portfolio inv Flashcards
definition on “Portfolio”?
Group of assets held simultaneously
ex: stocks, bonds, commodities
why do you want to hold several assets in a portfolio instead of one asset?
Risk reduction
instead of spread the risk on 1 asset you spread it across 20 assets
what is a risk premium on an asset?
the COMPENSATION you get for tolerating the extra risk in an investment
what if: the risk premium on an asset is “high” then what is true about the risk?
the Risk is also considered “high”
what if: the risk premium on an asset is “low” then what is true about the risk?
the Risk is also considered “low”
if the Risk of a portfolio is considered high then what is true about the expected return of that portfolio?
expected return is high
if the Risk of a portfolio is considered low then what is true about the expected return of that portfolio?
expected return is low
if σ = 0 then what is true about the asset? ALSO give an example of an asset that fulfill the condition
risk-free
Ex: Treasury bill
if σ > 0 then what is true about the asset? ALSO give an example of an asset that fulfill the condition
there is a risk and should therefore be a risk premium on that asset
Ex: Stock, some bonds etc
is this condition true? volatility = σ
YES! beacuse:
volatility = risk = σ
what is W1 in a Portfolio with 2 securities?
proportion of funds in security 1
how much of your money u have invested in security 1
for example could the W1 in a portfolio with 2 securities be negative? if its true then what could be the reason for that?
1: you are selling the security
2: you are short-selling the security
if σ12 > 0 for 2 assets then what is true about the correlation between them?
positive correlation, “tends to go the same way”
if σ12 < 0 for 2 assets then what is true about the correlation between them?
negative correlation, “tends to go the opposite way”
if we have a portfolio with a σ12 ≈ 0 is this considered a well diversified portfolio?
Yes they have almost no correlation with eachother
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?
YES!
see variance formula and observe lecture example
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?
variance ≈ 1%
covariance ≈ 99%
what if you hold a well diversified equally weighted portfolio, then what is the risk of holding that portfolio?
all assets perform poorly simultaneously
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?
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)
if the average covariance between a number of assets in a portfolio is approximately 0, will the volatility of the portfolio be large?
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)
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)
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
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
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
if you are a portfolio manager (in the real world) is there a limit to how much you can diversify? yes/No why?
YES! beacuse of taxes and fees etc.
the cost can exceed the benfits of diversification if you diversify to much
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?
CAL 1 beacuse we get much more expected retrun for our increase in risk
if the CAL1 is steeper then the CAL2 then what can you say about the sharpe ratio for the CAL:s?
CAL1 has a bigger sharpe ratio then CAL2
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
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
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?
YES! beacuse the stock is heavily undervalued
what is one reason to use Security Market Line (SML)?
to identify misspriced assets
the CAPM is a useful benchmark to evalute…?
How imperfect real life markets are
give an example for an “exotic” investment
Art, some coins, racing horses etc
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
purpose is to add a “risk premium for liquidity”
what is liquidity risk?
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
is it possible to diversify “systematic risk”
No! the risk is effecting a whole market or market segment
if you trade stocks in an “over the counter market” does this means that you liquidity risk increases?
Yes!
