3.3 Diversification Flashcards by Jakub Trybull

Q

Diversification diagrammatically

A

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Q

What are the benefits of diversification?

A

“Don’t put all your eggs in one basket”
By holding many stocks - risk is diversified, idiosyncratic or specific risk
- Factory burns down
- Competitor builds better product

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Q

What is a limit of diversification?

A

There exist risks that cannot be diversified known as systematic or market risk.

Economy slows - financial crash perhaps????

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Q

Two components of risks in individual asset returns

A

Systematic risks - common to most assets
Non-systematic, idiosyncratic risks - specific to individual assets

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Q

How is the approach to systematic and non-systematic risks different?

A

Non-systematic risks are diversifiable.
Systematic risks are not.

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Q

Define portfolio

A

A portfolio is a collection of assets, characterised by the mean, variance/covariances of their returns.

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Q

Notation for portfolios

A

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Q

Consider investing into swimwear or investing into umbrellas where:

What is the expected return on stock 1?

A

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Q

Consider investing into swimwear or investing into umbrellas where:

What is the expected return on stock 2?

A

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Q

Consider investing into swimwear or investing into umbrellas where:

What is the expected return of the equally weighted portfolio in the case of sun

A

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Q

Consider investing into swimwear or investing into umbrellas where:

Expected return of the equally weighted portfolio in the case of rain

A

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Q

Consider investing into swimwear or investing into umbrellas where:

Portfolio return of the equally weighted portfolio

A

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Q

Consider investing into swimwear or investing into umbrellas where:

StD of stock 1

A

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Q

Consider investing into swimwear or investing into umbrellas where:

StD of stock 2

A

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Q

Consider investing into swimwear or investing into umbrellas where:

Covariance between stock 1 and 2

A

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Q

Consider investing into swimwear or investing into umbrellas where:

[covariance is -1.44%]

Correlation coefficient between stock 1 and 2

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A

Q

Consider investing into swimwear or investing into umbrellas where:

Weighted average risk of the equally weighted portfolio

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A

Q

Consider investing into swimwear or investing into umbrellas where:

[covariance = -1.44%]

Portfolio risk of the equally weighted portfolio

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A

Q

Equation for the expected and unexpected return on a portfolio with two assets

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A

Q

Equation for the variance of return on a portfolio with two assets

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A

Q

How is the variance of the return for a portfolio with two assets derived?

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A

Q

Equation for the variance of return on a portfolio with three assets.

Derivation?

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A

Q

Portfolios of multiple assets

What is:

The return on the portfolio?
The expected return on the portfolio?
The variance of the portfolio?
The volatility of portfolio return?

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A