What are the assumptions of the mean variance theory?
The assumption is that investors makes investment decisions based on two parameters
return and risk (volatility)
What are the 2 normal choices for rational investors when it comes down to investment in a portfolio?
A rational investor would only invest in:
a portfolio that has the highest expected return for a given risk level (volatility) respectively
A portfolio that has the lowest risk level (volatility) for a given expected return (efficient portfolio)
How do you call the part of efficient portfolios by two risky assets?
efficient frontier
What is the meaning of the capital market line?
if a risk free asset is available (for example a german state bond) the efficient frontier is a traight line and is called the capital market line
When is diversification usefull?
Diversification is only usefull when the correlation between the assets is below one. Otherwise no efficient frontier is possible
How can you construct a portfolio, purely existing of bonds or shares, with an diversification effect?
the trick is that you can change many thing so that bonds or shares have a relativ low correlation, for example:
issuer
maturity
industries
sectors
countries
What is better a diversified portfolio of two or several investment?
portfolio, consisting of several investments with correlations lower than one, is more efficient than a portfolio consisting only of two investments.
What are the three steps of the markowith portfolio optimization?
Estimate the expected return and the volatility for each single investment
estimate the correlations
Determine the efficient portfolios (efficient frontier)
Choose one of the efficient portfolios
When it comes down to choosing a portfolio due to markowith theory of a optimazation of a portfolio what are the 3 main things to remember?
That fits the utility funtion of the investor
That offers the highest return for a level of risk targeted by the investor
that offers the lowest level of risk for a targeted return
Why should an investor choose the MVP (Minimal variance portfolio) instead of going with markowitz optimaziation theory?
the investor does ot need all the portfolio for his decision on the efficient frontier
he even does not need any return expectations
he implicitly is minimizing the risk and accepting the resulting expected return
What is the meaning of “naive diversification”
investing in a sufficient large number of different investments with equal weightings (weighting = 1/n) and positive correlated returns
This means, a naive diversified portfolio with many investments has approximately the same risk as the market portfolio
What is a singel index model?
The basic idea is to explain the return of each single asset (stock etc.) with its relationship to the return of an index
What is the meaning of the beta factor
beta factor of 1 means the portfolio the same risk as the index
beta factor is smaller than 1 means the portfolio is less sensitive to the index
beta factor is bigger than 1 means the portfolio is more sensitive to the index
What are the 3 components, the singel index modell states of the assets returns?
Alpha: is the specific constant
Beta: measuring the sensitivity of the asset‘s return to fluctuations in the index‘s return
e(asset): summarizing all variable (i.e. random) return components that cannot be explained by the common factor (the index return)
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