Portfolio Theory Flashcards
Differ between arithmetic and logarithmic returns.
Both returns measures realised reurns, which is the observed return on a security, measured as the cash flow received plus the change in value.
Arithmetic returns treat time as composed of a sequence of discrete time periods. Logarithmic returns treat time as evolving “continuously”.
Utility increases as we move in a ______________ direction of the reward-to-risk graph.
north-westerly
Mention the two main assumptions of modern portfolio theory:
- Returns on assets are normally distributed
- Investors are risk averse
To obtain the benefits of diversification, the correlation betweeen the portfolio must be _________.
less than +1 (perfectly positive)
What is investment leveraging?
It is when an investor borrows funds and invests all the available funds in a risky security or portfolio
What is short selling?
Short selling is selling first, and buying back later. Note that you make money if the shares price falls.
Explain the limits to the benefits of diversification.
Differ between diversifiable and non-diversifiable risk.
Risk that can be eliminated by diversification is called “doversifiable risk”. Risk that can;t be eliminated is called “non-diversifiable risk”.
What is the “efficient frontier”?
It is the portfolios that offer the highest expected return at given levels of risk (standard deviation).
If no risk-free asset is available, how would investors with different levels of risk aversion choose their portfolio?
If a risk free-asset is available, how would investors with different levels of risk aversion invest?
What is the “capital market line”?
It is the efficient frontier when a risk-free asset is available.
What is the market portfolio?
The market portfolio is the portfolio in which every risky asset is represented.
In what situation can the CML be used?
CML can be used to “price efficient portfolios”. An efficient portfolio is the one that offers the highest level of expected return at a given level of risk (SD). Therefore, CML can’t be used to price ineffcient portfolios or individual securities.
