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Bus 315 > Q2 > Flashcards

Q2 Flashcards

1
Q

for 1 asset dominate other what needed

A

Er1>Er2 and sigma1<sigma 2 with one strict

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2
Q

when is indiffernce curve convex and when flat

A

risk adverse so more risk need more return
risk neutral

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3
Q

CAL is

A

how much to invest into risky and risk free portfolio sharpe ratio

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4
Q

sharpe ratio is

A

risky-rf/sigma p

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5
Q

issue with sharpe is

A

sigma punish all shocks the same and in reality happy see positve shocks and kurtosis and skew not accounted for

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6
Q

where is best place on CAl and how to find

A

depend on risk aversion, solve for Y*

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7
Q

SML vs CML VS CAL

A

The CML shows the risk-return tradeoff for efficient portfolios based on total risk

the SML depicts the relationship between expected return and systematic risk (beta) for individual securities or portfolios

and the CAL represents the risk-return combinations of any risky portfolio and a risk-free asset.

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8
Q

what is diversification

A

small amount of wealth in each asset to reduce risk, when asset not perfectly correlated reduces risk

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9
Q

correlation levels mean

A

+1 = perfect corr, move tog no risk reduced
0= random reduce some risk
-1= perfect hedge move oppo

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10
Q

in total diversification what important

A

covariance especially with more assets

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11
Q

correlation between same stock is and cov is

A

1 and cov is just variance

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12
Q

how does correlation effect portfolio risk if corr = -1,0.3 and 1

A

-1= 0 risk with proper weights frontier connects graph staright to left side

0.3= some diversification

1= weighted avergae of 2 asset = risk and becomes straight line frontier

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13
Q

portfolio varince contains how many terms and covariance how many terms

A

variance = N terms, covariance = N^2-N–> shows why covarinace imporatnt with high N bc more terms

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14
Q

what does variance approx too in large portfolio

A

For portfolios with large n, the variance is essentially the
average covariance

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15
Q

what risk does covariance capture and what does this mean

A

systemic and cannot diversify away avg covar

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16
Q

As N oncreases what 3 things happen

A

1- effect sec own variance decreases
2-effect of the sec covariance with other sec increase importance
3- risk of portfolio become avergae covariance of sec in portfolio

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17
Q

explain 2 types of risk

A

idiosyncratic: unique to firm related to issues they face can diversify away

Systemic: common with all sec related to general econ condition we demand compensation for this risk

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18
Q

what is systemic risk made of

A

average covariance cannot drop below with diversification

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19
Q

as n increase what is effect of idiosyncratic risk

A

neglible effet on portfolio risk and return, if no systemic risk then add no risk to diversified portfolio

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20
Q

what makes portfolio effeceint

A

highest returns for level of risk, CAL steepest, or lowest risk for given level of return

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21
Q

what is GMVP

A

minimize risk, start point of effeceint frontier, left most point, lowest sigma

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22
Q

ineffeceint frontier made up of:

A

low return, high risk or poor diversification

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23
Q

frontier is what capital markets offerso Cal reflects

A

combo fo risky and risk free

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24
Q

without rf asset how find portfolio

A

go along frontier and look risk prefrence, focusing soley on risky aset combo–> utlity max

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25
Q

with rf rate how to fin portfolio

A

use steepest CAL, choose combo of p and rf tangent to the forntier

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26
Q

what is orp

A

max sharpe ratio with combo of assest

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27
Q

issue with solving orp

A

1- covar/var change with time
2- past dat not equal optimal future
3- ppl use index fund as orp

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28
Q

steps find orp

A

1- find effeceitn frontier
2- establish orp and its retruna dn sigma
3- choose optimal $ to invest in with P,A Rf

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29
Q

what is mean variance optimize

A

hold combo of optimal p and rf, with weights that offer highest CAL slope

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30
Q

what is portfolio theory

A

how construct risky/rf in terms of mean variance trade off

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31
Q

what is CAPM

A

predicts expected/fair returns on risky asset –> world where investors follow mean variance

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32
Q

CAPM assumptions not improtant

A

investors risk adverse utility max and rational

frictionless markets

borrow at rf

simple same HPR

homogenous expecattions= same frotnier

investments highly liquid and infitnely divisble

price taker investors

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33
Q

investors solve for Y* in CAPM and invest what would market look like

A

all hold market portfolio and CAL = CML bc hold market portfolio which is also ORP

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34
Q

what is market portfolio

A

large diversified idiosynccratic risk not important, risk prem indv sec reflect market portfolio risk, risky asse = high covariance

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35
Q

how to decide if add sec to portfolio

A

determine sec contribution to portfolio in terms of reward to risk ratio and compare to market if greater add

36
Q

due to s&d sec risk reward = market risk reward why?

A

sec with higher risk reward attract invetsors which increase prive lowering er till equil

37
Q

what is mpr

A

extra return market portfolio provide over rf / market price of risk and is equal for all sec

38
Q

In CAPM sec er depends on

A

A security’s expected return depends on the market risk premium and its exposure to market risk (beta)

39
Q

er sec in capm described

A

fair ret7urns sec varies as a function of market risk prem

40
Q

what is beta

A

contributuion of this sec to sigma or mp, how sensitive sec return is to market, asset systemic rick

41
Q

market beta =

A

1

42
Q

SML uses what vs stnd

A

beta

43
Q

what is beta

A

A high-beta security has greater exposure to market risk (systematic risk), which cannot be diversified away.

