Fine-411 Test 2 Cards

Front 1

What are the two key effects of adding stock to a portfolio?

Back 1

1) Own Effect
2) Interaction Effect

Front 2

What is a stock's "own effect" of adding it to a portfolio?

Back 2

the stock’s own inherent level of risk and potential
return.

Front 3

What is a stock's "Interaction Effect" of adding it to a portfolio?

Back 3

the stock’s interaction with every other stock
within the portfolio.

Front 4

As the number of stocks in a portfolio grows, what happens to portfolio standard deviation?

Back 4

It drops

Front 5

WHAT IS THE MINIMUM VARIANCE PORTFOLIO?

Back 5

the portfolio with the lowest risk (standard deviation). It does not have the lowest Expected return though!

Front 6

WHAT IS THE RELATIONSHIP BETWEEN PORTFOLIOS ON THE CURVE BELOW THE MINIMUM VARIANCE PORTFOLIO AND PORTFOLIOS ON THE CURVE ABOVE THE MVP?

Back 6

Portfolios on the curve below the Minimum Variance portfolio are dominated in the risk-return sense by portfolios on the curve located above the Minimum Variance portfolio.

These “dominating” portfolios form the Efficient Frontier.

Front 7

WHAT IS THE INDIFFERENCE CURVE?

Back 7

A curve that contains all combinations of risk and return that yield the same utility level.

Front 8

The steepness of an indifference curve indicates

Back 8

the level of risk aversion.

Front 9

what is the optimal portfolio for an individual with a particular level of risk aversion.

Back 9

he tangent portfolio, where the indifference curve just touches the efficient frontier, This portfolio will hold combinations of every type of risky asset in the economy (stocks, bonds, real estate, etc.).

Front 10

CAPITAL MARKET THEORY BASICS Builds on WHAT Markowitz Portfolio Theory Assumptions and Incorporates the following new assumptions

Back 10

1. Non-Satiation
2. Risk Aversion 3. Rationality 4. Mean-Variance, 1. There exists a risk-free asset
2. The use of margin (borrowing) is possible 3. Investors have identical expectations

Front 11

What is The goal of the CAPM?

Back 11

The goal of the CAPM is to tell us the Required Rate of Return E(RRR) for an asset by giving us an estimate of the Risk Premium for a particular asset.

Front 12

Total Risk=?

Back 12

Total Risk = Unique (diversifiable) Risk + Market (undiversifiable) Risk

Front 13

WHAT ARE THE TWO BASIC ASSUMPTIONS OF PORTFOLIO THEORY?

Back 13

1) INVESTORS WANT TO MAXIMIZE RETURNS FROM TOTAL SET OF INVESTMENTS FOR GIVEN LEVEL OF RISK
2) INVESTORS ARE RISK AVERSE

Front 14

HOW IS RISK GENERALLY DEFINED (2 WAYS)?

Back 14

1) UNCERTAINTY OF FUTURE OUTCOMES
2) THE PROBABILITY OF AN ADVERSE OUTCOME

Front 15

THE MARKOWITZ PORTFOLIO THEORY WAS DEVELOPED FOR WHAT PURPOSE?

Back 15

TO DEVELOP A PORTFOLIO MODEL THAT REFLECTED MEASURABLE RISK COMPARED TO THE EXPECTED RATE OF RETURN OF THE PORTFOLIO

Front 16

MARKOWITZ'S PORTFOLIO PROVED WHAT ABOUT DIVERSIFICATION?

Back 16

SHOWED WHY YOU SHOULD DIVERSIFY INVESTMENTS TO MINIMIZE RISK OF THE PORTFOLIO AND HOW YOU DIVERSIFY

Front 17

WHAT ASSUMPTIONS IS THE MARKOWITZ PORTFOLIO THEORY BASED OFF OF? (5)

