Question

Q1: what does the efficient frontier represents?

Q2: how do we estimate the return and standard deviation of a newly built portfolio from analyzing the stocks in that portfolio?

Q3: in the regression equation, what is meant by a regression that has an R-square with 0.95 and how does it compare with a regression with a R-square of 0.30?

Q4: why do we use adjusted beta?

Q5: what is the information ratio and why do we use it?

Answer 1

Ans 1) Efficient Frontier: it represents the portfolios that can maximize the returns against the risk. Portfolios which lies on upper half of frontier are the optimal portfolios and which lies on lower half of frontier are sub optimal portfolios.

Ans 2) Return of the portfolio will be calculated by multiplying return of the specific stock with allocation of that stocks.

Standard Deviation of portfolio will be can be determine by correlation between the stocks if its 1 then the standard deviation of two stocks will be summation of standard deviation of both the stocks and if it is less than one then standard deviation of the portfolio will be lesser than summation of standard deviation of both stocks.

Ans 3) R-square with .95 is better fit in the regression equation than the R-square with .3. Thus the higher the R-square value of regression equation is better fit.

Ans 4) Adjusted beta: Beta is generally derived from the historical data that's why it is different from 1. Adjusted beta is trying to adjust the beta near to one since in long run every company's beta will be equal to the market beta which is 1.

Ans 5) Information ratio = (return of portfolio - return of benchmark)/(standard deviation of portfolio - standard deviation of benchmark)

Information ratio is used to measure the manager's skill and ability to generate excess return.