Portfolio Management Notes
FINS2624 PORTFOLIO MANAGEMENT
Week 6
CAPM: The covariance of an assets returns with the market and the required return of the asset.
Assumptions: * Investors are price takers * Investors have identical investment horizons * Perfect capital markets * Investors are rational mean-variance optimizers
β: Measures how much risk an asset contributes in the market portfolio. * β > 1 asset contributes more risk than the average asset * β < 1 asset contributes less risk than the average asset
Systematic risk: Risk that is common with the market. Cannot be diversified away so you are compensated for it
Unsystematic/Idiosyncratic risk: Risk particular to the asset itself. Can be diversified away so you are not compensated for it
SML: The SML shows the expected return of an asset given a level of beta. The slope of the line is the market risk premium.
* An asset that lies above the SML is under-priced. Vice-versa * Assets typically plot on the SML as it relates expected returns to systematic risk only
CAL: Shows the relationship between the expected return and standard deviation of combined portfolios * Assets typically plot under the CAL as it relates expected returns to total risk * When on the CAL there is no unsystematic risk.
Discount rate/expected rate of return = risk premium + risk free rate
Week 7
α = actual return – return predicted by CAPM
Mispriced assets: When α ≠ 0, we can take advantage by tilting our portfolio away from the market, making an active portfolio. We exploit ‘a’ but gain unsystematic risk.
Four-Factor model: * SMB = difference between small and large cap stocks * HML = difference between high and low book-to-market stocks * MOM = returns difference between stocks with high and low past returns * CAPM
Fama-French (FF) model: Doesn’t include MOM. Predicts that firm size affects average returns
Arbitrage risk: * Execution (or leg) risk: Only
Week 6
CAPM: The covariance of an assets returns with the market and the required return of the asset.
Assumptions: * Investors are price takers * Investors have identical investment horizons * Perfect capital markets * Investors are rational mean-variance optimizers
β: Measures how much risk an asset contributes in the market portfolio. * β > 1 asset contributes more risk than the average asset * β < 1 asset contributes less risk than the average asset
Systematic risk: Risk that is common with the market. Cannot be diversified away so you are compensated for it
Unsystematic/Idiosyncratic risk: Risk particular to the asset itself. Can be diversified away so you are not compensated for it
SML: The SML shows the expected return of an asset given a level of beta. The slope of the line is the market risk premium.
* An asset that lies above the SML is under-priced. Vice-versa * Assets typically plot on the SML as it relates expected returns to systematic risk only
CAL: Shows the relationship between the expected return and standard deviation of combined portfolios * Assets typically plot under the CAL as it relates expected returns to total risk * When on the CAL there is no unsystematic risk.
Discount rate/expected rate of return = risk premium + risk free rate
Week 7
α = actual return – return predicted by CAPM
Mispriced assets: When α ≠ 0, we can take advantage by tilting our portfolio away from the market, making an active portfolio. We exploit ‘a’ but gain unsystematic risk.
Four-Factor model: * SMB = difference between small and large cap stocks * HML = difference between high and low book-to-market stocks * MOM = returns difference between stocks with high and low past returns * CAPM
Fama-French (FF) model: Doesn’t include MOM. Predicts that firm size affects average returns
Arbitrage risk: * Execution (or leg) risk: Only