Chapter 7 - x

Chapter 7 - x - Lecture Presentation Software to accompany...

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Unformatted text preview: Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown Chapter 7 Chapter 7 - An Introduction to Portfolio Management Questions to be answered: • What do we mean by risk aversion and what evidence indicates that investors are generally risk averse? • What are the basic assumptions behind the Markowitz portfolio theory? • What is meant by risk and what are some of the alternative measures of risk used in investments? Chapter 7 - An Introduction to Portfolio Management • How do you compute the expected rate of return for an individual risky asset or a portfolio of assets? • How do you compute the standard deviation of rates of return for an individual risky asset? • What is meant by the covariance between rates of return and how do you compute covariance? Chapter 7 - An Introduction to Portfolio Management • What is the relationship between covariance and correlation? • What is the formula for the standard deviation for a portfolio of risky assets and how does it differ from the standard deviation of an individual risky asset? • Given the formula for the standard deviation of a portfolio, why and how do you diversify a portfolio? Chapter 7 - An Introduction to Portfolio Management • What happens to the standard deviation of a portfolio when you change the correlation between the assets in the portfolio? • What is the risk-return efficient frontier? • Is it reasonable for alternative investors to select different portfolios from the portfolios on the efficient frontier? • What determines which portfolio on the efficient frontier is selected by an individual investor? Background Assumptions • As an investor you want to maximize the returns for a given level of risk. • Your portfolio includes all of your assets and liabilities • The relationship between the returns for assets in the portfolio is important. • A good portfolio is not simply a collection of individually good investments. Risk Aversion Given a choice between two assets with equal rates of return, most investors will select the asset with the lower level of risk. Evidence That Investors are Risk Averse • Many investors purchase insurance for: Life, Automobile, Health, and Disability Income. The purchaser trades known costs for unknown risk of loss • Yield on bonds increases with risk classifications from AAA to AA to A…. Not all Investors are Risk Averse Risk preference may have to do with amount of money involved - risking small amounts, but insuring large losses Definition of Risk 1. Uncertainty of future outcomes or 2. Probability of an adverse outcome Markowitz Portfolio Theory • Quantifies risk • Derives the expected rate of return for a portfolio of assets and an expected risk measure • Shows that the variance of the rate of return is a meaningful measure of portfolio risk • Derives the formula for computing the variance of a portfolio, showing how to effectively diversify a portfolio Assumptions of...
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Chapter 7 - x - Lecture Presentation Software to accompany...

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