Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

CPWA > Portfolio Theory > Flashcards

Portfolio Theory Flashcards

1
Q

What is the utility function of a portfolio?

A

U(E[r],σ)=E[r]-yσ2 where E(r) is your mean return and o is your standard deviation of your return in %.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What does the utility function determine?

A

Your utility function determines how happy you are
with your portfolio

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

You are happier with a higher/lower expected return and a higher/lower variance?

A

Higher, lower

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What are the three steps to the basic asset allocation problem? (Suppose that you have a one year horizon
– We’ll work with nominal returns although we really
should work with real returns)

A

Make forecasts about the assets
2. Decide the feasible set of investments available to us
(i.e., by varying our fraction of wealth w we invest in
each)
3. From the set of all feasible options, choose the one
that maximizes our utility (makes us happiest)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

In rw=wrs&p+(1-w)rf what does w mean in this formula?

A

w is the fraction of our wealth that we allocate to
stocks (i.e., we studied w=0, w=0.6)
* Any w between 0 and 1 is fine

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is an indifference curve?

A

a curve on a graph (the axes of which represent quantities of two commodities) linking those combinations of quantities which the consumer regards as of equal value.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Yes or No: Do we want the portfolio with the highest utility?

A

Yes

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

At what point on the feasible set E(r(w),o(w)) will we get the optimal portfolio?

A

When the indifference curve and the feasible set curves are tangent to each other.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

How can the standard deviation of the S&P 500 be measured?

A

With the VIX (Volatility Index)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What does the covariance of two variables X,Y equal to?

A

Cov(X,Y)=std(X)std(y)corr(X,Y)
Covariance measures the directional relationship between the returns on two assets

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What does variance equal to?

A

o^2

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

The ____ the correlation between the two assets, the _____ the effect of diversification

A

The lower the correlation between the two assets, the stronger the
effect of diversification

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What makes an asset attractive?

A

It has high expected return
* It has low variance
* It has low correlation with other things you own
– e.g., insurance policies
20

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Stocks tend to have some market wide systematic shocks which
can/cannot be diversified?

A

Cannot be diversified

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is Idiosyncratic Risk?

A

also called “diversifiable” or “unsystematic risk “
* this risk refers to factors that may affect one asset or
investment but not another
* MPT suggests that this risk may be mitigated through
diversification
33

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Should idiosyncratic risk be diversified? (Yes or No)

A

Yes

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What is the formula for the sharpe ratio?

A

Rp-Rf/op where Rp equals the return on the portfolio, Rf is the risk free rate and op is the standard deviation of portfolio’s excess return

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

If assets aren’t perfectly correlated, we can lower/increase our
portfolio’s volatility and lower/increase average returns by mixing
these assets: the risks offset each other?

A

Lower, increase

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

We should only hold ______ risk, or risk that we can not diversify?

A

Systemic

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

What is Systemic Risk?

A

also called “market risk” and “non-diversifiable risk”
* systematic risk is the inherent risk that comes from
having exposure to the overall market
* MPT suggests that systematic risk cannot be mitigated
through diversification

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

What are some challenges of Market Portfolio Theory?

A

Inputs are measured with (a lot of) error
Asset correlations are not fixed
Investors are not exclusively risk-averse
Risk is not known and constant
Investors cannot always borrow and lend risklessly for
free
Taxes and transactions costs are real

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

Variance is a good/bad measure of overall portfolio risk?

A

Good

23
Q

For an individual security is the covariance or variance the right measure of risk?

A

Covariance

24
Q

A security’s fair average return is determined by its_______

A

A security’s fair average return is determined by its
covariance with the market

25
Q

Risk is _________ with the market portfolio

A

Covariance

26
Q

Over many decades, average return of value stocks is much
higher/lower than that of growth stocks
– but doesn’t appear to be riskier?

A

Higher
Value stocks (with low ratios) appear to earn higher returns
than they “deserve,” for their risk
* Growth stocks (with high ratios) appear to earn lower returns
than they “deserve,” for their risk

27
Q

What is the Jensen’s Alpha or Jensen’s Measure?

A

The Jensen’s measure, or Jensen’s alpha, is a risk-adjusted performance measure that represents the average return on a portfolio or investment, above or below that predicted by the capital asset pricing model (CAPM), given the portfolio’s or investment’s beta and the average market return. This metric is also commonly referred to as simply alpha.

Return of Asset – Expected Return

where:

R(i) = the realized return of the portfolio or investment

R(m) = the realized return of the appropriate market index

R(f) = the risk-free rate of return for the time period

B = the beta of the portfolio of investment with respect to the chosen market index

28
Q

What is the sortino ratio?

A

S = (R – T) / DR

Sortino Ratio = (Average Realized Return – Expected Rate of Return) / Downside Risk Deviation

a risk-adjusted measure of return that uses downside
volatility (semi-standard deviation) to measure risk
* unlike the Sharpe ratio, Sortino only uses negative
returns in the calculation to measure downside risk
* considered a more effective way to than other ratios
to measure high volatility portfolios

29
Q

What is semi-variance?

A

a measurement of dispersion
measures data that is below the mean or target
value of a data set
* considered a better measurement of downside risk
* semi-variance is the average of the squared deviations
of all values less than the average or mean

30
Q

What is value at risk (VaR)?

A

A measure of loss most frequently associated with
extreme negative returns
* VaR is the quantile of a distribution below which lies q
% of the possible values of that distribution
– The 5% VaR , commonly estimated in practice, is
the return at the 5th percentile when returns are
sorted from high to low

31
Q

What is correlation?

A

Correlation, in the finance and investment industries, is a statistic that measures the degree to which two securities move in relation to each other

32
Q

What is standard deviation?

