Week 4- Portfolio Management 1

Question 1

What is a risky share?

Answer 1

`A share in which you invest in and expect a return but it is not guaranteed

Question 2

What is a risk free asset/share?

Answer 2

An asset/share with a guaranteed return

Question 3

What does Covariance tell us?

Answer 3

Used to understand the direction of the relationship between variables

Question 4

What does a Covarianace of +1 tell us?

Answer 4

Perfect positive correlation (i.e both variables travelling in same direction)

Question 5

What does a Covariance of -1 tell us?

Answer 5

Perfect negative correlation (i.e both variables travel in opposite directions)

Question 6

What does a Covariance of 0 tell us?

Answer 6

That there is no relationship between the variables

Question 7

What is return?

Answer 7

The total gain/loss experienced on an investment over a given period of time

Question 8

What is the formula for Annual Return?

Answer 8

Dividend + (P1-P2)/P0

Question 9

What is risk?

Answer 9

The possibility that actual future returns will deviate from expected returns

Question 10

How can risk be measured?

Answer 10

It can be measured by the variance or standard deviation of possible returns around the expected return.

Question 11

If greater the standard deviation/variance the greater the…

Answer 11

risk and dispersion of potential returns around the expected return

Question 12

When Standard Deviation/Variance is 0 what is the risk of the investment?

Answer 12

There is no risk because there is no dispersion of possible returns around the expected return meaning it is a certain return

Question 13

Give an example of a risk free asset?

Answer 13

Government bond

Question 14

Why is a government bond a risk free asset?

Answer 14

Because you are theoretically lending money to the government and along as there is a government in this country they will pay interest on your loan

Question 15

What are the three Risk/Return Approaches?

Answer 15

1) The historical approach
2) The probabilistic approach
3) The risk free approach

Question 16

What is the probabilistic approach to return/risk?

Answer 16

An approach that uses statistical probabilities to assess risk. Shows the possible unique outcomes and their associated probabilities

Question 17

How is the expected return formed using the probabilistic approach?

Answer 17

The expected return is calculated as a weighted average of possible returns, where the weights correspond to the probabilities

Question 18

What is the formula for expected return (probabilistic approach)?

Answer 18

(Probability x Expected return)^1 + (Probability x expected return)^2 + so on and so on

Question 19

What is the formula for Variance (Probabilistic approach)

Answer 19

(Expected return for 1 period-Mean of expected returns)^2 x Probability of 1 period

If you have multiple assets, calculate the above for all of them and then divide by how many there are to get the mean

Question 20

What is the formula for the covariance (probabilistic approach)

Answer 20

(expected return for 1 period Asset X - Mean of expected returns of asset X)

Multiplied with

(expected return for 1 period Asset Y - Mean of expected returns of asset Y)

Multiplied with

Probability of each state

Divided by Sum of them all

Question 21

What is the formula for standard deviation (probabilistic approach)

Answer 21

square root of variance

Question 22

what is the formula for the correlation coefficient (probabilistic approach)?

Answer 22

Covariance / Standard deviation

Question 23

What is total risk equal to?

Answer 23

Unsystematic risk (Diversifiable risk) + Systematic Risk (Non Diversifibe risk)

Question 24

What does systematic risk refer too?

Answer 24

The portion of a shares risk that is caused by factors affecting the market as a whole i.e Uncontrollable factors like interest rates and inflation and therefore undiversifiable

Question 25

What does unsystematic risk refer too?

Answer 25

The portion of a shares risk that is unique to the firm e.g management capabilities, strikes, availability of raw materials etc. Therefore this is controllable and also diversifiable

Question 26

What does the feasibilty set show?

Answer 26

The set of investment opportunities for a portfolio in question. Shows the risk and return of the assets.

Question 27

What does it mean when the feasibility set is touching the vertical axis?

Answer 27

That the risk of the portfolio is zero and the assets have a crrelation co-effiecient of -1.

Question 28

What does a negative correlation coefficient mean?

Answer 28

that the risk of the portfolio is close to zero

Question 29

Does the expected return change if you have a portfolio with a risk free and risky asset in opposed to one with just risky assets in?

Answer 29

No

Question 30

Does the standard deviation change if you have a portfolio with a risk free and risky asset in opposed to one with just risky assets in?

Answer 30

Yes because the risk free asset doesn’t have a variance or std dev because it is risk free!!

Question 31

What is different about a feasible set of a portfolio with more than two assets and one with just two assets?

Answer 31

A multi asset portfolio has a feasible set that covers the area inside the the curve aswell as the line itself

Question 32

What is the Mean-Variance efficient frontier (MVE)?

Answer 32

the set of portfolios that have teh highest expected returns for a given level of risk

Question 33

What is the Minimum variance portfolio?

Answer 33

The portfolio that has the lowest level of risk (variance)

Question 34

What is the utilty theory?

Answer 34

Shows the level of risk aversion an investor has and therefore shows them where thy should invest

Question 35

Where is the optimal portfolio placed for an investor?

Answer 35

The tangency point between the MVE frontier and the investors utility curve

Question 36

Will a less risk averse investor have a utility curve with a steep or shallow slope?

Answer 36

Steep