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54 Cards in this Set
- Front
- Back
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Portfolio perspective
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evaluating individual investments based on their contribution to the risk/return of an investor's portfolio
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Modern portfolio theory (MPT)
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theory that states risk adverse investors can create portfolio to optimize return based on certain risk level - however there is inherent market risk in all investments
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diversification ratio
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ratio of the risk of an equally weighted portfolio of n securities (standard deviation of returns) to risk of a single security selected at random from n securities
- quick measure to show benefits of diversification |
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endowment
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fund that is dedicated to providing financial support on an ongoing basis
- long investment horizon |
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foundation
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fund established for charitable purposes
- long investment horizon |
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bank investment objective
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earn more on the bank's loans and investments than the bank pays for deposits
- short investment horizon |
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insurance companies
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invest customer premiums with the objective of funding customer claims in the future
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investment companies
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manage pooled funds of many investors
- mutual funds manage these pooled funds |
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defined contribution pension plan
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retirement plan where firm contributes a sum each period to the employee's retirement account
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defined benefit pension plan
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firm promises to make periodic payments to employees after retirement
- based on employees years of service / employee compensation ex: 2% of final salary for 20yrs = (100,000 salary *.02 *20) = 40,000 each year |
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3 steps in portfolio MGT Process
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1. planning step
2. execution step 3. feedback step |
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investment policy statement (IPS)
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details investor's investment objectives/ constraints
- objective benchmark - updated a few times a year |
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mutual funds
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pooled investment. where an investor owns a portion of overall portfolio. net value of the assets/ # of shares = NAV
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open-ended fund
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investors can buy newly issued shares at NAV
Redeem - right to sell back shares at NAV |
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No-load funds vs. load funds
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no-load - do not charge additional fees for purchasing or redeeming
load - does charge |
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closed-end funds
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do not take new investments into fund or redeem investors shares
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money market funds
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type of mutual fund that invests in short-term debt securities
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exchange traded funds (ETFs)
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similar to close end funds - trading occurs in the market
- passively managed - designed to keep market price close to NAVs - higher liquidity / lower fees than mutual funds - can be sold short, purchased on margin, traded at intraday prices |
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Pretax nominal return
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return prior to paying taxes. div income, interest income, short-term gains, long-term gains may all be taxed at diff. rates.
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Real return
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nominal return adjusted for inflation
nominal return = real return + inflation 7% = 5% + 2% - measures increase in investor's purchasing power |
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leveraged return
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calc. as gain/loss on the investment as % of investors cash investment. ex: futures contracts have leveraged return b/c cash deposited is only faction of value of the asset
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minimum-variance portfolio
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adjusting weights on assets to determine portfolio with highest return but lowest standard deviation
- farthest to the left on the minimum-variance frontier |
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efficient frontier
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portfolios that have the greatest expected return for each level of risk - the upper arc of minimum variance frontier
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utility function
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investor's degree of risk aversion
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indifference curve
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plots combination of risk and expected return
- utility is the same for all points along the indifference curve - steeper slope = more risk adverse |
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two-fund separation theorem
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all investor's optimum portfolio will have both risky assets & risk free assets
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capital allocation line (CAL)
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line representing possible combinations of risky & risk free assets
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capital market line (CML)
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the optimal capital allocation line for all investors under homogeneous expectations
E(Rp) = rf + [(e(rm)-rf)/stand deviation market]*standard deviation of portfolio |
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passive investment strategy
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type of investing where investors believe market prices are informationally efficient
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Unsystematic risk
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firm specific risk - eliminated via diversification
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systematic risk
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market risk cannot be diversified away
total risk(standard deviation) = systematic + unsystematic risk |
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Multifactor model
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type of model to estimate expected return on risky securities based off of macroeconomic factors (GDP, inflation, consumer confidence, EPS, EPS growth, firm size etc.)
E(r)-rf = sum of factor sensitivity (B) * expected value of each factor |
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Single-index model
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E(r) - rf = B * [E(r)-rf]
- often the first step in a multifactor model - uses excess return on market portfolio |
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market model
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used to estimate a securities beta and alpha
see pg. 167 |
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beta
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sensitivity of an assets return to market index
= covar of asset with market/ variance of market |
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security characteristic line
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regression of stock prices to calc. beta, beta = slope of line
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security market line (SML)
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graph of systematic risk/ beta
x- axes = systematic risk y-axes = E(r) equation = CAPM |
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capital asset pricing model
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theory that in equilibrium expected return of a risky asset is the rf rate plus beta adjusted market premium
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Sharpe ratio
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excess returns per unit of total portfolio risk - higher ratio indicates better risk-adjusted performance
= (Rp- Rf)/ Standard deviation of portfolio - slope of CML |
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M-squared (m2)
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- produces same portfolio rankings as sharpe ratio, but stated in percentage terms
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Treynor Measure
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measure of risk-adjusted return on systematic risk (beta) based on slope
= rp - rf/ Beta of portfolio - excess returns per unit of systematic risk - slope of SML |
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Jensen's alpha
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measure of percentage return in excess of those from a portfolio that has same beta but lies on SML
- measurement of outperformance over CAPM = Rp - (RF + B(Rm-Rf)) |
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absolute risk objective
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ex: have no decrease in portfolio value during 12m period or not decrease more than 2%
- stated in nominal terms: 6% return - stated in real returns 3% more than inflation rate |
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relative risk objectives
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relate to a specific benchmark
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ability to bear risk
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depends on financial circumstances - ex: time horizon (20yrs rather than 2 yrs), a secure job etc.
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willingness to bear risk
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based on investor's attitudes and beliefs
- subjective |
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Things to cover in IPS (remember acronym)
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RRTTLLU
risk, return, time, taxes, liquidity, legal, and unique needs & preferences |
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Tactical asset allocation
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an active manager who rebalances asset allocations in order to take advantage of short-term opportunities
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Security selection
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deviation from index weights on individual securities in an asset class - a strategy by active management
- overweight energy / underweight financials |
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Risk budgeting
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risk limit for portfolio and allocates a portion of permitted risk to the systematic risk of the strategic asset allocation, tactical asset allocation, security selection
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active portfolio management two issues
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1. overlap of trades because multiple managers to one asset class ex: overweight while another manager underweight the same stock - net effect nothing
2. excessive trading |
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Core-satellite approach
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invests majority of $ in passive managed index and invests smaller/satellite portion in active strategies
- to combat overlap and excessive trading |
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Gross Return |
Total return after deducting commissions on trades & other costs necessary to create return |
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Net Return |
Total return after commissions & management fees |
