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What is a Strike Price?In the case of an option contract, the "strike price" is the predetermined and agreed-upon price at which a specific security may be bought (by the call option holder) or sold (by the put option holder) until or upon the expiration of the contract. The term "strike price" is also termed as "exercise price."Options are derivatives that offer their buyers a right, or an option—but not an obligation—to buy or sell a security, such as a stock at a specific price (or the strike price) until or on a certain date (the expiration date).Buying or selling ... Read More

The security market line (SML) is a graph that is drawn with the values obtained from the capital asset pricing model (CAPM). It is a theoretical presentation of expected returns of assets that are based on systematic risk.Non-diversifiable risk is not represented by the SML. In a broader sense, the SML shows the expected market returns at a given level of market risk for marketable security. The overall level of risk is measured by the beta of the security against the market level of risk.Security Market Line AssumptionsSince the security market line is a representation of the CAPM, the assumptions ... Read More

In simple words, both correlation and covariance show the relationship and the dependency between two variables.Covariance shows the direction of the path of the linear relationship between the variables while a function is applied to them.Correlation on the contrary measures both the power and direction of the linear relationship between two variables.In simple terms, correlation is a function of the covariance. The fact that differentiates the two is that covariance values are not standardized while correlation values are. The correlation coefficient of two variables can be obtained by dividing the covariance values of these variables by the multiplication of the ... Read More

In a study done to link the variance with returns, it was found that both genres of portfolio construction measures – minimum volatility and low volatility – deliver market return more than the average. Their information ratios (IRs) also are not statistically significant. It was also found that both strategies let investors assume palpable risk, in relation to the market prices, for which investors were not compensated.Minimum Variance Portfolio (MVP)The concept of Modern Portfolio Theory (MPT) has been the milestone for finance professionals for portfolio construction since Harry Markowitz introduced the idea into finance in 1952. Every finance student has ... Read More

Capital Market Line (CML) is a line that talks about a portfolio that accurately combines both risk and returns. It is a graphical representation that shows a portfolio’s expected and required return based on a chosen level of risk. The portfolios that are on the CML optimize the required risk and return relationship that maximizes the performance of the portfolio.Note − The slope of Capital Market Line is known as the Sharpe Ratio of the market portfolio. It is now believed by many investors that one should buy a security if the Sharpe ratio is above the CML and sell ... Read More

Mean-Variance AnalysisMean-Variance Analysis is a process that investors utilize to make investment decisions based on their risk tolerance. Investors actually consider the potential variance given by the volatility of returns produced by an asset in the market against the required expected returns of that asset. The mean-variance analysis looks into the average variance in the required expected return from an investment.The mean-variance analysis is a part of Modern Portfolio Theory (MPT) which is based on the assumption that investors tend to make rational decisions when they possess enough information. The theory also relies on the fact that investors enter the ... Read More

What is CAPM?The Capital Asset Pricing Model (CAPM) describes the association between the anticipated return and the risks of investing in a security. It represents the fact that the expected return on an asset is equal to the risk-free return rate plus a premium for taking the risk that is based on the beta of the security.Assessing the CAPM requires proper knowledge of systematic and unsystematic risks.Systematic risks are the general dangers, which apply to all forms of investment. For example, inflation rate, Wars, recessions, etc., are systematic risks.Unsystematic risks, on the other hand, show the specific dangers associated with ... Read More

A market portfolio is an assumed or virtual portfolio where every available type of asset is included in proportion to its market value. An investment portfolio is a group of investments that are owned and managed by one individual or organization. A typical investment portfolio may include numerous types of assets, but usually, it does not include all asset types. A market portfolio, however, virtually includes every asset that is available in the market.How is the market portfolio managed?A market portfolio is created to have the right mix of asset classes to maximize the returns from the investment and to ... Read More

The Capital Asset Pricing Model (CAPM) has some assumptions upon which it is built. Here are the five most influential assumptions of CAPM −The investors are risk-averseCAPM deals with risk-averse investors who do not want to take the risk, yet want to earn the most from their portfolios. Diversification is needed to provide these investors more returns.Choice on the basis of risks and returnsCAPM states that Investors make investment decisions based on risk and return. The return and risk are calculated by the variance and the mean of the portfolio. CAPM reinstates that rational investors discard their diversifiable risks or ... Read More

Portfolio Risk and ReturnThe general standard deviation (SD) of a portfolio is related to −The weighted mean average of each individual variance, andThe generally weighted covariances between all assets in the portfolio of investment.When a new asset is added to a large basket of portfolios with many assets, the new asset alters the portfolio's SD in two ways. It affects −The new asset's own variance, andThe covariance between the new asset and each of the other assets in the portfolio.The net effect of the numerous covariances will be more important than the effect of the asset's own variance. The more ... Read More