Chapter 7 - Optimal Risky Portfolios

When there are two assets with positive expectation have a low or negative correlation, variance is reduced. TRUE or FALSE?

True

If X and Y are independent, what is cov(X,Y) ?

0 , but this does not imply that if cov(X,Y) = 0 then the two are independent. Only true 1 way.

What two types of risk is your portfolio subject to?

1) Systematic (market) risk 2) Firm-specific risk

Give a informal definition of covariance.

Covariance is how two variables (assets in this case) change together

How can one reduce firm-specific risk within their portfolio?

Diversification of assets.

As the variety of assets increase in a portfolio, what happens to its standard deviation of risk?

It decreases.

How is correlation computed? What is the equation?

It is computed by scaling covariance so it is in between -1 and 1.

Describe the equation for the expected return on the portfolio

It is simply the weight of the expected return on the debt securities added with the weight of the expected return of the equities.

What is cov(X,X) ?

It is simply var(X)

What is efficient diversification?

It is the portfolio that gives the lowest risk, for a given level of expected return.

What are the optimal levels of weights if we want to minimize variance, when p = -1?

Keep in mind that minimum variance does not mean its the most efficient portfolio.

Is market risk diversifiable?

No