Podcast
Questions and Answers
Modern Portfolio Theory assumes that investors make ______ decisions when they possess sufficient information.
Modern Portfolio Theory assumes that investors make ______ decisions when they possess sufficient information.
rational
Investors enter the market to maximise their ______ while avoiding unnecessary risk.
Investors enter the market to maximise their ______ while avoiding unnecessary risk.
returns
MPT emphasizes that by diversifying investments across various asset ______, investors can reduce overall risk.
MPT emphasizes that by diversifying investments across various asset ______, investors can reduce overall risk.
classes
People place a higher value on assets they already own, which is known as the ______ Effect.
People place a higher value on assets they already own, which is known as the ______ Effect.
Signup and view all the answers
Investors tend to follow the crowd rather than rely on independent analysis, a behavior known as ______ Bias.
Investors tend to follow the crowd rather than rely on independent analysis, a behavior known as ______ Bias.
Signup and view all the answers
Investors seeking information that confirms their existing beliefs are exhibiting ______ Bias.
Investors seeking information that confirms their existing beliefs are exhibiting ______ Bias.
Signup and view all the answers
Optimism Bias is characterized by a tendency towards wishful thinking and ______ in our plans.
Optimism Bias is characterized by a tendency towards wishful thinking and ______ in our plans.
Signup and view all the answers
Investors may trade excessively due to ______ in their knowledge and abilities.
Investors may trade excessively due to ______ in their knowledge and abilities.
Signup and view all the answers
The ______ ratio is used to assess the performance of an investment by adjusting for its risks.
The ______ ratio is used to assess the performance of an investment by adjusting for its risks.
Signup and view all the answers
A higher ______ ratio indicates that the portfolio is providing better returns for each unit of total risk.
A higher ______ ratio indicates that the portfolio is providing better returns for each unit of total risk.
Signup and view all the answers
Treynor's ratio considers only systematic risks which is represented by ______.
Treynor's ratio considers only systematic risks which is represented by ______.
Signup and view all the answers
Jensen's Alpha measures the excess return of a portfolio over what would be expected based on its ______ and the market return.
Jensen's Alpha measures the excess return of a portfolio over what would be expected based on its ______ and the market return.
Signup and view all the answers
A positive ______ indicates that the portfolio has outperformed the market after adjusting for its risk.
A positive ______ indicates that the portfolio has outperformed the market after adjusting for its risk.
Signup and view all the answers
The Information Ratio measures the risk-adjusted return relative to a ______, accounting for the consistency of performance.
The Information Ratio measures the risk-adjusted return relative to a ______, accounting for the consistency of performance.
Signup and view all the answers
A higher Information Ratio indicates that the portfolio is delivering consistent excess returns over the ______.
A higher Information Ratio indicates that the portfolio is delivering consistent excess returns over the ______.
Signup and view all the answers
The Treynor ratio is particularly useful for evaluating the performance of a portfolio that is ______.
The Treynor ratio is particularly useful for evaluating the performance of a portfolio that is ______.
Signup and view all the answers
Study Notes
Sharpe Ratio
- Measures investment performance, adjusting for risk
- Higher ratio indicates better returns for each unit of risk
- Calculated as: (Portfolio Return - Risk-Free Rate) / Portfolio Standard Deviation
- Values below 1 are considered poor; 1-1.99 adequate; 2-2.99 very good; >3 excellent
- Considers both systematic and unsystematic risk
Treynor Ratio
- Measures risk-adjusted return, focusing on systematic risk (beta)
- Higher ratio implies better performance relative to systematic risk
- Useful for well-diversified portfolios
- Calculated as: (Portfolio Return - Risk-Free Rate) / Portfolio Beta
- A higher Treynor Ratio suggests that the security or portfolio is worth investing in.
Jensen's Alpha
- Measures portfolio excess return relative to market and beta
- Positive alpha indicates outperformance after risk adjustment
- Calculated as: Portfolio Return - [Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)]
- Assess and analyze portfolio or security performance
Information Ratio
- Measures risk-adjusted return relative to a benchmark, focusing on consistency
- Higher ratio suggests consistent excess returns versus benchmark volatility
- Useful for comparing actively managed funds against a benchmark
- Considers both consistency and magnitude of returns
Modern Portfolio Theory (MPT)
- Investors make rational decisions given sufficient information
- Aim to maximize returns while minimizing unnecessary risk
- Diversification across asset classes reduces overall portfolio risk
- Different assets don't always move in the same direction
- Combining uncorrelated assets reduces portfolio volatility
MPT Graph (Capital Allocation Line)
- X-axis: Risk (standard deviation)
- Y-axis: Expected Return
- Efficient Frontier: Set of portfolios offering highest expected return for a given level of risk
- Capital Market Line (CML): Represents the risk-return trade-off where the risk-free asset is also on the efficient frontier, indicating maximum expected return for all levels of risk
- Market Portfolio (M): Optimal portfolio that lies on the furthest point of the efficient frontier
Behavioral Finance Biases
- Endowment Effect: People value assets they own more than similar assets they don't own.
- Herding Bias: Making decisions based on what others are doing, rather than independent analysis
- Confirmation Bias: Seeking out or emphasizing information that confirms existing beliefs, ignoring contradicting evidence
- Overconfidence Bias: Overestimating one's knowledge, abilities, or accuracy of predictions, leading to excessive risk taking
- Optimism Bias: Wishful thinking and overconfidence in plans
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Related Documents
Description
Test your knowledge on key investment performance ratios including Sharpe Ratio, Treynor Ratio, and Jensen's Alpha. Understand how these ratios help in measuring risk-adjusted returns and their significance for portfolio management. Perfect for finance students and professionals alike.
