FINC314 Lecture Notes - Lecture 12: United States Treasury Security, Strike Action, Risk Aversion
10 Feb 2020
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Document Summary
The prior note highlights an important decision: the capital allocation between risk-free and risky assets. This decision determines (to a significant extent) an investor"s overall exposure to risk. The optimal allocation is determined by risk aversion as well as expectations for the risk-return trade-off of the optimal risky portfolio. This particular question is the subject of the note in hand. Suppose your risky portfolio is composed of only one stock. Consider these two categories (which should be familiar): Systematic/market/non-diversifiable risk shifts in risk factors (i. e. economic conditions, interest rates, taxes, monetary policy, consumption levels, geopolitics) have an impact on most securities. If we"re falling into a recession, most stocks will drop, but certain bonds like us treasury securities might increase in price because the government is safe in a recession. If interest rates go up, businesses are less likely to take loans and involve themselves in projects, which will lead to drops in stock prices.
