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5 -- Part 4: Modern Portfolio Concepts

- Diversifiable risk is minimized by off setting the below-average return on one investment with the above-average return on another.
- Minimizing diversifiable risk through careful selection of investments requires that the investments come from a wide range of industries.

- When we begin with a single asset in a portfolio and then expand the portfolio by randomly selecting additional securities, we can better understand how diversification benefits investors.
- There is a limit to how much risk reduction investors can achieve.

- Most of the risk- reduction benefits can be gained by forming portfolios containing two or three dozen carefully selected securities, but our recommendation is to hold 40 or more securities to achieve efficient diversification.
- The popularity of investment in mutual funds is supported by this suggestion.

- Undiversifiable risk is what you must be concerned with.
- The measurement of undiversifiable risk is important.

- The undiversifiable, or relevant, risk of a security is what is measured by the measure of the measure of the measure of the measure of the measure of the measure of the measure of the measure of the measure of the measure of the measure of the measure of the measure of the The market has a beta of 1.0.
- The market is less risky for securities with more than 1.0 and less than 1.0.
- The risk-free asset has a 0.

- The component assets can be used to calculate a portfolio's alpha.

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- The same way is used for portfolio and individual asset betas.

- They show the degree of responsiveness of the portfolio's return to the market return.
- When the market return increases by 10%, a portfolio with a beta of 0.75 will experience a 7.5% increase in its return.
- A portfolio with a pliy of 1.25 will see an increase in its return of 12%.
- High-beta portfolios are riskier than low-beta portfolios.

- The Austin Fund wants to assess the risk of two portfolios, V and W.

- Portfolio V's alpha is 1.20, and portfolio W's is 0.080.
- The values make sense because of the high- and low-beta assets in portfolio V and W. Portfolio V's returns are more risky than portfolio W's because they are more responsive to market returns.

- The market's rate of return affects the portfolio's rate of return.
- If the stock market as a whole experienced a 10% increase in return, the 1.0 beta portfolio would experience a 10% increase in return.
- If the market return fell, the return on the 1.0 alpha portfolio would also fall.

- An increase in market return of 10% and a decrease in market return of 10% are the expected returns for three portfolios.
- The market does not move as much as the port folio does.
- The portfolio's return will fall when the market return goes down.
- This portfolio is considered a high-risk portfolio.

- A low-risk, low-return portfolio is found in the middle.
- This is a conservative portfolio for investors who want to maintain a low-risk invest ment posture.
- The market is half as volatile as the portfolio.

- It's difficult to find securities with negative betas.
- Most securities have a tendency to experience return movements in the same direction as changes in the stock market.

- There is a link between undiversifiable risk and investment returns.
- The basic premise is that an investor needs a portfolio of relatively risky investments to earn a high rate of return.
- The relationship is shown in Figure 5.9.
- An investor can earn a return on a risk-free investment such as a U.S. Treasury bill or an insured money market deposit account.

- The risk-return tradeoff line shows portfolios of risky investments as depicted by four investment portfolios.
- Portfolio C is an excellent investment because it provides a high return at a relatively low risk.
- Portfolio D is an investment to avoid.

- We looked at two different approaches to portfolio management.
- The question must be decided by each investor.
- We can offer some useful ideas.

- The average investor doesn't have the resources to implement a total MPT portfolio strategy.
- Individual investors can use both traditional and MPT approaches to come up with new ideas.
- We will discuss security selection later in this text.
- Diversification of the portfolio is emphasized.

- Diversifiable risk is minimized by this approach.
- Diversification is needed to ensure satisfactory performance with either strategy.
- The level of a portfolio's undiversifiable risk should be part of the decision-making process.

- The following portfolio management policy uses aspects of both approaches.

- Diversification among types of securities and across industry lines is important.

- If you want to keep your portfolio in line with your risk level, you should consider how a security responds to the market.

- Evaluate alternative portfolios to make sure they give the best return for the risk.

