Week 3 Flashcards
How can we work out the price of shares at which a margin call will occur?
Market value - borrow/market value = maintenance margin requirement.
Our market value is given by the share price * the number of shares.
What is our margin given by in short selling?
equity/market value.
equity = total margin account - market value.
What is the geometric average given by?
((1+R1)(1+R2)…(1+Rn))^(1/n)-1
How do we find the annual percentage rate?
We annualise a return that has been given in a non annual form, so monthly becomes R*12.
However the effective annual rate is (1+R)^n
How do we annualise volatility?
the volatility of the period * sqrt(how many of those periods in a year).
What is the annual rate of return on stocks roughly?
Normal distributed 10% with a standard deviation of 20%.
What does skewness measure? What about kurtosis?
How symmetric the tails of a dataset are. Kurtosis measures how fat the tails are and how peaked the middle is.
What is the value at risk?
How much we can lose, it is generally given by (the expected return - 1.64*standard deviation) * portfolio size for 95% confidence.
What does being risk averse mean for risk premiums? What does it mean for asset proportions?
If an investor is risk averse they are not comfortable with risk and will require a higher risk premium for the same investment, this risk premium is given by the expected return - the risk free rate.
Risk averse investors will choose larger proportions of safe assets and vice versa.
What is the complete portfolio?
An investor’s full investment portfolio, consisting of stocks and risk free assets.
How do we calculate the expected return of the complete portfolio? What about standard deviation?
We multiply the components (risky portfolio and riskless) expected return by their allocation. The standard deviation is done in the same way, noting though that the standard deviation in risk free assets should be 0. There is an equation for standard deviation and variance.
What is the capital allocation line?
A plot of expected return against volatility when we have the choice between risky assets and the risk free rate. Volatility will be 0 when our money is fully in risk free assets, and will increase as the ratio of risky assets incrases. It is generally a straight line.
Where it the risk premium on a capital allocation line?
This is the vertical distance between the risk free rate and the return of the mixed portfolio.
What are the two main types of risks stock investors face? Which does the market reward?
Systematic and diversifiable, the systematic/market risk cannot be diversified against because the events affect the market as a whole. The market is not required to reward us for diversifiable risk.
How do we diversify stocks?
We combine stocks with low correlation, at the extreme end two stocks with -1 correlation are perfectly diversified. If we instead use stocks with high correlation we will receive very little diversification benefit.
