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32 Cards in this Set
- Front
- Back
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Gross Return (portfolio)
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portfolio return before deducting fees for management and administration
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Net return
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Gross return - management and administration fees
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Real return
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nominal return adjusted for inflation
Approximation: return - inflation Exact: (1 + return)/(1 + inflation) - 1 |
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Leverage return
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Gain or loss calculated based on investor's cash investment
(cash investment might be much smaller than the underlying asset) |
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What is correlation coefficient?
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correlation between the returns of the two securities
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Efficient frontier
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Those portfolios that have the greatest expected return for each level of risk make up the efficient frontier
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What is the capital allocation line (CAL)?
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a straight line from the risk-free asset through the optimal risky portfolio
optimal risky portfolio refers to the portfolios which fall on the efficient frontier. Thus it's the optimal risky portfolio given a certain level of risk |
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What is capital market line (CML)?
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Under the assumption of homogeneous expectations, CML is the optimal CAL which is tangent to the efficient frontier. The intersection is the market portfolio
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How to calculate the expected return of the portfolio (combination of optimal risky portfolio and risk free assets)?
function describing CML |
E(R_p) = R_f + [(E(R_M) - R_f) / σ_M] * σ_p
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What is the view of the total risk for a diversified portfolio?
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Diversification could reduce unsystematic risk and cannot reduce systematic risk
Total risk = unsystematic risk + systematic risk |
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What is the view on the relationship between risk and return?
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unsystematic risk is not compensated in equilibrium because it can be eliminated for free through diversification
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What is return generating model?
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model used to estimate the expected returns on risky securities
multifactor models: E(R_i) - R_f = ∑_m(β_im * Factor_im) β is called factor sensitivity or factor loading |
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What is single_index model?
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simplest factor model as one of the return generating models
E(R_i) - R_f = β_i * [E(R_m) - R_f] |
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What is the market model?
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Simplified form of a single-index model.
R_i = α_i + β_i * R_m + e_i Rm = market return β_i = slope coefficient α_i = intercept e_i = abnormal return on asset i |
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How to calculate beta in the market model?
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β_i = Cov_im / (σ_m)^2 = covariance of asset i's return with the market divided by variance of the market return
or β_i = ρ_im * σ_i / σ_m |
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What is SML?
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Security Market Line:
it describes the CAPM E(R_i) = RFR + β * [ E(R_mkt) - RFR ] β_i = Cov_im / (σ_m)^2 |
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What are the assumptions of CAPM?
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Risk aversion
Utility maximization investors frictionless markets one-period horizon homogeneous expectations divisible assets competitive markets |
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How to calculate M-squared (M^2)?
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(R_P - R_f) * σ_M / σ_P - (R_M - R_f)
M-squared produces the same ranking as Sharpe ratio (measures total risk) |
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How to calculate Treynor measure?
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(R_P - R_f) / β_P
only considers systematic risk |
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How to calculate Jensen's alpha?
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α_P = R_p - [R_f + β_P * (R_M - R_f)]
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What is IPS?
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Investment Policy Statement
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Important points to cover in an IPS?
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R-R-T-T-L-L-U
Risk, Return, Time Horizon, Tax situation, Liquidity, Legal restrictions, Unique Circumstances |
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What is minimum-variance portfolio and what is efficient frontier? How are they presented in the graph?
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pg 148, book 4
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What is the utility function for an investor and what is indifference curve?
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utility function represents the investor's preference in terms of risk and return combination.
portfolios on the same indifference curve are equally preferred by the investor |
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What is the indifference curve like for risk-averse investor?
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The curve slopes upward (the bigger the risk, the bigger the slope). page 149, book 4
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What is the minimum variance frontier?
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the curve made up with portfolios with lowest risk given a level of expected return
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How is SML different from CML?
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CML measures return against risk (standard deviation)
SML measure return against systematic risk (β) |
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What is the beta for market portfolio?
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beta = 1 (on SML)
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How to calculate Sharpe Ratio?
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Sharpe Ratio = (R_P - R_f) / σ_P
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What is market risk premium?
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The difference between the return on the market and the risk free rate
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What is tactical allocation?
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an allocation that deviates from the baseline (strategic) allocation
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What is core-satellite approach?
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the majority is invested in passively managed indexes and small portion is invested in actively managed assets
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