262596
Description
Flashcards by Nafisa Zahra, updated more than 1 year ago
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Created by Nafisa Zahra
over 10 years ago
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| Question | Answer |
| How would you calculate the maximum level of risk aversion to prefer risky over risk free portfolio | Use utility function to calculate risk free utility. Equate this to utility function for risky portfolio with the level of risk aversion unknown |
| What must be true about the sign of the risk aversion coefficient for a risk lover? | A risk lover, rather than penalizing portfolio utility to account for risk, derives greater utility as variance increases. This amounts to a negative coefficient of risk aversion. |
| Do question 28. Seems like exam style question | Do it right |
| Contrast the concepts of systematic risk and firm-specific risk. Give an example of each type of risk. | Systematic risk refers to fluctuations in asset prices caused by macroeconomic factors that are common to all risky assets; hence systematic risk is often referred to as market risk. Examples of systematic risk factors include the business cycle, inflation, monetary policy and technological changes. Firm-specific risk refers to fluctuations in asset prices caused by factors that are independent of the market, such as industry characteristics or firm characteristics. Examples of firm-specific risk factors include litigation, patents, management, and financial leverage. |
| Discuss how both systematic and firm-specific risk change as the number of securities in a portfolio is increased. | he total risk of a portfolio, or portfolio variance, is the combination of systematic risk and firm-specific risk. The systematic component depends on the sensitivity of the individual assets to market movements as measured by beta. Assuming the portfolio is well diversified, the number of assets will not affect the systematic risk component of portfolio variance. The portfolio beta depends on the individual security betas and the portfolio weights of those securities. On the other hand, the components of firm-specific risk (sometimes called nonsystematic risk) are not perfectly positively correlated with each other and, as more assets are added to the portfolio, those additional assets tend to reduce portfolio risk. Hence, increasing the number of securities in a portfolio reduces firm-specific risk. For example, a patent expiration for one company would not affect the other securities in the portfolio. An increase in oil prices might hurt an airline stock but aid an energy stock. As the number of randomly selected securities increases, the total risk (variance) of the portfolio approaches its systematic variance. |
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