Quiz Flashcards
What is the two fund separation property?
- Money Market Fund - Risk Free Investments - mutual fund with an optimal risky portfolio, “ P “ - on tangency point of CAL and efficient frontier - more efficient, less costly
In WSJ article, Time for Investing’s Four-letter word – explain the distinction between ‘how much risk you can afford to take’ versus how much risk you can stand to take.’ What explains each decision? How do financial advisors assess whether a client is conservative, moderate or aggressive investor?
What you can afford depends mainly on your time horizon – how long before you will need the money. Determining how much risk you can stand – your temperamental tolerance for risk – is more difficult. It isn’t quantifiable. “The aim is always to find the fine line between greed and fear,” risk quizzes and tax returns = aggressiveness
. Consider two investors with different risk profiles. Would the composition of the risky portfolio differ across two investors? If not, why not? How does risk preference affect the optimal portfolio allocation?
chosing the optimal complete portfolio, trade-off between risk and return
more risk-averse investors will choose to hold less of the risky asset and more of the risk-free asset
As ρ1,2 moves from +1 to -1, what happens to portfolio expected return and standard deviation? How does the correlation affect the shape of the Investment Opportunity Set? Explain the intuition?
ρ = sensitivity to interest rate
How is optimal asset allocation (y*) affected by the expected risk premium, the variance of risky asset, and the degree of risk aversion?
Er-rf, variance, and aversion all impact optimal asset allocation and diversification based on the investor’s risk-aversion levels
Based on historical data, what proportion of risk of a single stock, on average, can be removed by forming a well-diversified stock portfolio?
Unique Risk
Firm-Specific Risk
Nonsystematic Risk
Diversifiable Risk
What is the equity risk premium? What affects equity risk premium? Based on historical data, what is the risk premium for U.S. equities?
Use of historical returns, with the difference in annual returns on stocks and bonds over a long time period comprising the expected risk premium, looking forward.
Currency, foreign equity risk premiums volatility, etc.
Based on Historical Data from 1960-2018- 4.20% (Damodaran 2019)
1999-20184.70%
2009-20185.49%
End of 20185.96%
Explain the intuition behind reduction in portfolio risk when assets are not perfectly correlated.
Operating independent of one another, correlation coefficient gives intuutuion about relationship between rates of return
How does diversification reduce risk without a significant reduction in expected return?
Spreading exposure across many independent risk sources - “insurance principle”
