Risk vs. Return Flashcards
What is expected return?
the mean of all the returns
what is standard deviation?
tells us on average how much we think the expected realised return is going to differ from that of its mean.
what is covariance?
Tells us how the asset relates linearly can be from 0 or positive and negative 1.
0 - no linear relationship
+1 - perfect correlation so move in exact same way.
-1 - perfect negative correlation, opposite directions and offset eachother.
how do you find covaraince?
important to know that the covariance of any two assets is equal to the correlation divided by the product of the standard deviations.
What is the minimum variance portfolio?
portfolio that delivers the highest return for the lowest possible level of risk. This is great for investors that hate risk.
What are the three degrees of Risk Aversion?
high risk aversion
moderate risk aversion
low risk aversion
what are the properties of high risk aversion?
- investors don’t like risk
- their indifference curve is very steep
- require high increases in expected return to compensate for small increments in portfolio risk exposure.
- their optimal portfolio we assume in this case is the minimum variance portfolio (not always the case)
What are the properties of moderately risk averse?
- investors are more willing to take on risk than those investors that have a high degree of risk aversion.
- their indifference curves are flatter which shows their willingness to take on extra risk for smaller increases in portfolio expected return.
Their optimal portfolio is likely to be at point B on the efficient frontier.
what are the properties of low risk aversion/ risk loving?
- investors like risk, willing to take on high amounts of extra risk exposure for small increments in expected return.
- we can see this is the behaviour of flatness of their indifference curves relative to other types of investors.
- optimum portfolio likely to be point C
