40 Questions
What is the primary objective of calculating 'ex ante' expected returns and variance of returns?
To understand the effect of portfolio diversification on risk
What do investors expect to receive in the future when they invest in shares now?
Returns commensurate with the level of risk
What is the primary difference between LSE shares and gilts or T-Bills?
LSE shares have historically delivered higher returns than gilts or T-Bills
What is the key result of portfolio diversification on risk?
It reduces the risk of the portfolio
What determines the required rate of return for different shares?
The level of risk associated with the share
What is the characteristic of the states of the world in this scenario?
They are both exhaustive and mutually exclusive.
What is the primary distinction between systematic and unsystematic risk?
Systematic risk is associated with the market, while unsystematic risk is associated with the company
What is the purpose of modeling uncertainty about future returns?
To understand the level of risk associated with the investment
What is the expected return of an investment, denoted by E[R]?
The return that the investment is expected to generate on average.
What is the relationship between the required rate of return and the level of risk?
The required rate of return is directly proportional to the level of risk
What is the formula to calculate the expected return of an investment, E[R]?
E[R] = ∑π(s_i)R(s_i)
What is the unexpected return of an investment, denoted by U?
The actual return minus the expected return.
What is the variance of an investment, denoted by σ^2[R]?
The sum of the squared deviations of the actual returns from the expected return.
What is the standard deviation of an investment, denoted by σ[R]?
The square root of the variance of the investment.
What is the purpose of portfolio diversification?
To reduce the risk of an investment.
What is the formula to calculate the standard deviation of an investment, denoted by σ[R]?
σ[R] = √(∑π(s_i)(R(s_i) - E[R])^2)
If a portfolio consists of 5 shares, with equal investments in each, what are the portfolio weights?
1/5, 1/5, 1/5, 1/5, 1/5
What is the total amount invested in four securities with amounts £25,000, £5,000, £10,000, and £20,000?
£60,000
A portfolio consists of two securities with weights θ1 and θ2. What is the expected return of the portfolio?
θ1E[R1] + θ2E[R2]
What is the formula for the standard deviation of a portfolio return?
θ1σ[R1] + θ2σ[R2] + 2θ1θ2ρ12σ[R1]σ[R2]
What is the relationship between the standard deviation of a portfolio and the standard deviations of the constituent securities?
The standard deviation of the portfolio is always less than the standard deviations of the constituent securities.
What is the term for the risk that can be reduced through diversification?
Diversifiable risk
What is the expected return of a portfolio with two securities, R1 and R2, with weights θ1 and θ2, respectively?
θ1E[R1] + θ2E[R2]
What is the formula for the covariance between two securities, R1 and R2?
E[R1R2] - E[R1]E[R2]
What is the component of total risk that affects individual or a small group of securities?
Unsystematic risk
Which of the following is an example of systematic risk?
Information surprises about interest rates
What is the purpose of portfolio diversification?
To eliminate unsystematic risk
What is the principle that states that investors require higher expected returns to compensate them for systematic risk?
Systematic risk principle
What is the formula for total risk?
R = E[R] + U
What is the component of total risk that can be diversified away?
Unsystematic risk
Why do investors demand higher expected returns for riskier securities?
To compensate for systematic risk
What is the term for the unexpected part of total risk?
Unexpected return
What is the relationship between the expected return and systematic risk of a security according to the systematic risk principle?
Securities with higher systematic risk promise higher expected returns
What is the sum of the portfolio weights in a portfolio?
Equal to 1
What is the effect of diversification on the portfolio's risk?
It decreases the portfolio's risk
How is the portfolio's standard deviation related to the standard deviation of its constituent securities?
It is always less than the weighted average of the standard deviations of the constituent securities
What is the name of the principle that states that security prices are determined so that securities with higher systematic risk promise higher expected returns?
The systematic risk principle
What is the result of combining securities with high total risk and low systematic risk, such as biotechnology and internet stocks, in a portfolio?
The portfolio's total risk increases, but its systematic risk decreases
What is the purpose of modeling uncertain returns by their return in different states of the world?
To understand the behavior of a security's returns in different economic scenarios
What is the relationship between the portfolio's expected return and the expected returns of its constituent securities?
The portfolio's expected return is a weighted average of the expected returns of its constituent securities
This quiz covers the key concepts of risk and valuation, including calculating expected returns and variance, portfolio diversification, and the distinction between systematic and unsystematic risk. Test your understanding of these crucial finance topics.
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