T5

Question 1

PORTFOLIO CONSTRUCTION ASSUMPTIONS

Answer 1

Either all returns are normally distributed, or investors care only about mean return and variance/standard deviation (mean-variance utility)
All assets are tradable.
There are no transaction costs.

Question 2

POSTIVE/ NEGATIVE COVARIANCES

Answer 2

Positive covariance: returns of two assets move in the same direction
When one is high (relative to its own mean), the other tends to be high (relative to its own mean) or vice versa
Negative covariance: returns of two assets move in opposite directions
Zero covariance: returns of two assets do not co-move (unrelated)
Covariance is difficult to interpret because it depends on standard deviation of the two random variables.

Question 3

INVESTMENT OPPORTUNITY SET

Answer 3

CONSISTS OF ALL AVAILABLE RISK-RETURN COMBINATIONS

Question 4

minimum variance portfolio MVP

Answer 4

portfolio that provides the lowest variance among all possible portfolios of risky assets

Question 5

minimum variance frontier

Answer 5

set of all portfolios with minimum variance for a given expected return

Question 6

efficient portfolio

Answer 6

portfolio that has the highest possible expected return for a given standard deviation

Question 7

efficient frontier

Answer 7

set of efficient portfolios it is the upper portion of the minimum variance frontier starting at the minimum variance portfolio( efficient diversification)

Question 8

home bias

Answer 8

Exchange rate risk
Transaction costs
Asymmetric information
Behavioral biases

Question 9

non participation puzzle

Answer 9

Investors do not have mean-variance utility: Greater risk aversion to downside losses.
Participation costs:
Social factors: ( political activism, intelligence, previous investing, if neighbor invests)