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15 Cards in this Set
- Front
- Back
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What is a portfolio weight? |
The fraction of the total investment in the portfolio held by each individual investment in the portfolio |
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How do we calculate the return on a portfolio? |
Sum the returns of the individual stocks x their portfolio weights |
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What does correlation measure? |
Measures the strength of the relationship between two stocks. It is a barometer of the degree to which the returns share common risks and tend to move together. |
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What is covariance? |
Covariance is the expected product of the deviations of two returns from their means. +ve and -ve covariance determines how the returns move together. |
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What is short selling? |
The selling of a stock that the seller doesn't own (but promises to deliver): broker lends seller the stock; stock's proceeds are credited in seller's account; at some point, seller must "close" the short by buying back the same number of shares and returning them to broker. |
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How can short selling increase a portfolio’s expected return? |
If you sell a low return stock short and spend the money on a high return stock then you increase your expected returns. Of course, you also increase the level of risk which you assume. |
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How does the volatility of an equally weighted portfolio change as more stocks are added to it? |
The volatility declines as the number of stocks in the portfolio increases. This is a result of diversification. |
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How does the volatility of a portfolio compare with the weighted average volatility of the stocks within it? |
The volatility of a portfolio is less than the weighted average volatility of the individual stocks within the portfolio. This is a result of diversification. Note: The expected return of a portfolio is equal to the weighted average expected return. |
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How does the correlation between two stocks affect the risk and return of portfolios that combine them? |
Correlation: - has no effect on the expected return of a portfolio - however it does effect the volatility of the portfolio |
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Tangent portfolio |
The portfolio that provides the biggest reward per unit of volatility of any portfolio available. It is the efficient portfolio. |
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If investors are holding optimal portfolios, how will the portfolios of a conservative and an aggressive investor differ? |
The two investors differ how much each invests in the tangent portfolio versus the risk-free portfolio. |
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What is the capital market line (CML)? |
When the tangent line goes through the market portfolio (= efficient portfolio), that is the capital market line. According to CAPM, all investors should choose a portfolio on the capital market line by holding some combination of the risk-free security and the market portfolio. |
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What is the security market line (SML)? |
The line along which all individual securities should lie when plotted according to their expected return and beta. Risk-free investment (beta = 0); market (beta = 1) |
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According to CAPM, how can we determine a stock's expected return? |
Recall Expected Return of a portfolio is the expected return of the securities in the portfolio. The Beta of a portfolio is the weighted average of the individual investment betas in the portfolio |
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What is Capital Asset Pricing Model (CAPM)? |
Method for estimating the cost of capital CoC = Risk-free rate + Beta * Market premium |
