Fin 330 Ch 11

Front 1

Harry Markowitz

Back 1

first man to examine the role and impact of diversification

Front 2

efficiently diversified portfolio

Back 2

one that has the highest expected return given its risk.

Front 3

expected return

Back 3

weighted average return on a risky asset from today to some future date. the formula is:

= sum of all (Probability of state * return of state)

Front 4

expected risk premium

Back 4

simply the difference between the expected return on the risky asset in question and the certain return on a risk-free investment

= ( expected return ) - ( risk free rate)

Front 5

variance

Back 5

the formula adds up the squared deviations of each return from its expected return after it has been multiplied by the probability of observing a particular economic state

Front 6

standard deviation

Back 6

simply the square root of the variance

Front 7

portfolios

Back 7

groups of assets, such as stocks and bonds, that are held by an investor

Front 8

portfolio weights

Back 8

listing the proportions of the total value of the portfolio that is invested into each asset

Front 9

expected return on a portfolio

Back 9

linear combination, or weighted average, of the expected returns on the assets in that portfolio

Front 10

variance of portfolio expected returns

Back 10

portfolio variance is generally not a simple weighted average of the variances of the assets in the portfolio

sum of all [ probability of state of economy * { (expected portfolio return in state) - (portfolio expected return) }

Front 11

correlation

Back 11

tendency of the returns on two assets to move together

Front 12

imperfect correlation

Back 12

key reason why diversification reduces portfolio risk as measured by the portfolio standard deviation

positively correlated = tend to move up and down together
negatively correlated = tend to move in opposite directions

Front 13

correlation coefficient

Back 13

ranges from -1 (perfect negative correlation - looks like loops) through 0 (uncorrelated - looks crazy) to +1 (perfect positive correlation - similar waves)

Front 14

investment opportunity set

Back 14

various combinations of risk and return available from portfolios of these two assets all fall on a smooth curve

Front 15

efficient portfilio

Back 15

offers the highest return for its level of risk

Front 16

dominated/inefficient portfolio

Back 16

undesirable portfolio

Front 17

markowitz efficient frontier

Back 17

set of portfolios with the maximum return for a given risk AND the minimum risk given a return