Tutorial 3 Flashcards
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Explain why a portfolio may have smaller standard deviation of return than the individual securities that comprise it.
Diversification etc.
Give an example of two common stocks that you would expect to exhibit a relatively low correlation. Then give an example of two that would have a relatively high correlation.
Vodafone and Tesco. Because they belong to different industries.
Tesco and Asda. Because they belong to the same industry.
Explain why the Markowitz efficient frontier must be concave
The efficient frontier is concave because diversification reduces risk in a nonlinear way.
As risk increases, higher returns require disproportionately greater increases in risk, making the curve concave.
Mathematically, portfolio variance follows a quadratic function, ensuring concavity.
In terms of the Markowitz model, explain, using words and graphs, how an investor goes about identifying his or her optimal portfolio. What specific information does an investor need to identify this portfolio?
(return to this)
On the basis of the utility function, which investment would you select if you were risk neutral?
You have used the SIM to identify the Tangent risky portfolio (Tangent portfolio) in a feasible set that contains both risky and a riskless asset. The expected return and standard deviation of the Tangent portfolio is 0.04 and 0.1, respectively, while the prevailing return on the risk-free asset is 0.01.
a) Identify the slope of the Capital Allocation Line in this case.
