# Study Session 12: Portfolio Management

## About Security Market Line (SML)

Why a stock in the area above SML line meaning undervalued, and under SML line meaning overvalued?

## Question about Correlation and Risk Reduction

An asset has correlation with a portfolio’s return that is less than 1 but has the same standard deviation if returns as the portfolio. Adding some of this asset to the portfolio will most likely:

A. decrease portfolio risk

B. increase portfolio risk

C. increase or decrease portfolio risk depending on the individual securities mix in the portfolio.

The answer is A. Anyone can explain it to help me understand? Thank you!

## Portfolio Management Reading 39: Portfolio Risk & return Part 1

Which of the following statements is true?

An investment that is not on the efficient frontier always is high risk.

An investment that is not on the efficient frontier always has the lowest returns.

An investment that is not on the efficient frontier may create a portfolio that has a

lower risk for the same return

Can somebody please tell me the answer.

Thanks.

## Risk Premium

An analyst observes the following historic geometric returns:

**Asset Class****Geometric Return (%)**

Equities

8.0

Corporate Bonds

6.5

Treasury bills

2.5

Inflation

2.1

The risk premium for corporate bonds is *closest* to:

- 1.5%.
- 1.8%.
- 2.1%.

Solution:

(1 + 0.043)/(1 + 0.0250) – 1 = 1.8%

Can anyone help me with this calculation?

## Calculate Beta in Portfolio Management, Kap v CFAI

In the portfolio management section, Kaplan and CFAI materials give me different ways to calculate Beta.

## Inter-Temporal rate of substitution

From CFAI book:

## Portfolio Risk

Q- Two investors have utility functions that differ only with regard to the coefficient of risk aversion. Relative to the investor with a higher coefficient of risk aversion, the optimal portfolio for the investor with a lower coefficient of risk aversion will *most likely* have:

- a lower level of risk and return.
- a higher level of risk and return.
- the same level of risk and return.

Solution

## Beta and Expected Return

Hi all,

The relationship between return of an asset “i” and beta is R_{i} = Rf + beta_{X} (R_{m}-R_{f}). Also, beta= correlation(i,m)x StDev_{i}/StDev_{m}.

To have an asset which return is above market return (R_{i}>R_{m}), the only way possible is with a beta>1. That means, since correlation(i,m) is by definition contained between -1 and 1, that **for an asset to have greater returns than the market it must always have greater risk than the market.**

## Fundamental Factor Models: Intercept

Why is the risk-free rate not used as an intercept in a fundamental factor model?

## Regarding correlation calculation

Hi. I can’t find an exact answer, though I think I know it. When calculating correlation to use in calculation of beta, we should be using the risk-adjusted returns (i.e., excess returns of Ri-Rf) instead of the non-excess returns, right? I ask this because in calculating various performance measures, we take care to specify Rf-Rf. Just want to verify that we take the correlation of the excess returns, and that the outputted correlation coefficient is what is then used in calculating beta.

Thank you!

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