PM risk and return part 2

how is CML and SML different?

- CML uses total risk - SML uses beta (sys risk)

market model

- Single factor model where the only factor is excess return on the market portfolio - alpha is the intercept - epsilon is excess return

SML

- graphs CAPM - shows the (requires) return for any portfolio based on beta

beta

- sensitivity of one stock's return to the market return - a standardized measure of cov(i, m) = cov (i,m) / var (m)

M^2

- uses total portfolio risk - in % - 'additional return that could have been earned by borrowing at rf rate so that its risk = market portfolio'

difference between CML and SML

1. Measure of risk - SML uses systematic risk while CML uses total risk (st dv) 2. Application - SML is a tool to get expected returns for securities while CML is a tool to get appropriate allocation for risk free asset and market portfolio 3. Slope - SML is the market risk premium and CML is the sharpe ratio

assumptions of CAPM

1. Risk Aversion 2. Utility Maximizing investors 3. Frictionless markets 4. one period horizon 5. homogeneous expectations 6. divisible assets 7. competitive markets

factor loading

A correlation between a single measure and the factor to which it's being related.

systematic risk

A risk that influences a large number of assets. Also, market risk.

attribution analysis

An assessment technique designed to establish whether a manager's performance relative to a benchmark resulted from market timing or security selection skills.

The slope of the security characteristic line is an asset's: A. beta. B. excess return. C. risk premium.

BETAAAAAA

Which of the following performance measures is most appropriate for an investor who is not fully diversified? a. M2. b. Treynor ratio. c. Jensen's alpha.

M2 and Sharpe ratio because they are measured in total risk ==> no diversification needed

Is systematic risk diversifiable?

NOPE

With respect to capital market theory, correctly priced individual assets can be plotted on the: a. capital market line. b. security market line. c. capital allocation line.

SML because it plots to any security - uses only systematic risk --> the diversifiable risks are all diversified away --> to plot price correctly

Is unsystematic risk diversifiable?

YES aka firm-specific risk

CML

a special case of CAL where the optimal risky portfolio is the market portfolio

what does Sharpe ratio tell you?

excess return a portfolio gets per unit of total portfolio risk

when you increase # of stocks in a portfolio, how would the systematic risk change?

increase or decrease bc you could be adding low beta stocks, or high beta stocks

With respect to capital market theory, an investor's optimal portfolio is the combination of a risk-free asset and a risky asset with the highest: A. expected return. B. indifference curve. C. capital allocation line slope.

indifference curve because the optimal portfolio is different for everyone depending on their utility & ind curves

CAL

line of possible portfolio risk and return combinations with Rf asset and risky assets

Treynor Ratio

measures investment performance as the ratio of portfolio risk premium over portfolio beta

Jensen's alpha

measures investment performance as the raw portfolio return less the return predicted by the capital asset pricing model

sharpe ratio

ratio of portfolio risk premium to standard deviation

is sharpe ratio based on total risk or sys risk?

total risk --> S.D.