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145 Cards in this Set
- Front
- Back
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What is the stock index that best represents small cap stocks?
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Russell 2000
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Based on the current P/E ratio, right now is a _____ time to engage in a buy and hold strategy.
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bad
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When you build a portfolio, what is the best strategy for maximum diversification?
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-purchase assets with negative covariances
-because this is the same as having negative correlation |
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What is the document that specifies all the provisions of a hedge fund?
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-PPM
-Private Placement Memorandum |
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DJIA is a ______ weighted index.
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price-weighted
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What is the purpose of the divisor in the DJIA?
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it adjusts for stock splits
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What is the inverse of the divisor of the DJIA?
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8
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What is the current debt/GDP in the US?
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.91, up from .60
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_______ cap stocks historically have more volatility than _______ cap stocks.
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-small
-large |
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China's GDP in dollar terms is greater/less than that of the US
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less
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What type of market are we currently in?
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secular bear market
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Secular bull markets are started when the P/E ratio of the market is ______.
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11 or below
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What is the stock market that best represents large cap stocks?
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S&P 500
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What is the worst performing index of the decade?
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Nasdaq
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What two types of companies make up the Nasdaq?
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-small cap
-large cap hi-tech companies |
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Why is creating bond market indexes more difficult than creating stock market indexes?
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the universe of bonds is constantly changing
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What are four ways the universe of bonds is constantly changing?
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-numerous new issues
-bond maturities -call -bond sinking funds |
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How is the Fed monetizing the debt?
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purchasing Treasuries
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What will happen, in regards to inflation and the FFR, once the economy starts to improve?
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inflation will cause the Fed to increase the FFR
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What are two possible outcomes, if the treasury and congress continue their massive spending?
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-higher taxes
-higher interest rates |
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In which market does the CEF trade?
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secondary market
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Which type of fund mimics various bond, stock, and commodity indices?
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ETF
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What is the fund category that manages the most money?
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mutual funds
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Between UITs and mutual funds, which is the better investment?
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mutual funds
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What is the primary reason we see CEFs trade at a discount from their NAV?
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embedded tax liabilities
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If the VIX is going up, does that mean the stock market is also going up?
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no
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Hedge funds had a good/bad year in 2008, relative to what they should do. Why?
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-bad
-the goal of hedge funds is absolute returns |
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Are private investment funds allowed to advertise?
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yes
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What type of returns do private investment funds seek?
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absolute
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Who are accredited investors for private investment funds?
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-rich investors
-institutional investors |
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Who do private investment funds prefer to accredited investors?
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qualified clients
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Are private investment funds allowed to use leverage?
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yes, but it's not a good sign if they do
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What is the term that means a hedge fund won't take a performance fee until it recoups all prior losses?
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high water mark
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Who is the father of Modern Portfolio Theory?
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Harry Markowitz
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How do you create a portfolio with zero risk (zero standard deviation)?
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find two assets with perfect negative one correlation
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What was the first type of hedge fund?
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long-short
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What is long-short?
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the hedge fund strategy that will find undervalued and overvalued equities and then take the appropriate position based upon their analysis
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What does Tobin's Separation Theorem state?
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when investing, you separate the investment decision from the financing decision
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As you move up the CML, you are risk averse
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less
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What does the CML become once you throw in the risk-free asset?
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the new efficient frontier
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What was William Sharpe's goal? What did his work lead to?
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-to simplify MPT
-this led to a whole new genre of asset pricing models |
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What is the only important portfolio, according to William Sharpe's work?
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the market portfolio
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How was Sharpe's stock comparison different from that in MPT?
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instead of comparing stocks to one another, you would compare how a stock moves with the market portfolio
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What does Beta describe, in the Market Model?
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how your stock moves with the market portfolio
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Total risk is the same as...
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variance
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What do you get when you multiply the Beta of an asset by the variance of the market?
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-market risk
-non-diversifiable risk |
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What type of risk is non-diversifiable?
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market risk
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What type of risk is diversifiable?
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company-specific risk
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What does the variance of epsilon give you?
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-company-specific risk
-diversifiable risk |
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Who was the first to come up with the concept of Beta?
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William Sharpe
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What is the Beta of the market? Is this always the case?
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-1
-yes, it is always 1 |
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What is the relationship between the capital market line and the security market line?
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they are the same
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What type of model is CAPM?
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one factor model
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What is the one factor of the CAPM model?
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how does your stock move with the market (with the excess return of the market)?
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What does beta of CAPM measure?
