portfolio inv

Question 1

definition on “Portfolio”?

Answer 1

Group of assets held simultaneously

ex: stocks, bonds, commodities

Question 2

why do you want to hold several assets in a portfolio instead of one asset?

Answer 2

Risk reduction

instead of spread the risk on 1 asset you spread it across 20 assets

Question 3

what is a risk premium on an asset?

Answer 3

the COMPENSATION you get for tolerating the extra risk in an investment

Question 4

what if: the risk premium on an asset is “high” then what is true about the risk?

Answer 4

the Risk is also considered “high”

Question 5

what if: the risk premium on an asset is “low” then what is true about the risk?

Answer 5

the Risk is also considered “low”

Question 6

if the Risk of a portfolio is considered high then what is true about the expected return of that portfolio?

Answer 6

expected return is high

Question 7

if the Risk of a portfolio is considered low then what is true about the expected return of that portfolio?

Answer 7

expected return is low

Question 8

if σ = 0 then what is true about the asset? ALSO give an example of an asset that fulfill the condition

Answer 8

risk-free

Ex: Treasury bill

Question 9

if σ > 0 then what is true about the asset? ALSO give an example of an asset that fulfill the condition

Answer 9

there is a risk and should therefore be a risk premium on that asset
Ex: Stock, some bonds etc

Question 10

is this condition true? volatility = σ

Answer 10

YES! beacuse:

volatility = risk = σ

Question 11

what is W1 in a Portfolio with 2 securities?

Answer 11

proportion of funds in security 1

how much of your money u have invested in security 1

Question 12

for example could the W1 in a portfolio with 2 securities be negative? if its true then what could be the reason for that?

Answer 12

1: you are selling the security
2: you are short-selling the security

Question 13

if σ12 > 0 for 2 assets then what is true about the correlation between them?

Answer 13

positive correlation, “tends to go the same way”

Question 14

if σ12 < 0 for 2 assets then what is true about the correlation between them?

Answer 14

negative correlation, “tends to go the opposite way”

Question 15

if we have a portfolio with a σ12 ≈ 0 is this considered a well diversified portfolio?

Answer 15

Yes they have almost no correlation with eachother

Question 16

if the variance of a low risk portfolio is 4 and the variance of o a risky portfolio is 9 is it possible for a portfolio that only include these two portfolios to have a variance that is smaller then 4?

Answer 16

YES!

see variance formula and observe lecture example

Question 17

if we want to calculate the variance of the expected return of a portfolio, how much is determined by the average variance and the average covariance?

Answer 17

variance ≈ 1%

covariance ≈ 99%

Question 18

what if you hold a well diversified equally weighted portfolio, then what is the risk of holding that portfolio?

Answer 18

all assets perform poorly simultaneously

Question 19

if the average covariance between a number of assets in a portfolio is alot bigger than 0, will the volatility of the portfolio be large?

Answer 19

Yes! thus they have a positive correlation wich means that they will “tend to go the same way” simultaneously wich gives us high volatility, big chance to get the assets whiped out at the same time
(get ready to ride the rollercoaster)

Question 20

if the average covariance between a number of assets in a portfolio is approximately 0, will the volatility of the portfolio be large?

Answer 20

NO! thus they have a almost none correlation wich means that they almost have no relationship, low chance to get the assets whiped out at the same time
(safe portfolio)

Question 21

if we look at the composite portfolio that exists of stocks and bonds:
E(rc)=WsE(rs) + WbE(rb)
is the following then possible and how?
E(rc) > E(rs),E(rb)

Answer 21

YES! assume that Ws = -0,5 and Wb = +1,5 and E(rs) = 0,05 and also E(rb) = 0,06 then:
E(rc) = (-0,50,05) + (1,50,06)
E(rc) = 0,065
therefore our condition is fulfilled
0,065 > (0,05),(0,06)
conclusion: if one W is negative then its possible

Question 22

your homeboy alex tells you that if you have a portfolio consisting of two risky assets, then the portfolio will always be risky, is he right? why/why not

Answer 22

no beacuse you have to look at the covarinace between the two assets, if the covariance between them are close to zero and therefore you can send his theory out the window

Question 23

if you are a portfolio manager (in the real world) is there a limit to how much you can diversify? yes/No why?

Answer 23

YES! beacuse of taxes and fees etc.

the cost can exceed the benfits of diversification if you diversify to much

Question 24

if we have two diffrent Capital allocation lines (CAL) with two diffrent slopes, where CAL 1 is much steeper then CAL 2 wich one do we prefer?

Answer 24

CAL 1 beacuse we get much more expected retrun for our increase in risk

Question 25

if the CAL1 is steeper then the CAL2 then what can you say about the sharpe ratio for the CAL:s?

Answer 25

CAL1 has a bigger sharpe ratio then CAL2

Question 26

your friend vitvaruboi who is a portfolio manager tells you to picture in your mind a Security Market-line (SML) and tell you the following: if a stock is below the SML line then buy as much of that stock thats possible! is he correct and will be very rich, or is making a astronomical misstake? explain

Answer 26

Vitvaruboi is very wrong, stocks that is below the SML is overvalued and thus should be sold "quicker than you chug a beer during spring break" alternative be short-sold to earn money

Question 27

Jocke jonasson aka Joseph who is an opponent to Vitvaruboi`s firm has noticed a stock that is WAAAAAYYY above the Security market line (SML) and decide to buy as many stocks as possible. is this a good idea? should he really do this?

Answer 27

YES! beacuse the stock is heavily undervalued

Question 28

what is one reason to use Security Market Line (SML)?

Answer 28

to identify misspriced assets

Question 29

the CAPM is a useful benchmark to evalute...?

Answer 29

How imperfect real life markets are

Question 30

give an example for an "exotic" investment

Answer 30

Art, some coins, racing horses etc

Question 31

in the model: E(ri)= rf + βi[E(rm)-rf] + f(ci) the last term f(ci) have been added, whats the purpose of the term

Answer 31

purpose is to add a "risk premium for liquidity"

Question 32

what is liquidity risk?

Answer 32

Ex: if you buy an asset and hold it fore a while and then decides to sell it but having a hard time to sell it, the longer you have to wait to sell it the higher is the liquidity risk

Question 33

is it possible to diversify "systematic risk"

Answer 33

No! the risk is effecting a whole market or market segment

Question 34

if you trade stocks in an "over the counter market" does this means that you liquidity risk increases?

Answer 34

Yes!