A.01.BKM Ch 06

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Author:
Exam9_2012
ID:
134397
Filename:
A.01.BKM Ch 06
Updated:
2012-05-07 13:41:39
Tags:
risk aversion capital allocation
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Description:
Risk Aversion & Capital Allocation to risky assets
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  1. 3 levels of risk appetite
    • Risk averse: A > 0; require risk premium
    • Risk neutral: A = 0; only base decision on return
    • Risk lovers: A < 0; willing to accept lower return to gain higher lvl of risk
  2. Utility
    • Amount of benefit derived from fin inv
    • A = risk aversion degree
    • U = certainty equivalent rate: rate a rf inv would need to offer the same lvl of U as inv being analyzed
  3. Mean-Variance criterion
    • pf A dominates pf B if at least one strict inequality
  4. Estimating risk aversion
    • Subjective, hard to quantify
    • Can price ins contract w return = -1 or 0
  5. Capital Allocation Line / Optimal pf
    • Describes allocation of capital btwn risk & rf
    • Sharpe ratio = reward-to-variablility ratio:
    • Optimal pf:
  6. Selection of risky pf
    • Active strategy: use security analysis
    • Passive strategy: use benchmark pf (+) cheaper (+) free rider

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