1. Warm-up Problem If X and Y are uncorrelated, then Var[X-Y] = Var[X] - Var[Y]. T/F?

2. R = (1/N) ∑ j R j Var[R]  0 if R j uncorrelated Var[R]  constant if R j correlated Diversification reduces risk / uncertainty Not all risk can be diversified away –Idiosyncratic risk (diversifiable) –Market risk (undiversifiable)

4. What’s better to receive in 1 year? (You currently own a large diversified portfolio P.) a)$100 for sure b)$180 w/ prob. 60%, 0 w/ prob. 40% independent of everything else c)$180 if P goes up (w/ prob. 60%) $0, otherwise

5. Capital Asset Pricing Model (CAPM) Suppose everybody has the same opportunity to invest. Suppose everyone can borrow & lend at the risk-free rate Suppose everyone has the same information and horizon and measures –risk = standard deviation of portfolio return –reward = expectation of portfolio return