Portfolio Theory and Risk-Return Models Quiz

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Questions and Answers

What is the primary focus of FIN 355?

Teaching advanced portfolio management techniques

Analyzing macroeconomic factors affecting global markets

Introducing equity and debt markets (correct)

Exploring cryptocurrency investment strategies

What is the main objective of the final lecture in FIN 355?

Focus solely on theoretical financial models without practical applications

Introduce entirely new investment concepts not covered in previous lectures

Discuss historical trends in stock market performance

Review key ideas from earlier lectures and discuss their relation to common investing approaches (correct)

What does FIN 355 aim to provide experience with?

Predicting short-term stock price movements

Cryptocurrency mining techniques

Mathematical measures and concepts related to portfolio risk and return calculations (correct)

Advanced algorithmic trading strategies

What is briefly introduced in FIN 355?

Options and futures Signup and view all the answers

What does the balance sheet equation Assets = Debt + Equity explain?

The relationship between the value of financial assets and the cash flows generated by real assets Signup and view all the answers

What is the basis for the price of financial assets?

The present value of expected cash flows Signup and view all the answers

How is total risk measured?

Using standard deviation and variance Signup and view all the answers

What characteristic differentiates debt and equity contracts?

Different risk characteristics Signup and view all the answers

Which type of investment generally offers higher returns but with more volatility?

Equity Signup and view all the answers

What does the standard deviation measure in the context of investments?

Total risk Signup and view all the answers

Which type of investments tend to have higher volatility in returns compared to debt investments?

Equity investments in smaller firms Signup and view all the answers

What do historical returns for different types of investments show?

Varying levels of risk and return Signup and view all the answers

What do savings accounts typically have in terms of returns?

Small to zero returns Signup and view all the answers

What do equity investments like the S&P 500 generally offer in terms of returns?

Higher average returns but with higher volatility Signup and view all the answers

What topics are covered in the assignments for each module of the course?

Portfolio theory, security analysis, valuation, business cycles, and investing approaches Signup and view all the answers

What does the course FIN 355 provide a comprehensive understanding of?

Investment alternatives, financial markets, and the characteristics of various asset classes Signup and view all the answers

What is the primary trading location for stocks in the US?

NYSE and Nasdaq Signup and view all the answers

Which financial reporting requirements do public firms have to adhere to?

Standardized financial reporting requirements Signup and view all the answers

What measures and summaries of returns are commonly used?

Annualized returns, APRs, EARs, and arithmetic vs. geometric averages Signup and view all the answers

What does the Capital Allocation Line (CAL) show?

Different portfolios that can be created using different investment weights with one risk-free and one risky asset Signup and view all the answers

What does traditional portfolio theory assume about investor preferences?

It assumes investor preferences Signup and view all the answers

What topics are covered in the course outline?

Debt and equity markets, risk and return, portfolio theory, risk-return models, security analysis, and valuation Signup and view all the answers

What changes the formula for portfolio expected returns and risk?

Combining multiple risky assets in a portfolio Signup and view all the answers

What does the weighted average intuition apply to in the expected return equation?

It applies to the expected return equation Signup and view all the answers

What does the final exam cover?

Business cycles, inflation, efficient markets, and investing approaches Signup and view all the answers

What topics are covered in the course?

Derivative markets, diversification, efficient frontier, betas, and risk-return models Signup and view all the answers

What do investors commonly use for trading stocks?

Online brokerage accounts Signup and view all the answers

What do stock indices track?

Overall market performance Signup and view all the answers

What does diversification primarily mitigate?

Idiosyncratic risk Signup and view all the answers

Which risk can be broken down into firm-specific and systematic components?

Market risk Signup and view all the answers

According to the CAPM formula, what does it suggest a relation between?

Market risk and returns Signup and view all the answers

What does the variance formula for a portfolio with multiple risky assets suggest?

Decrease in portfolio risk Signup and view all the answers

How can specific investment weights affect risk?

Reduce risk Signup and view all the answers

What does leftward movement along the efficient frontier indicate?

Decrease in risk Signup and view all the answers

What do portfolios along the efficient frontier offer through investment weight choices?

Targeted return and risk characteristics Signup and view all the answers

When do the most efficient portfolios appear along the efficient frontier?

With a risk-free asset Signup and view all the answers

What type of frontier can be traced out whether using only two or many underlying risky assets?

Efficient frontier Signup and view all the answers

Where do the most efficient portfolios appear if there is a risk-free asset?

Along the Capital Allocation Line (CAL) tangent to the efficient frontier Signup and view all the answers

What can investors do if they can invest in both risky and risk-free assets?

Create new portfolios along the CAL tangent to the efficient frontier Signup and view all the answers

What does the Capital Allocation Line (CAL) tangent to the efficient frontier represent?

Possible portfolios created with the tangency portfolio and the risk-free asset Signup and view all the answers

How do less correlated assets affect the efficient frontier and the Capital Allocation Line (CAL) tangent?

Shift the frontier left, increasing the Sharpe ratio of the CAL tangent Signup and view all the answers

What is the range of correlation between assets according to the text?

Between -1 and 1 Signup and view all the answers

What happens when new asset classes are introduced according to the text?

Shift the frontier left, creating portfolios with better risk-return profiles Signup and view all the answers

What does the Capital Asset Pricing Model (CAPM) estimate the expected return as a function of?

Systematic risk (beta) and market risk premium Signup and view all the answers

What does the Capital Asset Pricing Model (CAPM) predict about the expected return on an asset?

Risk-free rate plus a risk premium based on systematic risk measured by beta Signup and view all the answers

What does the Security Market Line (SML) depict according to the text?

The CAPM model, with the height representing the expected return for a given beta Signup and view all the answers

What do multifactor models like the Fama-French 3-factor model measure?

Market risk but assume the need for multiple betas to adequately capture it Signup and view all the answers

Study Notes

Portfolio Theory, Efficient Frontier, and Risk-Return Models

The Capital Allocation Line (CAL) tangent to the efficient frontier has the highest Sharpe ratio among all possible CALs.
The CAL represents possible portfolios created with the tangency portfolio and the risk-free asset, which is a combination of risky assets.
Less correlated assets shift the frontier left, increasing the Sharpe ratio of the CAL tangent.
Correlation is bounded between -1 and 1, and diversification benefits exist even for assets with 0 correlation.
Introducing new asset classes shifts the frontier left, creating portfolios with better risk-return profiles.
The rightmost frontier is attainable using only US and foreign equity and corporate bonds, while the left-most frontier is attainable by adding REITs and Commodities alongside the other asset classes.
The Capital Asset Pricing Model (CAPM) is a famous risk-return model, estimating the expected return as a function of systematic risk (beta) and market risk premium.
The CAPM assumptions include rational mean-variance optimization and the pursuit of the portfolio with the highest Sharpe ratio on the efficient frontier.
The CAPM predicts that the expected return on an asset is the risk-free rate plus a risk premium based on systematic risk measured by beta.
The Security Market Line (SML) depicts the CAPM model, with the height representing the expected return for a given beta.
The CAPM has limitations due to unrealistic assumptions and varying opinions on the market risk premium.
Multifactor models like the Fama-French 3-factor model also measure market risk but assume the need for multiple betas to adequately capture it.

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Description

Test your knowledge of Portfolio Theory, Efficient Frontier, and Risk-Return Models with this quiz. Explore concepts such as the Capital Allocation Line, diversification benefits, the Capital Asset Pricing Model (CAPM), and the Fama-French 3-factor model. Sharpen your understanding of risk and return in investment portfolios.