(E(Rm) - Rf)*oc
———
om (std dev)

Combo of risk free asset and efficient asset

Question 16

Differences between CAL and CML

Answer 16

Only one CML; unlimited CALs
Market portfolio uses market value weights
Tangency portfolio differs across investors
CML special case for CAL

Question 17

CAPM (Systematic market line)

Answer 17

E(Ri) = Rf + Bi(E(Rm) - Rf)

Question 18

Key differences between SML and CML

Answer 18

Systematic risk vs. standard deviation
(Non diversifiable vs. total risk)
Use to benchmark returns vs. asset allocation
CAPM vs. efficient frontier
Slope is Market risk premium vs. sharpe ratio

Question 19

How to calc beta

Answer 19

Beta = Oi * p(i,M)
—-
Om

Question 20

Market model (regression model used to estimate betas for common stocks

Answer 20

Ri = Ai + Bi*Rm + Ei

Question 21

What three predictions does market model make?

Answer 21

1. E(Ri) = Ai + Bi*E(Rm)
2. Oi^2 = Bi^2*Om^2 + Oe^2
3. Cov(i,j) = BiBjOm^2

Question 22

Adjusted beta (to correct for beta instability)

Answer 22

Forecast B(i,t) = A0 + A1*B(i,t-1)

Blume assigns A0 = 1/3 and A1 = 2/3

Question 23

Difference between how macroeconomic, fundamental, and statistical factor models explain asset returns

Answer 23

Unexpected changes
Vs. returns from multiple firm-specific factors
Vs. determine which “factors” best explain on a cross section of securities

Question 24

Unique features of Macroeconomic factor model

Answer 24

Sensitivities are regression slope estimates Macro factors surprises in variables Fewer factors that represent systematic risk Intercept = stocks expected return

Question 25

Unique features of fundamental factor model

Answer 25

Sensitivities are calculated from attribute data Fundamental factors are rates of return estimated using multiple regression Detailed - large number of factors Intercept has no economic interpretation

Question 26

What is Arbitrage pricing theory

Answer 26

Equilibrium asset pricing model with less restrictive assumptions Intercept = risk free rate Factors are actual risk premiums

Question 27

Active return

Answer 27

Active return = portfolio return - benchmark return

Question 28

Active risk

Answer 28

Active risk ^2 = active factor risk + active specific risk

Question 29

Information ratio

Answer 29

IR = Rp - Rb --------- S S= active risk

Question 30

What is a factor portfolio

Answer 30

Constructed w/sensitivity of one