Mean-Variance Portfolio Theory Flashcards
Investors are risk-averse. What does it imply?
In return for accepting the risk of an investment losing money, they want a higher expected return.
What does the arithmetic mean of past return estimate?
Estimate for future returns.
When do we use the geometric average of the returns?
Measure past performance of the stock.
How can the volatility be annualized?
Multiply the volatility by the square root of the number of period in a year.
How can you calculate the standard error of the sample mean?
Divide the SD by the square root of the size of the sample.
True or False: the sharpe ratio doesn’t vary much for large portfolios?
TRUE, but it will vary greatly for SINGLE STOCKS.
What can you use to lower volatility?
Diversification
True or false : if a portfolio is made of 2 stocks and they are perfectly negatively correlated, it is not possible to create a portfolio with no volatility?
FALSE : it IS possible.
Consider an equally-weighted portfolio. What is the formula for the variance of the portfolio’s return?
Var(R) = (1/n)AvgVar +AvgCov(n-1)/n
If the number of stocks in the equally-weighted portfolio approches infinity, what is the variance of the return of the portfolio?
Var(R) approches the average covariance*.
*If the stocks are uncorrelated, it approches 0.
How can you find the most efficient portfolio created with 2 stocks and a risk-free investment using a graph with volatility on the horizontal axis and rate of return on the vertical axis?
The most efficient portfolio will be at the point where a tangent from (o,r) intersects the curve of the stock portfolio’s volatilities and returns.
Every point on the tangent line is the efficient portfolio for that given level of volatility.
How can you determine the most efficient two-stocks portfolio using the sharpe ratio?
The most efficient has the HIGHEST sharpe ratio.
What is the risk premium?
The excess return of an investment over the risk-free rate.
