Study Session #12
Learning Outcome Statements
(Last revised 11/15/04)

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A. “The Investment Setting”
A. Explain the concept of required rate of return and discuss the components of an
investor’s required rate of return.
B. Differentiate between the real risk-free rate of return and the nominal risk-free rate of
return and compute both return measures.
C. Explain the risk premium and the associated fundamental sources of risk.
D. Define the security market line and discuss the factors that cause movements along,
changes in the slope of, and shifts of the security market line.
B. “The Asset Allocation Decision”
A. Describe the steps in the portfolio management process.
B. Explain the need for a policy statement.
C. Explain why investment objectives should be expressed in terms of risk and return.
D. List the factors that may affect an investor’s risk tolerance.
E. Describe the return objectives of capital preservation, capital appreciation, current
income, and total return.
F. Describe the investment constraints of liquidity, time horizon, tax concerns, legal and
regulatory factors, and unique needs and preferences.
C. “An Introduction to Portfolio Management”
A. Define risk aversion and cite evidence that suggests that individuals are generally risk
averse.
B. List the assumptions about individuals’ investment behavior of the Markowitz Portfolio
Theory.
C. Compute expected return for an individual investment and for a portfolio.
D. Compute the variance and standard deviation for an individual investment.
E. Compute the covariance of rates of return and show how it is related to the correlation
coefficient.
F. List the components of the portfolio standard deviation formula and explain which
component is most important to consider when adding an investment to a portfolio.
G. Describe the efficient frontier and explain its implications for an investor willing to
assume more risk.
H. Define optimal portfolio and show how each investor may have a different optimal
portfolio.
D. “An Introduction to Asset Pricing Models”
A. List the assumptions of the capital market theory.
B. Explain what happens to the expected return, the standard deviation of returns, and
possible risk-return combinations when a risk-free asset is combined with a portfolio of
risky assets.
C. Identify the market portfolio and describe the role of the market portfolio in the
formation of the capital market line (CML).
D. Define systematic and unsystematic risk and explain why an investor should not expect
to receive additional return for assuming unsystematic risk.
E. Describe the capital asset pricing model.
F. Diagram the security market line (SML).
G. Define beta.
H. Calculate, using the SML, the expected return on a security and evaluate whether the
security is undervalued, overvalued, or properly valued.
I. Explain how the systematic risk of an asset is estimated using the characteristic line.

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