Risk and Return in a Portfolio

13 important questions on Risk and Return in a Portfolio

What is a portfolio?

When an investor owns several stocks

What is diversification of profits?

Spreading riks and profits by investing in different things.

What is an efficient frontier?

The bent curve that shows the relation between share A and B. It represents the best possible returns that investors can expect from their portfolio depending on the risk they want to take. The perfect portfolios (optimal division in term of risk and return) are on this line
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What is the minimum variance point of the efficient frontier curve?

The point on the efficient curve with the lowest risk

What is a risk-free security?

Securities of which you are 100% true that you will not lose your investment.

What is a risk-free rate?

The return on risk-free investments. This is necessary to compensate for economic factors such as inflation and liquidity risk.

What is the Capital Market Line?

The line drawn from the risk-free rate (on the Y axis) along the efficient frontier. The intersection of the two indicates the perfect portfolio if an investor wants to include risk-free securities in his portfolio.

What is the market return in the efficient frontier model?

The return associated with the CML and efficient frontier intersection that provides the highest return at the lowest risk

What is the separation property?

You have to borrow or lend money if you want to earn a higher return or be at less risk than the risk associated with market return

What are the 2 different types of risk?

1. Systematic risk/ market risk - type of risk concerning the entire financial market, e.g. economic recessions, changes in government regulations, natural disasters, etc.
2. Unsystematic risk/ unique risk - type of risk specifically to an investment in a particular sector, e.g. investment in restaurants and regulation for food.

What 2 parts does the return on a share consist of according tot the CAPM?

1. Time value of money, indicated by the risk-free rate as this is the return solely influenced by time
2. Risk taken, (measure of risk x (return on market portfolio - risk-free rate))

What does the beta in the CAPM model indicate?

The volatility of a share compared to the market.
- Beta lower than 1: less risky
- Beta equal to 1: medium risk
- Beta higher than 1: riskier

What is the security market line?

Sets the beta as a risk factor against the expected return.

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