Risk return & diversification

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14 Terms

1
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Correlation

how 2 investments move in relation to each other

2
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postive correlation

one goes up, other goes up by same amt

3
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negative correlation

one goes up, other goes down

4
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how to compute risk of portfolio with 2 risky assets

using stdev formula

5
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stdev of risk free asset

is 0

6
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why are 2 risky assets better than one alone

diversification with positive weights gives overall lower risk than risk of single risky asset

7
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dominated portfolios

points on cure not chosen bc returns decrease as risk increases

8
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non-dominated portfolios (efficient frontier)

offer highest expected return for given risk, top part of efficient frontier

9
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perfect correlation portfolio

no real benefit or diversification here as they move the same, choice depends on preference

10
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intermediate levels of correlation

there is a portfolio here that minimizes risk, use excel to find

11
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capital allocation line (CAL)

risk return trade off shown for portfolio of risky and non risky asset

12
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sharpe ratio

slope of CAL line, excess return per unit of risk, higher is better

13
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tangency portfolio

where CAL is tangent to efficient frontier, portfolio with highest sharpe ratio

14
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asset allocation process (with 2 risky and one risk free)

find tangency portfolio (for 2 risky assets), now problem is 1 risky and non risky asset, than use the utility maximization formula