Portfolio Theory

Question 1

What is the formula for expected return?

Answer 1

E[R]=sum(pi*Ri) for all i

Question 2

What is the formula for the variance of the returns?

Answer 2

sigma^2=sum(pi*(Ri-E[R])^2) for all i

Question 3

What is a portfolio weight?

Answer 3

How much is invested in a given assets as a percent of the total investment in a portfolio.

$10 in Toyota and $90 in McDonalds -> 10% is the weight for Toyota

Question 4

What is the general formula for the variance of a portfolio?

Answer 4

sigma^2p = Sum_i{sum_j{wiwjsigmai,j}}
OR
sigma^2p = sum{wi*Cov(Ri,Rp)}

Question 5

What is the formula for the correlation?

Answer 5

corr(x,y)=covar(x,y)/(sigma(x)*sigma(y))

Question 6

What does the efficient frontier tell us?

Answer 6

The best possible return (for a market) at any given risk level.

It is represented as a curve in Expected Return vs Sigma of Return.

Question 7

What is idiosyncratic risk?

Answer 7

The risk that is particular to a given asset (this can be diversified away).

Question 8

What is systematic risk?

Answer 8

The risk of the market itself (this can not be diversified away).