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1.Why will the standard deviation not be a good measure of risk when returns are negatively skewed?
2. What are the risk implications for an investor for a returns series that exhibits fat tails?
3. A price weighted index places more weight on stocks with a higher price, whilst a value weighted index places more weight on stocks with a higher market capitalization. Discuss.
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- You have been hired at the investment firm of Bowers Noon. One of its clients doesnt understand the value of diversification or why stocks with the biggest standard deviations dont always have the highest expected returns. Your assignment is to address the clients concerns by showing the client how to answer the following questions: d. Construct a plausible graph that shows risk (as measured by portfolio standard deviation) on the x-axis and expected rate of return on the y-axis. Now add an illustrative feasible (or attainable) set of portfolios and show what portion of the feasible set is efficient. What makes a particular portfolio efficient? Dont worry about specific values when constructing the graphmerely illustrate how things look with reasonable data.What is a characteristic line? How is this line used to estimate a stocks beta coefficient? Write out and explain the formula that relates total risk, market risk, and diversifiable risk.You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Suppose a risk-free asset has an expected return of 5%. By definition, its standard deviation is zero, and its correlation with any other asset is also zero. Using only Asset A and the risk-free asset, plot the attainable portfolios.
- You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Write out the equation for the Capital Market Line (CML), and draw it on the graph. Interpret the plotted CML. Now add a set of indifference curves and illustrate how an investor’s optimal portfolio is some combination of the risky portfolio and the risk-free asset. What is the composition of the risky portfolio?You have been hired at the investment firm of Bowers Noon. One of its clients doesnt understand the value of diversification or why stocks with the biggest standard deviations dont always have the highest expected returns. Your assignment is to address the clients concerns by showing the client how to answer the following questions: e. Add a set of indifference curves to the graph created for part b. What do these curves represent? What is the optimal portfolio for this investor? Add a second set of indifference curves that leads to the selection of a different optimal portfolio. Why do the two investors choose different portfolios?You have been hired at the investment firm of Bowers Noon. One of its clients doesnt understand the value of diversification or why stocks with the biggest standard deviations dont always have the highest expected returns. Your assignment is to address the clients concerns by showing the client how to answer the following questions: Add a set of indifference curves to the graph created for part b. What do these curves represent? What is the optimal portfolio for this investor? Add a second set of indifference curves that leads to the selection of a different optimal portfolio. Why do the two investors choose different portfolios?
- You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: What is the Capital Asset Pricing Model (CAPM)? What are the assumptions that underlie the model? What is the Security Market Line (SML)?You have been hired at the investment firm of Bowers & Noon. One of its clients doesn’t understand the value of diversification or why stocks with the biggest standard deviations don’t always have the highest expected returns. Your assignment is to address the client’s concerns by showing the client how to answer the following questions: Plot the attainable portfolios for a correlation of 0.35. Now plot the attainable portfolios for correlations of +1.0 and −1.0.Market equity beta measures the covariability of a firms returns with all shares traded on the market (in excess of the risk-free interest rate). We refer to the degree of covariability as systematic risk. The market prices securities so that the expected returns should compensate the investor for the systematic risk of a particular stock. Stocks carrying a market equity beta of 1.20 should generate a higher return than stocks carrying a market equity beta of 0.90. Nonsystematic risk is any source of risk that does not affect the covariability of a firms returns with the market. Some writers refer to nonsystematic risk as firm-specific risk. Why is the characterization of nonsystematic risk as firm-specific risk a misnomer?
- Which of the following statements is INCORRECT? A stock's beta is calculated as the covariance between the stock's price and the market portfolio return, divided by the variance of the market portfolio return. If we assume that the market portfolio (or the S&P 500) is efficient, then changes in the value of the market portfolio represent systematic shocks to the economy. The risk premium investors can earn by holding the market portfolio is the difference between the market portfolio's expected return and the risk-free interest rate. A stock’s standard deviation is a measure of the total risk.No matter how the stock price fluctuates, as long as it can provide a positive return, the risk of investing in stocks is low.If the concept of standard deviation is applied, is this true or false?Which of the following arguments has been put forward as a criticism of using the PEG ratio as the basis of an investment strategy? Select one: a. The PEG ratio buys growth stocks without any consideration of their price. b. Stocks with a low PEG ratio are all large cap stocks. c. Stocks with a low PEG ratio have been shown to generate lower stock returns. d. Stocks with a low PEG ratio also have a positively skewed distribution of returns. e. Stocks with a low PEG ratio are shown to be riskier.