44
Q

beta of portfolio

A

SUM (weight of each security * beta of each security)

45
Q

what is alpha

A

abnormal ror above or below capm, regression point from sml diff, excess risk adjusted return

46
Q

3 factor capm model incl

A

beta excess return market, smb size beta, hml beta for value vs growth

47
Q

limits capm

A

only beta captured, single period, not testable

48
Q

total risk in capm sec =

A

beta * market stnd+ idiosyncratic

49
Q

market effeceint when

A

all avil info reflected in pruce right away, asset refelct value so price = value no alpha

50
Q

if there is an alpha in EMH then

A

people tarde on it pushing price to actual so no alpha in equil

51
Q

for EMH what assumption req 1 of 3

A

everyone rational, some irrational but not systemic so cancel out, sometime irrational systemically and arb tarders make price right

52
Q

what is weak effeceincy

A

Price reflects all information contained in market trading data
(past prices, volume, dividends, interest rates, etc.)

53
Q

what cannot work to ID mispriced sec in weak effeceiency

A

past prices and technical analysis

54
Q

what is technical analsyis

A

Refers to the practice of using past patterns in stock prices (and
trades) to identify future patterns in prices.
* Is not profitable in a market which is at least weak form (i.e.,
weakly) efficien

55
Q

how to test market effeceincy

A

can yesterday predict today, how fast stock price change when info released, stock picking ability possibel or not, stcok prices should be random and stock return all info known so price only change when new info arrive = random

56
Q

eveidience stock pikcing ability not work bc EMH

A

performance mutual funds, mean reversion

57
Q

what is medium form in EMH

A

Price reflects all publicly available information.
2. So, an investor can not use publicly available information to identify
mispriced securities. If a market is semi-strong form efficient, then it is also weak form
efficient since past prices and other past trading data are publicly
available

58
Q

what doesnt work in medium form EMH

A

Fundamental analysis:
* Refers to the practice of using financial statements, announcements,
and other publicly available information about firms to pick stocks.
* Is not profitable in a market which is at least semi-strong form (i.e.,
semi-strongly) efficient.

59
Q

what is strong form EMH

A

Price reflects all available (public & private) information.
2. If a market is strong form efficient, then it is also semi-strong and weak form
efficient since all available information includes past prices and publicly
available information

60
Q

what is private info and 2 types

A

What is “private” information?
* Information that you hold that is not reflected in the market price
* Two types of private information:
a) “Inside information” – info known to company management but not
yet made public – knowledge of an impending takeover bid –
knowledge that earnings are going to be lower than the street expects.
b) A private assessment based on public information – an analyst’s
report based on public accounting statements.

61
Q

test with random walk is

A

stock price random past dont predict future, if ebeliev random = nbo pattern to trade on inbstant reflection in price

62
Q

how else tets market effecenicy

A

how fast prices change when new info arrive

63
Q

test market effeciency how with mujtual funds

A

consistent return above average but 50% investor above average so need LR test

64
Q

fund manager not generate consistent alpha what proof

A

revert mean after 5 years, slight skew to negative alpha after fees,

65
Q

Jan effect, size effect, BM, momentum, post earning drift, SEO

A

Jan: invest in jan close pos end of month average gen alpha

Size: small outperform large

BM: Low BM = growth and high BM gen alpha

momentum: shouldnt exist in effecient market, under 1 year winners win– 2-5 years reverse

post earn driftL take time reflect earnings bc markets slow

SEO: after SEO unerperform for 5 years drifting down

66
Q

Publicvation effect

A

people learn alpha startand trade in it making market more effeceint

67
Q

market effeceint if sec price = value how this happenb

A

people are rational in capm or arb correct mispring

68
Q

what does BF suggest

A

contends EMH, investor irrational when make invest decesion so prices not right observe mispricng

69
Q

can we exploit mis pricing in BF

A

no bc fricition so not able act mispring start bc arb costly

70
Q

2 main point of BF

A

[yschology and costly arb

71
Q

what does BF pyschology suggest

A

investor irrational in systemic way, people make mistake from capm

72
Q

3 pyschological effect BF

A

conservatism, repreentativness and overconfidence

73
Q

what is conservatism

A
  • Slow updating when facing new information that contradicts current
    beliefs;

not incrop new inf right away but defend

74
Q

Conservatism and Post-earnings Drif

A

under react to news suggest change in firm bc concservatism take time to acknowledge vs EMH

75
Q

what is represativness

A

Representativeness involves the tendency of humans to generalize
about a population of future outcomes after observing only a small
sample

76
Q

what is representivness and return anomlies

A

look at growing stocks and use past performance into expected returns like high price to book = lower returns nut long term reversals

77
Q

Representativeness and Mutual Funds

A

Representativeness could explain how investors choose investment
managers:

78
Q

overconfidence

A

Overconfidence is a bias in which people demonstrate unwarranted faith
in their own intuitive reasoning, judgment, and cognitive abilities

79
Q

what is self attrition bias

A

Events that confirm a person’s ability are because of the person’s high ability Events that disconfirm a person’s ability are due to bad luck or sabotage

80
Q

why
don’t other people just capitalize on mispricing and keep markets efficient?

A

arb is costly, costly risky and hardmight nto be money made

81
Q

2 types cost with arb

A

transaction like comission and spread

holding like noise and fundemental

82
Q

what is noise trading

A

irrational investor trade on noise if was info,risk of mispricing worse befor ebetter, continue trade wrong direction lossess get worse

83
Q

why timing market so difficult

A

aggregatley noise trader could be stronger than rational investor

84
Q

what is fundemntal risk

A

intrisnic value changes after you buy = fundemntal volatility

this can cause arb to lose $ so reduce arb in volatiale investments

85
Q

arb prefer less volaitale costs what cost arb

A

idiosyncratic risk more of it = less effeciency more mispricing in high idiosyncratic assets no one fix issue and hard make alpga

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