Week 5- Portfolio Management 2 Flashcards
What does U mean?
Expected Return (Er)
What are the two necessary conditions for risk to be 0?
The assets in the portfolio to have a correlation co-efficient of -1 and the assets to be proportioned optimally
What is the formula to calculate the global minimal variance of a portfolio?
-b/2a
What will be the covariance between a risk free asset and a risky asset?
zero
What will the correlation between any risk free and risky asset be?
Zero
What is the relationship called between a risk free and risky asset?
A linear relationship
What is the formula for the expected return of a portfolio when it contains a risk free and risky asset?
Erp = Wrisk free (r risk free) + (1-Wrisk free)(expected return of risky asset)
How do you calculate the Proportion (W) of a risk free asset in a portfolio?
W risk free = Expected return portfolio- Expected return of risky asset / return of risk free asset - expected return of risky asset
How do you calculate the standard deviation of a portfolio with a risky and risk free asset?
6p = (1-Wriskfree) x std dev of risky asset
Why is calculating the slope of a portfolio on the Markowitz frontier important?
The slope shows the additional amount of expected return produced by the portfolio for each additional unit of risk taken
What is the formula for the slope of a portfolio?
Slope = (rp-rf)/6p
What is the result of investing in portfolios between the rf and market rate (M)?
Higher level of return
What is the line called between the rf and market rate (M)
Capital Market Line (CML)
What does the lending zone of the capital market line represent?
The lending zone is the point of the CML between the rf and market rate. Along this line, investors invest a proportion of their funds in risky assets represented by M and the reminder in risk free assets represented by rf.
What is the borrowing zone of the capital market line?
This is the point of the CML that sits above the market rate (M). investors in this zone place all their funds in the portfolio of risky assets (M), borrow additional funds at an interest rate of rf an invest those additional funds also in M.
WHat is the market portfolio?
The portfolio containing all risky assets in proportion to their marke value
What is a proxy market portfolio?
The FTSE 100
How many randomly selected assets do you need in a portfolio to eliminate 90% of systematic (market) risk?
15 to 20
What type of risk does the market portfolio contain?
Systematic risk which means that the share prices are in EQUILIBRIUM. This means they produce the an expected return that is sufficient compensation for the risk they involve
What is the ultimate diversified portfolio?
The market portfolio. All risk that is possible to eliminate has been eliminated
What does the CML test for and why?
The CML tests for efficiency as all efficient portfolios lie along it
What type of risk will investors only be compensated for holding?
Systematic risk. The market will not provide a reward for risk that could be eliminated by holding an investment in a well diversified portfolio
What does Beta (B) measure?
Systematic risk. Aka the sensitivity of the return on an asset to the return on the market portfolio
What is the formula for Beta?
Cov (rj, rm)/ std dev^2m
What does a beta value greater than 1 indicate?
A higher sensitivity to the market (and a beta value lower than 1 indicates lower sensitivity)
How do you calculate the beta value of a portfolio?
It is a weighted average of all the betas
Bp = (Bj x W1) + (Bn xW2) + (Bc x W3)
What does the Sercurity Market line consider?
Return and Market risk, aka the level of systematic risk. This is opposed to teh CML which considers TOTAL risk and return
What does CAPM stand for
Capital Asset Pricing Model
What does the capital asset pricing model tell us?
That the expected return of an asset is equal to the risk free rate of return plus a market premium
What does a market Beta (1) signify?
That the asset moves in the same direction and at the same rate as the market
What is the Beta value of a risk free asset?
0
Are assets over or under priced if they are located above the SML?
Under priced
