Financial Market Concepts Review and Consolidation

Week One

VaR - “Value at Risk”

• Lets’s say 1%, one-year value at risk of 10 million, it means that there is a 1% chance that the portfolio will lose 10 million in one year.

Cauchy Distribution

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Central Limit Theorem

• Average of a large amount of independent identically distributed stocks are approximately normally distributed
• Can fail if the underlying stocks are fat tailed
• Can fail if the underlying stocks lose their independence

Covariance

• Covariance between two investments or more is the central to Captial Asset Pricing Model, because you always want to ask for a low covariance.
• Risk is determined by the covariance.

Captial Asset Pricing Model (CAPM)

• Based on Rational market and rational investors
• The CAPM implies that the expected return on the $i_(th)$ asset is determined from its Beta(𝛽).
• Beta(𝛽) is the regression slope coefficient when the return on the $i_(th)$ asset is regressed on the return on the market

Calculating the Optimal Portfolio

• Portfolio Expected Return: $ r = X_1r_1+(1-X_1)r_2 $

• Portfolio Variance: $ X_1^2Var(r_1)+ (1-X_1)^2Var(r_2)+ 2X_1(1-X_1)Cov(r_1,r_2)$

• Positive Covariance is bad for you portfolio, it rasie the variance of your portfolio

• Negetive Covariance is good, and it reduce the variance of the portfolio

Grodon Growth Model

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Week Two