Flash Cards #3

Flash Cards #3 - Expected return is the weighted average...

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Expected return is the “weighted average” return on a risky asset, from today to some future date To calculate an expected return, you must first : Decide on the number of possible economic scenarios (states) that might occur. Estimate how well the security will perform in each state, and Assign a probability to each state Portfolios are groups of assets, such as stocks and bonds, that are held by an investor. Portfolio weights the proportion of the total value of the portfolio that is invested into each asset Correlation : The tendency of the returns on two assets to move together. Imperfect correlation is the key reason why diversification reduces portfolio risk as measured by the portfolio standard deviation. Imperfect correlation , positive or negative, is why diversification reduces portfolio risk. Investment opportunity set: The various combinations of risk and return available all fall on a smooth curve. It shows the possible combinations of risk and return available from portfolios of these two assets Efficient Portfolio A portfolio that offers the highest return for its level of risk Dominated/Inefficient The undesirable portfolios The Markowitz Efficient frontier is the set of portfolios with the maximum return for a given risk AND the minimum risk given a return. For the plot, the upper left-hand boundary is the Markowitz efficient frontier. All the other possible combinations are inefficient . That is, investors would not hold these portfolios because they could get either more
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