Self Study Questions Topic 1

Question 1

Expected return

Answer 1

probability x return
add up for all states

Question 2

variance

Answer 2

probability (actual - expected) squared
add up for all states

Question 3

standard deviation

Answer 3

square root of variance

Question 4

covariance

Answer 4

probability (actual1- expected1) x (actual2 - expected 2)

Question 5

correlation

Answer 5

covariance divided by variance x variance

Question 6

investment decisions

Answer 6

dominates or dominated

dominates = higher return & lower risk
dominated = inefficient, lies below mean variance efficient frontier

Question 7

monthly arithmetic return

Answer 7

current period - previous period divided by previous period

Question 8

expected monthly return

Answer 8

add up all arithmetic divide by number of periods

Question 9

plotting the MF

Answer 9

• GMRP
• where cross the x axis
• std deviation = x-axis
• return (%) = y-axis

Question 10

CML

Answer 10

Question 11

slope of CML

Answer 11

Question 12

market portfolio expected return

Answer 12

Question 13

GMRP

Answer 13

-b / 2a

Question 14

composition

Answer 14

Question 15

holding period return

Answer 15

1. shares held
2. share value
3. holding period =
   current share value - period 1 value / period 1 value

Question 16

shares held

Answer 16

period 1 = 1

previous shares held x ( 1+ current dividend/current share price)

Question 17

share value

Answer 17

shares held x share price

Question 18

logarithmic return

Answer 18

ln ( 1 + arithmetic)

Question 19

arithmetic

Answer 19

current share + divided - previous share divided by previous

Question 20

diversification

Answer 20

negative correlation = reduced risk

lower correlation = lie within/inside frontier

Question 21

optimal portfolio with preference function

Answer 21

IC = equal a constant and rearrange for mu

slope of I.C = slope of the CML

Question 22

composition regarding lending and borrowing

Answer 22

lend if less than the market portfolio

borrow if more than market portfolio

Question 23

short selling

Answer 23

• sells dont own by borrowing
• buy back later = profit from decline
• benefit from downwards
• hedging/risk management
• manipulation/investor confidence

Question 24

Determine MF

Answer 24

1. inputs
2. return and risk
3. optimisation
4. plot
5. dominate portfolios

Question 25

critique of MPT

Answer 25

1. assumptions 2. investor criteria sufficient? 3. availability of parameters 4. guide not dictate decisions 5. estimation risk

Question 26

arithmetic vs logarithmic

Answer 26

a = discrete, multiplicative, non symmetric l = continuous, additive, symmetric, normally distributed

Question 27

ambiguity

Answer 27

form of uncertainty unsure about correct probability distribution

Question 28

risk averse vs risk hating

Answer 28

averse & no RF rate = efficient lie on MVE frontier averse & RF rate = CML (combination between risk free and market portfolio) hating = no Rf = lowest point on MVE Rf = entirely rf

Question 29

market portfolio

Answer 29

tangency between CML & MVEmo

Question 30

modern portfolio theory

Answer 30

pros = risk return trade off, diversification, starting points cons = real world = ambiguous, behavioural factors, markets are dynamic