Back 17

1. INVESTORS CONSIDER EACH INVESTMENT ALTERNATIVE AS BEING REPRESENTED BY A PROBABILITY DISTRIBUTION OF EXPECTED RETURNS OVER SOME HOLDING PERIOD
2. INVESTORS MAXIMIZE ONE-PERIOD EXPECTED UTILITY, AND THEIR UTILITY CURVES DEMONSTRATE DIMINISHING MARGINAL UTILITY OF WEALTH
3. INVESTORS ESTIMATE THE RISK OF THE PORTFOLIO ON THE BASIS OF THE VARIABILITY OF EXPECTED RETURNS
4. INVESTORS BASE DECISIONS SOLELY ON EXPECTED RETURN AND RISK, SO THEIR UTILITY CURVES ARE A FUNCTION OF EXPECTED RETURN AND THE EXPECTED VARIANCE (OR STANDARD DEVIATION) OF RETURNS ONLY
5) FOR A GIVEN RISK LEVEL, INVESTORS PREFER HIGHER RETURNS TO LOWER RETURNS. SIMILARLY, FOR A GIVEN LEVEL OF EXPECTED RETURN, INVESTORS PREFER LESS RISK TO MORE RISK.

Front 18

A SINGLE ASSET OR PORTFOLIO OF ASSETS UNDER THE ASSUMPTIONS OF THE MARKOWITZ THEORY...

Back 18

IS CONSIDERED TO BE EFFICIENT IF NO OTHER ASSET OR PORTFOLIO OF ASSETS OFFERS HIGHER EXPECTED RETURN WITH THE SAME (OR LOWER) RISK OR LOWER RISK WITH THE SAME (OR HIGHER) EXPECTED RETURN

Front 19

A MEASURE THAT ONLY CONSIDERS DEVIATIONS BELOW THE MEAN IS CALLED..

Back 19

SEMIVARIANCE

Front 20

COVARIANCE IS DEFINED AS...

Back 20

A MEASURE OF THE DEGREE TO WHICH TWO VARIABLES MOVE TOGETHER RELATIVE TO THEIR INDIVIDUAL MEAN VALUES OVER TIME

Front 21

CORRELATION COEFFICIENT CAN BE WHAT VALUES?

Back 21

-1 to 1

Front 22

WHAT IS UNIQUE ABOUT LOW, ZERO, OR NEGATIVE CORRELATIONS?

Back 22

IT IS POSSIBLE TO DERIVE PORTFOLIOS THAT HAVE LOWER RISK THAN EITHER SINGLE ASSET

Front 23

WHAT IS THE EFFICIENT FRONTIER?

Back 23

THE ENVELOPE CURVE THAT CONTAINS THE BEST OF ALL THE POSSIBLE COMBINATIONS, REPRESENTS THAT SET OF PORTFOLIOS THAT HAS THE MAXIMUM RATE OF RETURN FOR EVERY GIVEN LEVEL OF RISK OR THE MINIMUM RISK FOR EVERY LEVEL OF RETURN

Front 24

THE ENDS OF THE EFFICIENT FRONTIER CURVE REPRESENT...

Back 24

THE ASSET WITH THE HIGHEST RETURN AND THE ASSET WITH THE LOWEST RISK

Front 25

SINCE THE SLOPE OF THE EFFICIENT FRONTIER CURVE DECREASES STEADLY AS YOU MOVE UPWARD, WHAT DOES THIS IMPLY?

Back 25

ADDING EQUAL INCREMENTS OF RISK AS YOU MOVE UP GIVES DIMISHING INCREMENTS OF EXPECTED RETURN

Front 26

WHAT IS THE OPTIMAL PORTFOLIO?

Back 26

THE EFFICIENT PORTFOLIO THAT HAS THE HIGHEST UTILITY FOR A GIVEN INVESTOR

Front 27

CAPM ALLOWS YOU TO DETERMINE WHAT

Back 27

THE REQUIRED RATE OF RETURN FOR ANY RISKY ASSET

Front 28

WHAT IS THE MARKET PORTFOLIO

Back 28

A COLLECTION OF ALL THE RISKY ASSETS IN THE MARKETPLACE THAT SSUMES A SPECIAL ROLE IN ASSET PRICING THEORY

Front 29

WHAT ARE THE ASSUMPTIONS OF THE CAPITAL MARKET THEORY (8)

