Portfolio Management Flashcards
What is the diversification ratio? How is it calculated?
Measures the of simple measure of the value of diversification of a stock in a portfolio. The standard deviation of an equal weighted portfolio is divided by the standard deviation of a randomly selected component of the portfolio.
Describe the Time Horizon, Risk Tolerance, Income Needs, and Liquidity Needs of each of the following:
Defined benefit pension plans
Endowments and foundations
Banks
Insurance Companies
Defined benefit pension plans typically have a long term time horizon, have a high risk tolerance, have high income needs for mature funds/low for growing funds, and low liquidity needs.
Endowments and foundations have very long term time horizons, high risk tolerances, must be able to make spending commitments, and low liquidity needs.
Banks have a short time horizon, low risk tolerance, must be able to pay interest and opex, and high liquidity needs.
Insurance companies have short term time horizons for property and casualty; long term for life insurance, low risk tolerance and income needs, and high liquidity needs.
Explain the difference between a load and no-load mutual fund.
Load means they charge a percentage fee for investing in the fund and/or for redemption from the fund on top and an annual fee.
No load only charge an annual fee based on a percentage of the funds NAV.
What do Utility Theory (functions) provide?
It quantifies the preferences for investment choices using risk and return.
What assumptions does Utility Thoery hold?
That investors are generally risk averse but prefer more return to less return
That investors are able to rank different portfolios based on their preferences and these preferences are internally consistent.
Explain what the Treynor ratio shows
It replaces total risk (std dev) with systemic risk (beta). Therefore, it shows the risk taken (acheived) above systemic risk (returns).
Explain Jensen’s alpha.
Based on systematic risk. The difference between the portfolios actual return and the required return as predicted by the CAPM is called Jensen’s alpha. Jensen’s alpha for the market equals zero. The higher the alpha for a portfolio the better its risk adjusted performance.
Regressing a security’s returns against the market’s returns can be used to find:
A stocks beta
The optimal portfolio for an investor is best described as
The point where his/her highest utility curve is tangential to the efficient frontier
True or false, regarding global equity markets
In a financial crisis, diversification is not effective at reducing risk as markets tend to move down together.
The Security Market Line (SML) relates the expected return on an asset to its:
Beta
True/False: The CML is an efficient frontier.
True
True/False: Systemic risk can be mitigated by diversification.
False
Steep indifference curves indicate that the investor is.
Cautious, (risk averse)
The risk in a portfolio containing two stocks can be eliminated completely if:
The two stocks are perfectly negatively correlated.
