Week 4- Portfolio Management 1 Flashcards
What is a risky share?
`A share in which you invest in and expect a return but it is not guaranteed
What is a risk free asset/share?
An asset/share with a guaranteed return
What does Covariance tell us?
Used to understand the direction of the relationship between variables
What does a Covarianace of +1 tell us?
Perfect positive correlation (i.e both variables travelling in same direction)
What does a Covariance of -1 tell us?
Perfect negative correlation (i.e both variables travel in opposite directions)
What does a Covariance of 0 tell us?
That there is no relationship between the variables
What is return?
The total gain/loss experienced on an investment over a given period of time
What is the formula for Annual Return?
Dividend + (P1-P2)/P0
What is risk?
The possibility that actual future returns will deviate from expected returns
How can risk be measured?
It can be measured by the variance or standard deviation of possible returns around the expected return.
If greater the standard deviation/variance the greater the…
risk and dispersion of potential returns around the expected return
When Standard Deviation/Variance is 0 what is the risk of the investment?
There is no risk because there is no dispersion of possible returns around the expected return meaning it is a certain return
Give an example of a risk free asset?
Government bond
Why is a government bond a risk free asset?
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
What are the three Risk/Return Approaches?
1) The historical approach
2) The probabilistic approach
3) The risk free approach
What is the probabilistic approach to return/risk?
An approach that uses statistical probabilities to assess risk. Shows the possible unique outcomes and their associated probabilities
How is the expected return formed using the probabilistic approach?
The expected return is calculated as a weighted average of possible returns, where the weights correspond to the probabilities
What is the formula for expected return (probabilistic approach)?
(Probability x Expected return)^1 + (Probability x expected return)^2 + so on and so on
What is the formula for Variance (Probabilistic approach)
(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
What is the formula for the covariance (probabilistic approach)
(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
What is the formula for standard deviation (probabilistic approach)
square root of variance
what is the formula for the correlation coefficient (probabilistic approach)?
Covariance / Standard deviation
What is total risk equal to?
Unsystematic risk (Diversifiable risk) + Systematic Risk (Non Diversifibe risk)
What does systematic risk refer too?
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
