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Level 115

Optimal Portfolio Choice


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Portfolio Weights
The fraction of the total investment in a portfolio held in each individual investment in the portfolio.
Covariance
The product moment of two random variables about their mean. Correlation and covariance are related and generally measure the same phenomenon.
estimate of the covariance from historical data
helps to know the degree to which the stocks face common risks and their returns move together. If 2 stocks move together, returns will tend to be above or below average at the same t…
correlation
the extent to which variables are related
inefficient portfolio
whenever it is possible to find another portfolio that is better in terms of both expected return and volatility
long position
one who is buying is said to be in _______
short position
one who is selling is said to be in _______
efficient frontier
developed by Prof Harry Markowitz 1952
buying stocks on margin
using leverage; borrowing money to invest in stocks. Risky investment strategy.
Sharpe Ratio
Slope of the capital market line
efficient portfolio
tangent portfolio; the portfolio with the highest Sharpe ratio in the economy. By combining with the risk-free investment, an investor will earn the highest possible expected return for any level of volatility he or she is willing to bear
required return
the expected return that is necessary to compensate for the risk investment i will contribute to the portfolio
homogenous returns
all investors have the same estimates concerning future investments and returns
Capital market line (CML)
the line with an intercept point equal to the risk-free rate that is tangent to the efficient frontier of risky assets; represents the efficient frontier when a risk-free asset is available for investment
Security market line (SML)
a graphical representation of the CAPM with beta on the x-axis and expected return on the y-axis; slope of the line is the market risk premium (Rm - Rf)