- Diversifiable, undiversifiable, and total risk of a portfolio are defined.

- The table was assembled to achieve one or more goals.

- A weighted average of the returns of assets is used to calculate the return on a portfolio.
- The standard deviation of a portfolio's returns can be found using the same formula that is used to find the standard deviation of a single asset.

- Adding assets with negatively correlated returns is the best way to diversify.

- The ability to reduce risk depends on the degree of correlation and the proportion of each asset in the portfolio.

- An investor may be able to reduce portfolio risk without reducing return.
- It can be achieved by investing abroad or in domestic funds, but it can't be done by investing in U.S. multinationals.
- Individual investors prefer the use of international mutual funds in the United States.
- Over time, opportunities to earn excess returns in international investments are diminishing, but international investments still provide an effective way todiversify.

- The risk associated with a security investment can be measured in the form of Beta.

- Plan 5.4 relates risk to return.
- The security market line is depicted in a graphic.
- Increasing required returns are reflected in the CAPM.

- The efficient frontier is found with a traditional portfolio investor's risk-indifference curves.

- The Video Learning Aid can be used to develop efficient portfolios.
- Problem P5.22 is a weighted average of the individual assets in the portfolio.
- The traditional approach and MPT are used by investors to create portfolios.
- This approach involves figuring out how much risk you are willing to take, looking at alternative portfolios to pick the one that offers the highest return for an acceptable level of risk, and using beta to Diversify your Portfolio.

- Make a list of your portfolio objectives.
- A 10-stock portfolio is what you want to build.

- A and B are two of the stocks that Ahmed Zahran is building a new portfolio of.
- 40% of his portfolio will be stock A while the other 40% will be stock B.

- Discuss the benefits of the creation of this portfolio.

- Finance can get a current estimate of the risk-free rate.

- You can find the required return for each stock with the capital asset pricing model by using the information you gathered along with the market risk premium.

- Finance can get a current estimate of the risk-free rate.
- The companies are listed on page 186.

- The February 27, 2015 betas for each of the companies are given in the chapter.

- The required return for each stock with the CAPM can be found by using the current betas and market risk premium.

- Obtain a prospectus and an annual report for a major mutual fund that has international securities.
- Carefully read the prospectus and annual report to understand the fund's stated objectives.

- Evaluate the amount of industries and companies held.

- Discuss the risks faced by an investor in this fund compared to an investor in a domestic stock portfolio.

- Four stocks have a range of 0.50 to 1.50.
- If you want to create a portfolio that combines all four stocks in such a way that the resulting portfolio is about 1.10, you need to think about it.

- Use all four stocks to create a portfolio with a target beta of 1.10.

- The portfolio standard deviation can be calculated using your data.

- Assets L and M will make up 40% of the dollar value of the portfolio.
- The following table shows the projected returns over the next six years.

- Discuss the benefits of creating a portfolio.

- You have been given return data on three assets over the course of a year.

- You have been asked for your advice in selecting a portfolio of assets.

- You can create two portfolios, one consisting of assets A and B and the other consisting of assets A and C, by investing equal proportions in each of the two component assets.

- The risk and return behaviors associated with various nations of assets V and W are assumed to be perfect positive, uncorrelated, and perfect negative.
- The average return and risk values for these assets were calculated.

- If the returns of assets V and W are perfectly correlated, describe the range of return and risk associated with all possible portfolio combinations.

- If the returns of assets V and W are uncorrelated, describe the approximate range of return and risk associated with all possible portfolio combinations.

- If the returns of assets V and W are negatively correlated, describe the range of return and risk associated with all possible portfolio combinations.

- Home Depot and Lowe's have their annual returns in the table.
- The returns are calculated using end-of-year prices and an equally weighted portfolio of HD and LOW.
- The average annual return for both stocks and the portfolio is calculated.

- The portfolio standard deviation is associated with each portfolio composition.
- You will need to use the standard deviations found for HD and LOW.

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