Efficient Diversification Lecture Notes

These flashcards cover crucial concepts related to efficient diversification, portfolio risk, and asset allocation to aid in understanding key financial principles.

Diversification

The process of spreading investments across various financial assets to reduce risk.

Market Risk

The risk that affects all securities in the market; also known as systematic risk.

Nondiversifiable Risk

Risk that cannot be eliminated through diversification; synonymous with market risk.

Unique Risk

Risk that is specific to a particular company or industry; also called firm-specific or nonsystematic risk.

Covariance

A measure of how two securities move in relation to each other.

Correlation Coefficient

A statistical measure indicating the extent to which two securities move in relation to each other, ranging from -1 to +1.

Expected Return

The anticipatory return of an investment based on historical data and probability.

Variance

A statistical measurement of the spread between numbers in a data set, often used to measure portfolio risk.

Efficient Frontier

A graph representing the set of optimal portfolios that offer the highest expected return for a given level of risk.

Sharpe Ratio

A measure of risk-adjusted return; calculated as the average return earned in excess of the risk-free rate per unit of volatility.

Mean-Variance Criterion

A principle for constructing an efficient portfolio by maximizing expected return for a given level of risk.

Two-Asset Portfolio Standard Deviation

A measure of the risk associated with a portfolio containing two assets, calculated based on their individual standard deviations and the correlation between them.

Optimal Risky Portfolio

The combination of risky and risk-free assets that produces the highest expected return for the lowest risk.