Risk and Return

Question 1

Risk

Answer 1

Variance in returns
Measured using st dev.

Question 2

Variance

Answer 2

1/n S(ri - ¡r)^2

Question 3

Expected portfolio return

Answer 3

w1·r1 + w2·r2 + …. + wn·rn

Question 4

Covariance

Answer 4

1/n S (rai - ¡ra)(rbi - ¡rb)

Question 5

Why cov. to measure portfolio risk

Answer 5

Behaviour of stocks in relation to one another affects variance of portfolio returns

Question 6

Portfolio Risk (cov)

Answer 6

w1^2·o1^2 + w2^2·o2^2 +2(w1·w2·cov12)

Question 7

Magnitude of cov affected by

Answer 7

Stocks comovement
Stock’s indv. returns

Question 8

Why correlation to measure risk

Answer 8

Hard to interpret cov as stocks indv. returns affect it

Question 9

Correlation

Answer 9

cov12/(o1·o2)

Question 10

Portfolio variance (corr.)

Answer 10

w1^2·o1^2 + w2^2·o2^2 +2(w1·w2·p12·o1·o2)

Question 11

Notes on Portfolio Variance

Answer 11

o^2 -> find std dev. to measure risk
Add more stocks, add to the formula (comb. between all)

Question 12

Types of risk

Answer 12

Specific (eliminated by diversification)
Market (cannot be eliminated)

Total risk = Specific + Market

Question 13

Diversification

Answer 13

Strategy to reduce a portfolio’s specific risk by spreading the portfolio accross different securities

Question 14

Well-diversified portfolio

Answer 14

Perfectly co-moves with market
Carries only market risk

Question 15

Market portfolio

Answer 15

All assets in economy
Proxy with SP500

Question 16

B

Answer 16

Stocks’ risk relative to the market
B=1 market portfolio
B=0 rf asset

Question 17

o due to market risk

Answer 17

Bstock · Omarket

Question 18

O due to market (meaning)

Answer 18

Risk of adding an extra stock to a well-diversified portfolio

Question 19

Market risk for whole portfolio

Answer 19

Weighted average of the B of all stocks
(if well-diversified this is only risk)

Question 20

Bi

Answer 20

covim/om^2

Question 21

B from regression analysis

Answer 21

Slope of line of best fit in a historical graph of indv. returns (y) and market returns (x)

R^2 -> total variance in returns due to market risk