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Documente Cultură
Diversification
&
Index Models
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Objective
Indices
Construction
Contribution to a portfolios risk
How to simplify the portfolio inputs
Index models
Decomposition of risk
Systematic and unsystematic
Diversification
Other multifactors
Fama-French 3 factor model, etc
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Stock Indices
Uses
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Representative?
Broad or narrow?
How is it constructed?
o
o
o
o
o
o
o
o
o
o
o
o
o
o
o
Canadian
S&P/TSX 300 Composite Index
TSX 35 (also known as Toronto 35 or T35)
TSX 100
S&P/TSX 60
US
Dow Jones Industrial Average (30 Stocks)
Standard & Poors 500 Composite
NASDAQ Composite
NYSE Composite
Wilshire 5000
International
TSE (Tokyo) - Nikkei 225 & Nikkei 300
FTSE (Financial Times of London)
Dax
Han Seng
Shanghai Composite Index
Region and Country Indexes
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EAFE
Far East
United Kingdom
W. Suo
Bond Indices
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Construction of Indices
How are stocks weighted?
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o
o
Misleading name
o
o
o
DJIA Divisor
o
o
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W. Suo
Price
$50
$10
Total
Average
$60
60/2 = 30
shares as before.
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If Stock X
undergoes a
2 for 1 stock
split
Stock
Price
$25
$10
Total
Average
$35
35/2 = 17.5
Points
DJIA is price-weighted
More weight is given to higher priced stocks
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W. Suo
How is it calculated?
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W. Suo
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Diversification
Famous quotes
I prefer to keep all my eggs in one basket and watch that basket
closely.
Diversification is a protection against ignorance. It makes very little
sense for those who know what theyre doing.
If you are a know-something investor, able to understand business
economics and to find five to ten sensibly priced companies that
possess important long-term competitive advantages, conventional
portfolio diversification (broadly based active portfolios) makes no
sense for you.
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Contribution to a portfolios
risk
For a large and diversified portfolio, it is the
covariance of the stock that contributes to the
overall risk of the portfolio?
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Why?
Diversification
Random selection
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Diversification
The effect of random diversification
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Markowitz diversification
Can we do better than the
random selection?
Markowitz diversification
How to simplify the
approach?
What kind of risk is reduced?
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Risk premium
format
(e)
2ii2M
22i
=total
variance
=systematic variance
=unsystematic variance
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Components of Risk
Market or systematic risk
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(
e
)
(R1e)
2
2
2
2
M
2
2i
Examining Percentage of
Variance
i M
R squared
2
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. . .. .
.
. . . .. .
.
.
. . . .
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. .
.
. . .
.
.
.
.
. . . .
. .
.
SCL
. .
.
Excessreturns
. . .onmarketindex
.
.
e
i
iP
i
M
i
e
P
P
P
M
P
2
2
2
2
(
)
M
n
n
n
1n
1Pn
;i1i
;i1ieP1n
e1i
Index Model and Diversification
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RiskReductionwith
Diversification
St.Deviation
UniqueRisk
2(eP)=2(e)/n
P2M2
MarketRisk
Numberof
Securities
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Multifactor Models
Use
factors in addition to market return
Where
SMB=small minus big: return of portfolio of small stocks in excess
of return on a portfolio of large stocks
HML=high minus low: return of portfolio of high book-to- market ratio
stocks in excess of return on a portfolio of high book-tomarket ratio stocks
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