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systematic risk
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True or false: beta of CAPM captures all of the systematic risk
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not necessarily true
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If alpha > 0, what does that tell us about how much of systematic risk CAPM's beta is capturing?
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if alpha > 0, beta is not capturing all of systematic risk
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What did APT (arbitrage pricing theory) state?
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-there are other factors that probably measure systematic risk more than just the simple market risk premium factors
-you can create portfolios through which there will be an arbitrage opportunity until alpha becomes positive -you can make self-financing portfolios and make an arbitrage profit until the market factors in systematic risk (alpha > 0) |
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What started the multiple factor model craze?
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APT
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Who developed APT?
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Stephen Ross (197)
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When was Fama-French model developed?
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1993
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What two things did the Fama-French model do?
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-took APT and applied it
-added two factors to CAPM |
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What two factors did Fama-French add to CAPM?
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-HML
-SML |
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Beta is ______ HML
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2 times
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What does HML stand for? What are you trying to model?
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-High minus low
-high book to market minus low book to market -you are trying to model anomalies |
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How is book to market related to P/E of company?
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-inversely
-high book to market means low P/E |
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What is more important in the long run between value and growth? Short-run?
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- long-run: value outdoes growth
- short-run: growth is more important |
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Beta is ______ SML
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3 times
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What does SML stand for?
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small cap minus large cap
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Which perform better: small caps or large caps? What about when risk-adjusted?
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-small caps, even when risk-adjusted
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Why is CAPM the standard?
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it's simple
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What are 5 ways to evaluate portfolios?
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-rbar (mean)
-geometric mean -sharpe ratio -treynor ratio -jensen's alpha |
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What does rbar, alone, tell us?
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-nothing, until you consider the investment amount
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How good a measure is arithmetic average, in evaluating a fund's past performance?
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terrible
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What is Variance Sink?
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-says variance sinks returns
-the more volatile a fund, the greater a distance between arithmetic and geometric means |
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What are 4 good measures of past performance?
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-geometric mean
-sharpe ratio -treynor ratio -jensen's alpha |
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What is CAGR?
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compound annual growth rate
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Is sharpe ratio good for funds or stocks?
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-funds
-NOT good for stocks |
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Is treynor ratio good for funds or stocks?
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-both
-can be used for stocks because it uses beta |
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What do you have to do in order for treynor and sharpe ratios to be useful?
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compare them to something
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what is the historic sharpe ratio, when you use the t-bill as the risk free rate?
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.4
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What is the sharpe ratio of the s&p 500, using the t-bill as the risk-free rate?
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.397
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What is the treynor ratio of the s&p 500, using the t-bill as the risk-free rate? What is the implication?
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-8
-8 is the market risk premium |
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What does the sharpe ratio tell you?
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what are you getting over the risk-free rate, compared to the risk associated with getting that number
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What is sharpe ratio good for?
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comparing funds to one another
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What is the implication if, long-term, you are managing a fund and your sharpe ratio is greater than one?
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you are a superstar
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How do you know if you have a good fund, using jensen's alpha?
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if it's positive, it's good; if it's negative, it's bad
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What is rbar(p), in the formula for jensen's alpha?
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arithmetic average
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What is (rbar(M)-r(RF)), in the formula for jensen's alpha?
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what you should get based on CAPM theory
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YTM of a bond =
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YTM=r=treasury security of equivalent maturity + maturity risk premium
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Yield spread =
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f(credit rating)
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What are the 3 components of treasury?
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real rate of return + inflation premium + maturity risk premium
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What do the three components of treasury determine?
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-the rest of the yield curve, apart from the short end, which is determined by the fed
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What is maturity risk premium?
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-long-term bonds have more interest rate risk than do short-term bonds, and fluctuate more in price
-SO, you require more return on a long-term bond than you do on a short-term one |
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What is the first consideration, in purchasing/pricing a bond?
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inflation premium
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What is the driver, when it comes to fixed income instruments?
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inflation premium
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What is inflation premium?
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-once you buy a bond, you get a fixed amount of income for the life of the bond
-at the least, you want to keep up with inflation |
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What is the real rate of return a reward for?
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-not consuming
-you want to increase your purchasing power if you aren't purchasing today -you want to at least do better than inflation |
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Supply and demand of funds are going to soon become a real issue worldwide. Where will this show up?
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real rate of return
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How could inflation premium become an issue moving forward?
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-people are fearful that we are monetizing our debt, causing inflation and ir to go up
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What is the worst case scenario, regarding inflation premium?
