Finance Chapter 4: EGARCH and Portfolio Analysis
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Questions and Answers

What is the expected return from the risk-free asset?

  • 0.08
  • 0.03
  • 0.10
  • 0.05 (correct)
  • What is the formula for the return from the combined portfolio?

  • rc = q.Rp + (1-q).σf
  • rc = q.rf + (1-q).σp
  • rc = q.E[rf] + (1-q)E[σp]
  • rc = q.Rf + (1-q).rp (correct)
  • What does the standard deviation of the risk-free asset equal?

  • 0.05
  • 0.08
  • 0 (correct)
  • 0.10
  • How is the standard deviation of the combined portfolio calculated?

    <p>σc = (1 - q).σp</p> Signup and view all the answers

    The riskier asset offers a higher expected return due to what characteristic?

    <p>Inherent risk</p> Signup and view all the answers

    What does the utility of an investment depend on?

    <p>The expected return and risk of the investment</p> Signup and view all the answers

    How does the coefficient of risk aversion (C) affect utility?

    <p>Higher C increases the penalty for risk, reducing utility</p> Signup and view all the answers

    What best describes the relationship between risk aversion and investment choices?

    <p>Higher risk aversion leads investors to prefer lower return but lower risk investments</p> Signup and view all the answers

    Which of the following is true about the Sharpe ratio?

    <p>It measures excess return relative to risk</p> Signup and view all the answers

    Which investment alternative has the highest Sharpe ratio?

    <p>Investment C</p> Signup and view all the answers

    Which statement about inefficient investments is true?

    <p>An inefficient investment can never yield the highest utility</p> Signup and view all the answers

    If two investment alternatives have close Sharpe ratios, what is likely to happen?

    <p>Performance differences may be negligible</p> Signup and view all the answers

    What influences an investor's decision to add an asset to their portfolio?

    <p>How much the asset contributes to the portfolio's total risk</p> Signup and view all the answers

    What happens to utility as risk aversion increases?

    <p>Utility decreases due to higher penalties for riskier choices</p> Signup and view all the answers

    What is the consequence of having a higher risk aversion in an investment?

    <p>More compensation is needed for taking on additional risk</p> Signup and view all the answers

    What characterizes an indifference curve in risk-return profiles?

    <p>It shows the trade-off between risk and expected return at a fixed utility score</p> Signup and view all the answers

    Which of the following statements is true about asset D?

    <p>It dominates alternative investments by offering a higher return at a lower risk</p> Signup and view all the answers

    Which investment strategy allows for both risky assets and risk-free assets?

    <p>Capital allocation strategy</p> Signup and view all the answers

    What does it mean when an asset is weakly or negatively correlated with existing assets?

    <p>It may still be worth adding to the portfolio despite low expected returns</p> Signup and view all the answers

    What key factor should not influence the assessment of an asset's addition to a portfolio?

    <p>Personal taste for higher risks</p> Signup and view all the answers

    What must be fulfilled for an investor to consider the risk-return of different assets as equally useful?

    <p>The utility score must be fixed with a specific risk tolerance</p> Signup and view all the answers

    What does a negative value of b in the EGARCH model indicate?

    <p>Negative shocks have a greater impact on future volatility than positive shocks of the same magnitude.</p> Signup and view all the answers

    Which characteristic of the EGARCH model distinguishes it from other volatility models?

    <p>It allows coefficients to be negative due to the log function.</p> Signup and view all the answers

    Which statement about the Sharpe ratio is correct?

    <p>It helps to compare the expected reward for an additional unit of risk.</p> Signup and view all the answers

    In the context of portfolio selection, what does the Markowitz approach primarily address?

    <p>Balancing individual preferences with objective portfolio choices.</p> Signup and view all the answers

    What can be inferred about the portfolio with the highest expected return among the provided options?

    <p>The expected return of extremely high-risk portfolio is the same as the high-risk portfolio.</p> Signup and view all the answers

    Which portfolio exhibits the highest standard deviation of excess return?

    <p>Portfolio E</p> Signup and view all the answers

    What does the quadratic utility function represent in the context of investment decisions?

    <p>It provides a way to evaluate risk preferences relative to expected returns.</p> Signup and view all the answers

    If a portfolio has an expected return of 0.05 and a standard deviation of excess return of 0.09, what is its Sharpe ratio?

    <p>0.56</p> Signup and view all the answers

    Study Notes

    EGARCH Model

    • The EGARCH model, similar to the GJR-GARCH model, reflects volatility asymmetry.
    • Negative shocks have a larger impact on future volatility compared to positive shocks of equal magnitude (if b < 0).
    • This model doesn't require constraints on coefficients, allowing them to be negative due to the log function.
    • EGARCH models account for leptokurtic conditional variance.

    Chapter 4: Utility and Indifference Curves

    • Choosing between investment options is difficult.
    • The Sharpe ratio can indicate expected reward per unit of risk, but further personal preference needs to be assessed
    • The Markowitz portfolio selection method separates personal preferences from objective portfolio optimization.
    • Portfolio A to E provide examples with varying risk levels, expected return, excess return standard deviation, and respective Sharpe ratios

    Portfolio Analysis

    • Investor preferences heavily influence investment choices.
    • Quadratic utility functions (U = E(r) - c.σ²) guide decision-making, where:
      • U = Utility
      • E(r) = Expected return
      • σ² = Variance of return
      • c = Risk aversion coefficient (higher c = higher risk penalty)
    • Utility depends on the expected return and its associated risk (measured by standard deviation).

    Investor Preferences and Sharpe Ratios

    • Higher risk aversion leads investors to prefer investments with lower returns and lower risk.
    • The choice of investment does not solely depend on the Sharpe ratio, but also risk aversion
    • It is difficult to compare investment options that are close together in terms of risk and return
    • An investment with low Sharp ratio can still be preferred over another if its risk and return are more suitable to the investor

    Capital Allocation Line

    • Investments can be in risk-free or risky assets.
    • A risk-free asset has a standard deviation of zero.
    • The expected return and standard deviation of a risky investment is calculated
    • Investors must decide how much of their wealth goes into risk-free and risky investments to optimize their portfolios.

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    Description

    Explore Chapter 4 discussing the EGARCH model's asymmetry in volatility and its implications for investment strategies. Learn about utility and indifference curves in portfolio selection, and see how different investment options can be evaluated using the Sharpe ratio. This quiz will test your understanding of key concepts in finance and investment analysis.

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