Week 4 Ch 5 - Modul.pdf - REFRESHER READING 2 0 2 0 C FA P...

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Portfolio Risk and Return: Part I by Vijay Singal, PhD, CFA Vijay Singal, PhD, CFA, is at Virginia Tech (USA). LEARNING OUTCOMES Mastery The candidate should be able to: a. calculate and interpret major return measures and describe their appropriate uses; b. compare the money-weighted and time-weighted rates of return and evaluate the performance of portfolios based on these measures c. describe characteristics of the major asset classes that investors consider in forming portfolios; d. calculate and interpret the mean, variance, and covariance (or correlation) of asset returns based on historical data; e. explain risk aversion and its implications for portfolio selection; f. calculate and interpret portfolio standard deviation; g. describe the effect on a portfolio’s risk of investing in assets that are less than perfectly correlated; h. describe and interpret the minimum-variance and efficient frontiers of risky assets and the global minimum-variance portfolio; i. explain the selection of an optimal portfolio, given an investor’s utility (or risk aversion) and the capital allocation line. INTRODUCTION Construction of an optimal portfolio is an important objective for an investor. In this reading, we will explore the process of examining the risk and return characteristics of individual assets, creating all possible portfolios, selecting the most efficient portfolios, and ultimately choosing the optimal portfolio tailored to the individual in question. 1 Portfolio Management R E F R E S H E R R E A D I N G 2 0 2 0 C FA P R O G R A M • L E V E L I • R E A D I N G 5 2 C F A I N S T I T U T E M E M B E R U S E O N LY © 2019 CFA Institute. All rights reserved.
Refresher Reading Portfolio Risk and Return: Part I 2 C F A I N S T I T U T E M E M B E R U S E O N LY During the process of constructing the optimal portfolio, several factors and invest - ment characteristics are considered. The most important of those factors are risk and return of the individual assets under consideration. Correlations among individual assets along with risk and return are important determinants of portfolio risk. Creating a portfolio for an investor requires an understanding of the risk profile of the investor. Although we will not discuss the process of determining risk aversion for individuals or institutional investors, it is necessary to obtain such information for making an informed decision. In this reading, we will explain the broad types of investors and how their risk–return preferences can be formalized to select the optimal portfolio from among the infinite portfolios contained in the investment opportunity set. The reading is organized as follows: Section 2 discusses the investment charac- teristics of assets. In particular, we show the various types of returns and risks, their computation and their applicability to the selection of appropriate assets for inclusion in a portfolio. Section 3 discusses risk aversion and how indifference curves, which incorporate individual preferences, can be constructed. The indifference curves are

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