Review Items

Question 1

What is a risk lover and what does their indifference curve look like compared to a risk averse investor!

Answer 1

Risk lovers gain more utility from higher risk (A<0). Their indifference curve slopes downward vs that of the risk averse which slopes upward.

Question 2

What is the mean-variance criterion?

Answer 2

One asset dominates another of it’s expected return is at least as high and variance is no lower, and one of those two is absolute.

Question 3

Formula for weight in one asset in minimum variance portfolio

Answer 3

Question 4

Formula for beta-adjusted weight in Active portfolio of the single index model

Answer 4

Question 5

Formula for the Sharpe ratio of the ORP in the single index model

Answer 5

Question 6

List the extensions of CAPM

Answer 6

Labor-adjusted CAPM - in the numerator and denominator of B add terms for Ri, Rh, weighted by value of human capital / value of all assets.
ICAPM - add extra betas for change in vestment opportunity parameters and change in price of consumption goods
Consumption CAPM - use a consumption tracking portfolio instead of the market

Question 7

How to determine the risk free rate given accurately priced securities with -1 correlation?

Answer 7

Their 0-risk return is the risk free rate

Question 8

What’s the difference between a forward rate and a short rate?

Answer 8

The forward rate is EXPECTED in the future and short is observed in the past

Question 9

How to calculate convexity?

Answer 9

The convexity value is t^2 + t/k, and each weight is pv of cash flow/total pv. Multiply those then divide by (1+y/k)^2

Question 10

Formula for duration of perpetuity

Answer 10

(1+y)/y

Question 11

Duration of Franchise Value formula

Answer 11

Question 12

How to calculate covariance for Mango problems

Answer 12

The sum across each event of p(1-p)Lx*Ly and remember to multiply by 2 when using in the Covariance Share problems

Question 13

Index model - how to get portfolio risk premium?

Answer 13

Alpha plus beta times market risk premium

Question 14

Single index model initial weight in active portfolio

Answer 14

(Active portfolios alpha divided by variance of errors ) / market risk premium divided by market variance

Question 15

Index model variance of a security

Answer 15

B^2* market variance + variance of errors

Question 16

Excel formulas for matrix multiplication and inverse

Answer 16

MMULT and MINVERSE

Question 17

What does it mean for a portfolio to be well diversified

Answer 17

There is no firm-specific risk

Question 18

How are bonds taxed?

Answer 18

Always tax the interest income (coupons) and imputed interest (price appreciation due to passage of time - if sold at a discount). Tax the capital gains (price change due to interest rate change) when sold.

Question 19

What is the liquidity premium?

Answer 19

The difference between the forward rate and the expected future short rate for the same time period.

Question 20

Weight in asset in optimal risky portfolio-markowitz

Answer 20

Question 21

EPD normally distributed losses

Answer 21

Question 22

EPD normally distributed liabilities

Answer 22