HELP! Finance Professor Is Delusional
I'm going over my midterm for finals and I'm pretty sure my finance Professor has the wrong answers for two problems. He's not exactly the type of person you can have a rational conversation with, so I figure I'd ask here to see if I'm right before I challenge my grade with the department. SB's will be rewarded for helpful answers.
1) A bond investor seeking capital gains should purchase
A) bonds with short maturity dates when interest rates are expected to rise.
B) bonds with distant maturity dates when interest rates are expected to rise.
C) bonds with short maturity dates when interest rates are expected to decline.
D) bonds with distant maturity dates when interest rates are expected to decline.
I'm going with D,my Professor thinks it is C.
2) You are thinking of adding one of two investments to an already well diversified portfolio.
Security A
Expected return= 12%
Standard deviation of returns= 20.9%
Beta= 0.8
Security B
Expected return= 12%
Standard deviation of returns= 10.1%
Beta= 2
If you are a risk-averse investor
A) security A is the better choice.
B) security B is the better choice.
C) either security would be acceptable.
D) cannot be determined with information given
Since we not care about systematic risk (beta) in a well diversified portfolio, shouldn't we pick the stock with the lower standard deviation of returns? My Professor thinks it is A.
No idea about these theoretical problems, but here's my guess: 1. bond due in a month with declining interest rates will net u greater capital gains than with longer maturity since capital gains erode as well, no ? 2. risk-averse you'd still choose security w/ greatest return, no ?
DELTED.
I'm sendimg as proof to the department and would like to remain anonymous.
Answer 1) You would say D because longer maturity bonds are more impacted by a shift in interest. Therefor the longer the maturity the higher the volatility. Increasing the price more if interest rates decrease. Answer 2) I would say is A. It is not the standard deviation that is important. It is the covariance with the rest of the portfolio that is important. So I would chose the lower beta security. SD is not relevant because you have alot of offsetting securities in the portfolio. If one could choose only 1 asset you would be right.
you're correct on #1
2 you're incorrect, for the same reasons @"klaasv" mentioned. think about it like this: std dev of the portfolio is what Markowitz referenced when he designed MPT (something with which I staunchly disagree, btw), but because different assets move differently, an asset's individual std dev is irrelevant because the portfolio vol is all that matters (in classical finance teachings)
I will tell you from a practitioner's standpoint we look at both, and would prefer to add a lower vol asset as measured by std dev, ceteris paribus.
Thanks. I guess the reason I got confused is because the Professor said in a well diversified portfolio we don't care about systematic risk and when I looked in my textbook it defines beta as systematic risk. So, under the condition we don't care about systematic risk (beta) and expected returns are the same, I'd opt for the lower SD. At least that was my thought process on test day. It makes much more sense now though.
don't sweat it, if you ever go into AM, HF, or PWM as a PM, you'll unlearn most of that bullshit you learned in uni anyway. unfortunately, there's no way around it. I'm sure that stuff helped me, but I find more often than not I'm doing something different than what the Book of Fama/Markowitz/every finance prof suggests.
Questions like these are why I'm not a finance major.
don't need this in HF/AM, just use consensus :)
Interesting thread in terms of the finance theory. But I'm not sure it's really worth challenging the grade. What are the odds this has a meaningful impact on FT recruitment?
Instead of creating a hostile relationship w/ your department, you could take it the other way. I once impressed a professor by coming into his office after the semester to see the answers to the final. It showed I actually cared about the material beyond the grade. He ended up being an important mentor for me.
Because my Professor is a fucking lunatic who responds to all questions with "you'll be fine", "who are you", "calm down", "you have to feed the beast", or "you will like this creature." He also posts homework assignments to blackboard, takes them down the night before it's due and reposts questions for upper level finance courses and goes over the irrelevant coursework. When people tell him those aren't the questions he posted or part of our curriculum he says to "calm down" and proceeds to go over the wrong material for weeks. The guy has a 1.1 on Ratemyprofessor.com.
Rant over.
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