A

Standard deviation is the statistical measure of market volatility, measuring how widely prices are dispersed from the average price. If prices trade in a narrow trading range, the standard deviation will return a low value that indicates low volatility.

33
Q

What is Beta?

A

Beta (β) is a measure of the volatility—or systematic risk—of a security or portfolio compared to the market as a whole (usually the S&P 500).

34
Q

Does standard deviation affect Beta?

A

Standard deviation does affect beta but not necessarily individual securities but rather a diversified portfolio.

34
Q

Does standard deviation affect Beta?

A

Standard deviation does affect beta but not necessarily individual securities but rather a diversified portfolio.

35
Q

What is the difference between standard deviation and beta?

A

Beta and standard deviation are two ways to describe market volatility. Beta measures the fund’s volatility in comparison to other funds, whereas standard deviation measures the fluctuation in the fund’s share price over time.

36
Q

What is the difference between beta and correlation?

A

Correlation tells us IF 2 variables move together. Are they directionally related, and how strong this relationship is. Beta tells us HOW MUCH a variable moves when compared to another To understand, take some data sets.

37
Q

What is the Treynor ratio?

A

Performance metric for determining how much excess return was generated for each unit of risk taken on by a portfolio

(Return of asset – Risk free rate) divided by Beta

A main weakness of the Treynor ratio is its backward-looking nature. Investments are likely to perform and behave differently in the future than they did in the past. The accuracy of the Treynor ratio is highly dependent on the use of appropriate benchmarks to measure beta.

Risk/return measure that allows investors to adjust a portfolio’s returns for systematic risk

Although there is no true risk-free investment, treasury bills are often used to represent the risk-free return in the Treynor ratio.

Risk in the Treynor ratio refers to systematic risk as measured by a portfolio’s beta. Beta measures the tendency of a portfolio’s return to change in response to changes in return for the overall market.

38
Q

Coefficient of determination

A

It provides a measure of how well observed outcomes are replicated by the model, based on the proportion of total variation of outcomes explained by the model

The coefficient of determination can also be found with the following formula: R2 = MSS/TSS = (TSS − RSS)/TSS, where MSS is the model sum of squares (also known as ESS, or explained sum of squares), which is the sum of the squares of the prediction from the linear regression minus the mean for that variable; TSS is the total sum of squares associated with the outcome variable, which is the sum of the squares of the measurements minus their mean; and RSS is the residual sum of squares, which is the sum of the squares of the measurements minus the prediction from the linear regression.

39
Q

Time weighted return

A

The time-weighted rate of return (TWR) is a measure of the compound rate of growth in a portfolio. The TWR measure is often used to compare the returns of investment managers because it eliminates the distorting effects on growth rates created by inflows and outflows of money. The time-weighted return breaks up the return on an investment portfolio into separate intervals based on whether money was added or withdrawn from the fund.

The time-weighted return measure is also called the geometric mean return, which is a complicated way of stating that the returns for each sub-period are multiplied by each other.

TWR=[(1+HP 1)×(1+HP 2)×⋯×(1+HP n)]−1
where:
TWR= Time-weighted return
n= Number of sub-periods
HP=
(Initial Value+Cash Flow)
End Value−(Initial Value+Cash Flow)HP n= Return for sub-period n
​

40
Q

Dollar weighted return

A

A Dollar-weighted return (DWR) is the rate at which the discounted cash inflows and outflows are equalized. The DWR is the same as the internal rate of return and the money-weighted return (MWR).

41
Q

Difference between TWR and DWR?

A

The major difference between TWR and DWR is how the cash flows are accounted for. DWR takes cash flow into account when calculating investment performance, while TWR is not affected by inflows or outflows.

42
Q

What is tracking error?

A

Tracking error is the divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark.

43
Q

What is Sharpe Ratio?

A

a measure that indicates the average return minus the risk-free return divided by the standard deviation of return on an investment.

44
Q

What is Alpha?

A
45
Q

What is the Information Ratio?

A

The information ratio (IR) is a measurement of portfolio returns beyond the returns of a benchmark, usually an index, compared to the volatility of those returns.

46
Q

Which of these three are best indicator of investment selection:
Sharpe Ratio
Alpha
Information Ratio?

A

Definitely not alpha

If all money goes into one fund then Sharpe is the best indicator. However in the more likely scenario that only a portion of money will be invested in a particular fund, then the information ratio is a better indicator.

47
Q

The IR is often used as a measure of a portfolio manager’s level of skill and ability to generate excess returns relative to a benchmark, but it also attempts to identify the consistency of the _______.

A

The IR is often used as a measure of a portfolio manager’s level of skill and ability to generate excess returns relative to a benchmark, but it also attempts to identify the consistency of the performance by incorporating a tracking error, or standard deviation component into the calculation.

48
Q

What is the formula to calculate the information ratio?

A

​

IR=
Portfolio Return−Benchmark Return
​______________________________
Tracking Error

where:
IR=Information ratio
Portfolio Return=Portfolio return for period
Benchmark Return=Return on fund used as benchmark
Tracking Error=Standard deviation of difference
between portfolio and benchmark returns
​

49
Q

What is the minimum variance portfoio?

A
50
Q

A __________________ IR result implies a better portfolio manager who’s achieving a higher return in excess of the benchmark, given the risk taken.

A

A higher IR result implies a better portfolio manager who’s achieving a higher return in excess of the benchmark, given the risk taken.

51
Q

What is the key determinant of the benefits of diversification?

A

correlation

52
Q

What is the formula to calculate the Sharpe Ratio?

A

CPWA (99 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions