class 5 notes 4 3 2017 - ACE 446 Class 5-6 Outline(w\/extra materials April 3-5 2017 Administrivia Midterm likely 4\/19 Also need a date for a quiz to

class 5 notes 4 3 2017 - ACE 446 Class 5-6 Outline(w/extra...

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ACE 446 - Class 5-6 Outline (w/extra materials) April 3-5, 2017 Administrivia : Midterm likely 4/19. Also need a date for a quiz to prep for midterm. Handouts : (i) Notes Class Goals : i). Any Qs on Duration? Hedging applications? Use of Solver vs. Goal Seek? Other? ii). Begin "Modern Portfolio Theory" concepts by building own portfolio assessment utility. ( See example sheets. Starting settings in Excel. Copy file to own folder – don’t open from class folder) I . Portfolio Problem: "how to allocate wealth across a set of available investments". You typically first encounter the concepts from a perspective of stock selection, but the principles apply to most facets of constrained financial decision making. An example could be how much to spend on clothes, housing, cars, savings, insurance, retirement items and how to allocate within each category. Or more generally, these items represent an approach for general constrained optimization – a useful thing to know how to attack and solve regardless of the context. In any case, modern portfolio theory begins by developing multiple investment asset versions of mean return or µ , standard deviation or σ , and introducing a measure of the association between the outcomes of two variables at a time, or correlation. The correlation between x and y is often represented by ρ x,y . The covariance or σ 2 xy is the analogue of the variance, but instead of the probability weighted squared deviations is found by multiplying the deviations from the means of two variables at a time – and thus can be negative unlike variance. Common notations for covariance includes cov(x,y), and sometimes without the power as σ x,y . Our motivating examples will involve combining various investments with different individual returns distributions and correlations or covariances among returns. In practice, you then add the complication of different risk aversions and the resulting implication for choosing “most preferred” mixture of assets. Financing is nearly always treated as separable.