6
Concepts
4
Formulas
1
Decisions
3
Quiz Questions
6 concepts covered in this module.
Higher expected return requires accepting higher risk. Historical data: stocks > bonds > T-bills in return and risk.
U = E(R) - ½Aσ². Risk-averse investors (A>0) require compensation for bearing risk. Indifference curves slope upward.
Set of portfolios offering maximum return for each level of risk. Rational investors choose portfolios ON the frontier.
Portfolio with lowest possible risk. Starting point of the efficient frontier.
Line from risk-free rate tangent to efficient frontier. Slope = Sharpe ratio. Optimal risky portfolio at tangent point.
All investors hold the same optimal risky portfolio; they differ only in allocation between it and the risk-free asset.
4 essential formulas for this module.
Where: A = risk aversion coefficient (A>0 for risk-averse)
Where: Slope = Sharpe ratio of optimal portfolio
Where: Excess return per unit of total risk
Where: Diversification benefit when ρ < 1
1 decision frameworks to guide your analysis.
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Risk-Return Tradeoff
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