FIN 501 Study Guide - Modern Portfolio Theory, Systematic Risk, Efficient Frontier

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31 Jul 2012
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Chapter 12 return, risk, and the security market line. Risk that can be eliminated by diversification do not yield an expected reward; risk that cannot be eliminated by diversification does yield an expected reward. Security market line (sml) shows the relationship between risk and return. Total risk: an investment measured by the variance or standard deviation of its return. Total return: investment has expected return and unexpected return: on average, the actual return equals the expected return. Total return - expected reutrn = unexpected return. An announcement can be broken into two parts: anticipated (expected) plus surprise (innovation) In the modern portfolio theory, investors would choose at every expected return level the assets and portfolio with minimum risk, assuming that investors are risk-averse and rational. Finding the minimum risk portfolio at every return level plots a parabola and the upper part of the parabola is called the efficient frontier.

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