Risk vs. Return

Question 1

What is expected return?

Answer 1

the mean of all the returns

Question 2

what is standard deviation?

Answer 2

tells us on average how much we think the expected realised return is going to differ from that of its mean.

Question 3

what is covariance?

Answer 3

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.

Question 4

how do you find covaraince?

Answer 4

important to know that the covariance of any two assets is equal to the correlation divided by the product of the standard deviations.

Question 5

What is the minimum variance portfolio?

Answer 5

portfolio that delivers the highest return for the lowest possible level of risk. This is great for investors that hate risk.

Question 6

What are the three degrees of Risk Aversion?

Answer 6

high risk aversion
moderate risk aversion
low risk aversion

Question 7

what are the properties of high risk aversion?

Answer 7

• 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)

Question 8

What are the properties of moderately risk averse?

Answer 8

• 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.

Question 9

what are the properties of low risk aversion/ risk loving?

Answer 9

• 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