CHAPTER
11 PORTFOLIO CONCEPTS
LEARNING OUTCOMES After completing this chapter, you will be able to do the following: Mean–Variance Analysis Define mean–variance analysis and list its assumptions. Explain the concept of an efficient portfolio. Calculate the expected return and variance or standard deviation of return for a portfolio of two or three assets, given the assets’ expected returns, variances (or standard deviations), and correlation(s) or covariance(s). Define the minimum-variance frontier, the global minimum-variance portfolio, and the efficient frontier. Explain the usefulness of the efficient frontier for portfolio management. Describe how the correlation between two assets affects the diversification benefits achieved when creating a portfolio of the two assets. Describe how to solve for the minimum-variance frontier for a set of assets, given expected returns, covariances, and variances with and without a constraint against short sales. Calculate the variance of an equally weighted portfolio of n stocks, given the average variance of returns and the average covariance between returns. Describe the capital allocation line (CAL), explain its slope coefficient, and calculate the value of one of the variables in the capital allocation line given the values of the remaining variables. Describe the capital market line (CML), explain the relationship between the CAL and the CML, and interpret implications of the CML for portfolio choice. Describe the capital asset pricing model (CAPM) including its underlying assumptions, resulting conclusions, security market line, beta, and market risk premium. Explain the choice between two portfolios given their mean returns and standard deviations, with and without borrowing and lending at the risk-free rate. Appraise whether an investor can achieve a mean–variance improvement by adding a particular asset class to his existing portfolio. Explain the limitations of using historical estimates of inputs in a mean–variance optimization.
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