Portfolio theory + CAPM

Question 1

Risk and Return

Answer 1

Graph + direction risk-averse investors

Question 2

Efficient Portfolio

Answer 2

Provides greatest return for a level of risk = lower risk for a given return

Question 3

Portfolio domination

Answer 3

More returns with same or higher risk
or
Same returns lower risk

Question 4

The capital allocation line CAL

Answer 4

Graph
Risk-return relation
Explain both sides of A

Question 5

Sharpe ratio

Answer 5

Slope of CAL

Question 6

Sharpe ratio formula

Answer 6

Risk premium/risk

or

(E(r)-r)/o

Question 7

Markowitz Portfolio Theory

Answer 7

Combinig risky assets into a portfolio reduces risk due to imperfect correlations

Graph

Question 8

Extreme correlation

Answer 8

Graph
p=1
p=-1
-1<p<1

Question 9

The Efficient Frontier

Answer 9

To prevent domination the optimal portfolio choice is at the frontier

Graph

Question 10

Tangency portfolio

Answer 10

Highest sharpe ratio between a point in frontier and rf

Graph

Question 11

CAPM assumption

Answer 11

All investors are the same and thus hold tangency portfolio

Question 12

CAPM transitions

Answer 12

Tangency portfolio -> market portfolio
o -> B
If we know market risk E(r) can be computed
Graph

Question 13

CAPM

Answer 13

r = rf + B(rm - rf)

Question 14

rm - rf

Answer 14

Market Risk PREMIUM

Question 15

Alternatives to CAPM: MCR (DDM)

Answer 15

Re = D1/P0 + g
Cannot be used if revenues not stable

Question 16

Alternatives to CAPM: ECR

Answer 16

Re = EPS1/P0
Assumes no growth and no reinvestment (EPS=D1)