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-US could lose credit rating because there's a chance of default
-would cause ir to go up |
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True or false: there's nothing we can do to avoid both the real rate of return and interest rates to go up.
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true
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What is the minimum for which people will want to buy a bond?
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yield on a treasury
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What is the current yield on a 5-year A-rated bond? How much higher is this than the yield on a treasury security?
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-3.46
-93 basis points above t-security |
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How often will r and yield of a t-security change?
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throughout the day
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Yield spreads get ______ in a recession?
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wider
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On what do yield spreads change?
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-expectations of the macroeconomy
-if you think there will be a recession, you require a higher yield spread per rating |
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What is the only way we can have more money without having inflation?
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-productivity
-it is good news, and is considered deflationary |
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Why does the bond market hate good news?
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typically, good news for main street is inflationary
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What happens to the value of bonds when inflation goes up?
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decreases
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What happens to the value of bonds when gdp goes up?
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-decreases for those already owning bonds because people buying bonds will demand a higher inflationary rate
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If you're already holding a bond, do you like good news or bad news?
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bad news
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Why do you like bad news, if you're already holding a bond?
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-because your bond price will go up
-because of perceived lessened potential for inflation in the future |
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What is the difference between buying an individual bond and buying a bond fund, when there is good news and your interest rate goes up?
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-with an individual bond, you can hold to maturity, so it doesn't necessarily have to be bad news
-with a bond fund, it just takes one person to want their money back for a paper loss to become a realized loss - then everyone loses a little bit |
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What is a tip? What is the rate on a tip?
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-you get $1000 par value that increases every 6 months based on cpi
-real rate |
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Can you strip tips?
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yes
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How much default risk do strips have?
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none
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Given a 4% coupon on a 10 -year note, for a strip, what have you essentially created? Explain.
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-21 new zero coupon bonds
-20 have a par value of $20 (40/2); one has a par value of $1000 |
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What are the 3 benefits of strips?
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-no default risk
-no inflation risk (you are compensated for actual inflation) -no reinvestment rate risk (zero coupon) ***essentially no risk of anything*** |
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What does it mean to say derivatives are a zero sum game?
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-no wealth is created in the macroeconomy
-wealth is just transferred from one person to another -unique to derivatives |
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Why is wealth created in the stock market?
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most people are long in the stock market, so wealth is created in the long run
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Why do derivatives exist?
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-because of hedging
-if people want to hedge, you need speculators |
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What are the two main types of derivatives?
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-futures
-options |
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What do you buy when you buy an option?
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the option to do something
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What do you buy when you buy a future?
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-nothing - you just take a side
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Which side do you take in a future if you think price will go down?
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short
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Which side do you take in a future if you think price will go up?
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long
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Who can enter into a futures contract?
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-anyone
-but individual investors should stay away |
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How do you get out of a futures contract early?
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by taking the opposite side, thus canceling yourself out
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What is the spot price?
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today's price
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How do you win or lose every day with a futures contract? Are these real losses or paper losses?
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-because they are marked to market every day
-actual wins and losses |
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How long have organized trading options been around?
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-since 1973
-new compared to futures |
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Who is the buyer in a call option? Writer?
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Buyer: bull
Writer: bear |
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What does the writer of a call option get? What are his/her responsibilities? What does he/she hope?
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-gets the premium
-obligated to sell to buyer -hopes stock goes down |
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What is the riskiest thing you can do in the world of finance?
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write a naked call option
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Why is writing a naked call option risky?
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-if stock starts shooting up, you're losing money
-you're going to have to buy the option at the higher price because the buyer will exercise it |
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What is writing a covered call?
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you own the asset and then write the call
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What is the negative of writing a covered call?
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-if the stock goes up, you have to sell at the lower price, so you lose the opportunity of making more money
-you would've been better off not writing the call |
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When strike price is _______ spot price, you have an in-the-money option.
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less than
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Why is it called in-the-money?
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it could get exercised
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When strike price is ________ spot price, you have an out-of-the-money option.
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greater than
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The more bullish you are on the stock, the more in/out of the money you write the price.
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out of the money
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What does it mean when you are bullish on stock, and thus, write it more out of the money?
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-less likely that you'll get the option exercised on you
-means you kind of like owning the stock |
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Why does Hart like going in-the-money?
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-it will more likely get exercised
-you can pick the premium on it -you are picking up time value |
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Who is the buyer of a put option? Writer?
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-buyer: bear
-writer: bull |
