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38 Cards in this Set
- Front
- Back
Capital Asset Pricing Model
CAPM |
RFR + b (market - RFR)
CAPM can be also considered a special case of APT where there is only one risk factor and this |
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Standard deviation of investment that
combines risky with risk-free? |
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Market Model Predicts
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Strategies
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THINK: BICCCO
Basis Index Curve Correlation Capital Structure Options |
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Law of one price
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A good should have the same real price in all countries
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beta =
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Active Return
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portfolio - benchmark
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Sources of Active Return
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1. Factor tilts
2. Asset Allocation |
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Active Risk
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Standard deviation of active return over time
Standard deviation of portfolio - benchmark |
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Information Ratio
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Active Return........Portfolio - Benchmark...
--------------- = --------------------------- .Active Risk......standard deviation of p - b |
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FCRP
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Foreign Currency Risk Premium
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RFR has what standard deviation/variance?
and covariance with other assets? |
All Zero
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Expected Return on 2 asset portfolio
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Expected Return Two Assets one being RFR
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Variance of two assets
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Variance of equally-weighted portfolios
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Lower correlation leads to what diversification?
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Greater
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alpha
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Forecast - CAPM
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Foreign Currency Risk Premium
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2 Ways to calc domestic currency (DC) return to
holding foreign bond |
1. DC return = FC interest + FC appreciation
2. DC return = DC interest + Foreign Currency Risk Premium (FCRP) |
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Money Demand Model
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Inc real econ activity leads to inc demand domestic currency,
currency appreciates, stock prices up Dec econ activity causes currency depreciation, stock prices down |
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Traditional Model
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Decrease currency lead to strong economy in
long run |
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Security Market Line (SML)
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Expected return vs. Beta
Slope is the market risk premium (Mkt-RFR) Intercept is the RFR Inc expected inflation or RFR moves line up |
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Capital Market Line (CML)
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Expected return vs. variance
This is a line. Market portfolio (M) is the tagency portfolio of the RFR line to the efficient frontier. At RFR 100% lending (T-bills), at M 100% funds in tagency portfolio, above M on RFR line borrowing since more than 100% invested. Slope = sharpe ratio of market portfolio "Best combination of risk reward" |
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SML vs CML
Security Market Line vs. Capital Market Line |
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Capital Market Line (CML) equation
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Capital Allocation Line (CAL) equation
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Minimum-Variance Frontier (MVF)
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Expected Return vs. Variance
Set of portfolios with lowest variance at expected return |
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Capital Allocation Line (CAL)
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Expected return vs. variance
CAL is the line from the risk-free rate (RFT) to the point of tagency on the efficient frontier "Best risk portfolio" |
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Capital Allocation Line (CAL) equation
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Differences between CAL and CML
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1. Only one CML - the tagency is the market portfolio
2. Unlimited CALs, each developed unique per investor 3. Tangency for CAL can differ accros investors depending on expectations. 4. CML is a special case of CAL. CML is the "Market Portfolio" |
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Market Model
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the regression mode used to estimate beta
Return = alpha + (beta)(return on market) + error |
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Multifactor Models. Give 3 types:
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Market Model is 1 factor model. Assests explained by return of
market porfolio 1. Macroeconomic 2. Fundamental 3. Statistical |
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International CAPM
ICAPM |
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In ICAPM R sub f
is |
domestic currency risk free rate
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Market Price of Risk
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= Sharpe ratio of market portfolio
= Slope of CML (Capital Market Line) = Market risk premium per unit of market risk |
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If CAPM assumptions don't hold
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1. Market Porfolio not on efficient frontier
2. non-linear relation expected return and beta 3. Not allowing shorts 4. Risk adverse investor may hold diff then more risk-adverse investor |
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Portfolio Management Planning Process
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Analyse
1. Risk/Return 2. Constraints: Liquidity, time horizion, legal/regulation, taxes, unique circum 3. Develop IPS: purpose, duties, objectives, modify policy, rebalancing guidlines 4. Determine Strategy: Passive/Active 5. Select Asset Allocations: Weight based on capital market expectations |