Portfolio Risk Management

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What is the formula for calculating portfolio variance?

$w1σ1 + w2σ2 - 2w1w2Cov(1,2)$

$w1^2σ1 + w2^2σ2 - 2w1w2Cov(1,2)$

$w1σ1 + w2σ2 + 2w1w2Cov(1,2)$

$w1^2σ1^2 + w2^2σ2^2 + 2w1w2Cov(1,2)$ (correct)

If the correlation coefficient between two assets is 1, what does this indicate?

Perfect negative correlation

No correlation

Perfectly random correlation

Perfect positive correlation (correct)

In the context of a portfolio, what does a higher covariance between two assets imply?

Less diversification benefits (correct)

Lower risk

Higher diversification benefits

Higher expected return

How is the standard deviation of a portfolio affected by the correlations between its assets?

Higher correlation leads to higher portfolio standard deviation Signup and view all the answers

Why might an investor choose to diversify their portfolio?

To decrease the overall risk of the portfolio Signup and view all the answers

What effect does a higher weight in a high standard deviation asset have on the overall portfolio volatility?

Increases overall portfolio volatility Signup and view all the answers

Which measure is used to find the risk of a portfolio by assessing how the returns of two stocks move together?

Covariance Signup and view all the answers

If the covariance between two stock returns is negative, what does it indicate about their movements?

They move in opposite directions Signup and view all the answers

What is used to normalize the covariance and provide a measure of common risk shared by stocks?

Correlation Signup and view all the answers

Which measure helps reduce risk through diversification by considering how prices of different stocks move together?

Correlation Signup and view all the answers

What does portfolio variance measure in terms of risk for a set of securities in a portfolio?

How actual returns fluctuate over time Signup and view all the answers

If the correlation between two stocks is -1, what does this imply about their relationship in terms of movements?

They move in opposite directions perfectly Signup and view all the answers

What is the main difference between an inefficient portfolio and an efficient portfolio?

In an inefficient portfolio, there is no way to reduce volatility without lowering expected return, while in an efficient portfolio, the volatility of the portfolio cannot be reduced without lowering its expected return. Signup and view all the answers

How does correlation affect the volatility of a portfolio?

The lower the correlation between assets in a portfolio, the lower the volatility we can obtain. Signup and view all the answers

Why might it be beneficial to add Bore Industries to a two-stock portfolio despite having lower returns?

Bore Industries offers diversification benefits even with lower returns and similar volatility to Coca-Cola. Signup and view all the answers

What is the impact of changing the correlation between stocks on portfolio volatility?

Lower correlation between stocks results in lower volatility for the portfolio. Signup and view all the answers

What is the key difference between a short position and a long position in investments?

A short position involves borrowing a stock to sell it, while a long position involves buying a stock with the intention of selling it later. Signup and view all the answers

What happens to the curve representing portfolios when correlation between assets decreases?

The curve bends to the left to a greater degree. Signup and view all the answers