Back 29

1. ALL INVESTORS ARE MARKOWITZ-EFFICIENT IN THAT THEY SEEK TO INVEST IN TANGENT POINTS ON THE EFFICIENT FRONTIER
2) INVESTORS CAN BORROW OR LEND ANY AMOUNT OF MONEY AT THE RISK-FREE RATE OF RETURN
3. ALL INVESTORS HAVE HOMOGENOUS EXPCTATIONS
4. ALL INVESTORS HAVE THE SAME ONE-PERIOD TIME HORIZON
5. ALL INVESTMENTS ARE INFINITELY DIVISIBLE, IN OTHER WORDS IT IS POSSIBLE TO BUY OR SEL FRACTIONAL SHARES OF ANY ASSET OR PORTFOLIO
6. THERE ARE NO TAXES OR TRANSACTION COSTS INVOLVED IN BUYING OR SELLING ASSETS
7. THERE IS NO INFLATION OR ANY CHANGE IN INTEREST RATES, OR INFLATION IS FULLY ANTICIPATED
8. CAPITAL MARKETS ARE IN EQUILIBRIUM, WE BEGIN WITH ALL INVESTMENTS PROPERLY PRICED IN LINE WITH THIER RISK LEVELS

Front 30

WHAT IS THE MAJOR FACTOR THAT ALLOWED PORTFOLIO THEORY TO DEVELOP INTO CAPITAL MARKET THEORY

Back 30

THE CONCEPT OF RISK-FREE ASSET

Front 31

THE STANDARD DEVIATION OF A PORTFOLIO THAT COMBINES THE RISK-FREE ASSET WITH RISKY ASSETS IS...

Back 31

THE LINEAR PROPORTION OF TH STANDARD DEVIATION OF THE RISKY ASSET PORTFOLIO

Front 32

WHAT IS UNIQUE ABOUT THE CAPITAL MARKET LINE?

Back 32

IT RECEIVES THE HIGHEST LEVEL OF EXPECTED RETURN (IN EXCESS OF THE RISK-FREE RATE) PER UNIT OF RISK FOR ANY AVAILABLE PORTFOLIO OF RISKY ASSETS

Front 33

THE CML REPRESENTS..

Back 33

A NEW EFFICIENT FRONTIER THAT RESULTS FROM COMBINING THE MARKOWITZ EFFICIENT FRONTIER OF RISKY ASSETS WITH THE ABILITY TO INVEST IN THE RISK-FREE SECURITY

Front 34

AS THE CML IS A STRAIGHT LINE, WHAT DOES THIS IMPLY?

Back 34

THAT ALL THE PORTFOLIOS ON THE CML ARE PERFECTLY POSITIVELY CORRELATED, OCCURS B/C ALL PORTFOLIOS ON THE CML COMBINE RISKY ASSET PORTFOLIO AND THE RISK-FREE ASSET

Front 35

DEFINE COMPLETELY DIVERSIFIED PORTFOLIO AND GIVE AN EXAMPLE

Back 35

ALL RISK UNIQUE TO INDIVIDUAL ASSETS IN THE PORTFOLIO IS DIVERSIFIED AWAY, MARKET PORTFOLIO

Front 36

WHAT IS THE SEPERATION THEOREM?

Back 36

TO BE SOMEWHERE ON THE CML EFFICIENT FRONTIER, YOU INITIALLY DCIDE TO INVEST IN THE MARKET PORTFOLIO M= INVESTMENT DECISION, SUBSEQUENTLY BASED ON RISK PREF, MAKE SEPERATE FINACING DECISION

Front 37

WHAT IS THE ONLY IMPORTANT CONSIDERATION FOR ANY INDIVIDUAL RISKY ASSET?

Back 37

ITS AVERAGE COVARIANCE WITH ALL THE RISKY ASSETS IN PORTFOLIO M, THE ASSET'S COVARIANCE WITH THE MARKET PORTFOLIO

Front 38

WHAT IS BETA AND WHAT DOES IT CALCULATE?

