Portfolio Mgmt Flashcards
Variance of equally weighted portfolio
= (1/n)(avg variance) + [(n-1)/n](avg covariance)
Covariance
= ρ(σ1)(σ2)
Capital allocation line
- Line tangent to the efficient frontier
- Slope of the CAL represents best possible risk-return trade-off given the investor’s expectations
= Rf + [E(RT) - Rf]*(σC/σT)
Capital market line
- CAL, assuming all investors have the same expectations
- New efficient frontier replacing Markowitz frontier to determine asset allocation to risk-free asset and market portfolio
= Rf + [(E(RM) - Rf)/όM]*όA
Security market line
- shows relationship between an asset’s expected return and its systematic risk
= Rf + β[E(Rm - Rf)]
β
Measure of asset’s systematic risk
= Cov/σm^2
= (ρ*σi)/σm
Value added
= α - λ*ω^2
= residual return - (risk aversion x residual risk^2)
Arbitrage portfolio
Factor sensitivities of zero to all factors, positive expected net cash flow, and an initial investment of zero
Tracking portfolio
Specific set of factor sensitivities designed to replicate the factor exposures of a benchmark index
Factor portfolio
Factor sensitivity of one to a particular factor in a multi-factor model and zero to all other factors
Determining if an asset should be added to a portfolio
Only if the Sharpe ratio of the new asset is greater than the Sharpe ratio of the portfolio
E(Rnew) - Rf]/σnew > [[E(Rp) - Rf]/σp]*ρ(new,p)
Information ratio
Measure of manager’s opportunities
= information coefficient x SQRT(breadth)
= ann. residual return/ann. residual risk
= t-stat/SQRT(years) for ex-post IR
Information coefficient
Correlation between each forecast with the actual outcome (measure of skill)
= IC x SQRT[2/(1+r)]
Total risk
Represented by σ
= systematic risk + unsystematic risk
Systematic risk
Represented by β
