Portfolio theory (summary)

Portfolio theory (summary) With Complete Answers. portfolio theory - Answer-risks in an individual asset returns have systematic and non systematic risks systematic risk - Answer-common to many assets and are non- diversifiable non- systematic risk - Answer-specific to individual asset; unique to stock; can be eliminated; are diversifiable how to diversify non-systematic risks? - Answer-1. form portfolios 2. investors hold diversified portfolios instead of single assets what is the optimal way to combine assets in a portfolio? - Answer-analyze and quantify how assets work together as they form a portfolio. what are the key effects of adding a stock to a portfolio? - Answer-1. own effect: stocks own inherent level of risk and potential return 2. interaction effect: stocks interaction with every other stock in the portfolio f harry Markowitz - Answer-first to formalize portfolio theory at age 25 - "portfolio selection" in journal of finance - nobel prize in econ 1990 - investors had a tool to reduce the risk of the portfolio without a significant reduction of expected return of the portfolio mean historical portfolio return - Answer-weighted average of the individual returns (HPYs) what does the portfolio's risk depend on? - Answer-risk of the individual asset in the portfolio and the interaction of the asset returns. what do you need to calc return variance of a portfolio - Answer-1. portfolio weights 2. individual variances 3. covariances define covariance - Answer-a statistical measure of the correlation of the fluctuations of the annual rates of return of different investments define correlation coefficient - Answer-the degree to which the returns of two stocks co-move is measured by the correlation coefficient. range between -1 and 1