Back 38

REDEFINES THE RELEVANT MEASURE OF RISK FROM TOTAL VALIDITY TO JUST NONDIVERSIFIABLE PORTION OF THAT TOTAL VOLATILITY, CALCULATES LEVEL OF SECURITY'S SYSTEMATIC RISK COMPARED TO THAT OF THE MARKET PORTFOLIO

Front 39

WHAT DOES THE CAPM SAY ABOUT MARKET RISK PREMIUM?

Back 39

ONLY OVERALL MARKET RISK PREMIUM (E(RM)-RFR) MATTERS AND QUANTITY CAN BE ADAPTED TO ANY RISKY ASSET BY SCALING IT UP OR DOWN ACCORDING TO ASSETS RISKINESS RELATIVE TO MARKET (BETA)

Front 40

SML EXPRESSES

Back 40

TRADE-OFF BTWN RISK AND EXPECTED RETURN AS STRAIGHT LINE INTERSECTING VERTICAL AXIS AT RISK-FREE RATE

Front 41

WHAT ARE THE TWO MAIN DIFFERENCES BTWN CML AND SML

Back 41

1) CML MEASURES RISK BY STANDARD DEVIATION WHILE SML EXPLICITLY CONSIDERS ONLY SYSTEMATIC COMPONENT OF INVESTMENT'S VOLATILITY
2) CML CAN ONLY BE APPLIED TO PORTFOLIO HOLDINGS THAT ARE ALREAD FULLY DIVERSIFIED, SML CAN BE APPLIED TO ANY INDIVIDUAL ASSET OR COLLECTION OF ASSETS

Front 42

IN EQUILIBRIUM, WHAT HAPPENS ON THE SML

Back 42

ALL ASSETS AND ALL PORTFOLIOS OF ASSETS SHOULD PLOT ON THE SML, ALL ASSETS SHOULD BE PRICED SO ESTIMATED RATES OF RETURN ARE CONSISTENT WITH LEVELS OF SYSTEMATIC RISK

Front 43

ASSETS W/ ESTIMATED RATE OF RETURN THAT PLOTS ABOVE SML WOULD BE UNDERVALUED B/C, AND UNDER AND ABOVE B/C

Back 43

IMPLIES THAT YOU ESTIMATED YOU WOULD RECEIVE A RATE OF RETURN ON THE SECURITY THAT IS ABOVE ITS REQUIRED RATE OF RETURN BASED ON SYSTEMATIC RISK

Front 44

THE DIFFERENCE BETWEEN ESTIMATED RETURN AND EXPECTED RETURN IS REFERRED TO AS WHAT

Back 44

STOCK'S EXPECTED ALPHA, EXCESS RETURN

Front 45

THE SEGMENT RFR-F INDICAES WHAT

Back 45

THE INVESTMENT OPPORTUNITIES AVAILABLE WHEN AN INVESTOR COMBINES RISK-FREE ASSETS AND PORTFOLIO F ON THE MARKOWITZ EFFICIENT FRONTIER

Front 46

THE CML IS MADE UP OF WHAT

Back 46

THE RFR-K-F-K, LINE SEGMENT (RFR-F), CURVE SEGMENT (F-K), ANOTHER LINE SEGMENT (K-G)

Front 47

RELAXING THE ASSUMPTION THAT THERE ARE EQUAL BORROWING AND LENDING RATES, WHAT HAPPENS?

Back 47

YOU CAN EITHER LEND OR BORROW, BUT THE BORROWING PORTFOLIOS ARE NOT AS PROFITABLE AS WHEN IT WAS ASSUMED THAT YOU COULD BORROW AT THE RFR

Front 48

IF THERE ARE TRANSACTION COSTS, THEN...

Back 48

INVESTORS WILL NOT CORRECT ALL MISPRICING BECAUSE IN SOME INSTANCES THE COST OF BUYING AND SELLING THE MISPRICED SECURITY WILL EXCEED ANY POTENTIAL EXCESS RETURN

Front 49

WHAT ARE THE TWO EFFECTS OF A MISTAKENLY SPECIFIED MARKET PORTFOLIO?

Back 49

1) THE BETA COMPUTED FOR ALTERNATIVE PORTFOLIOS WOULD BE WRONG
2) THE SML DERIVED WOULD BE WRONG