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37 Cards in this Set
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- Back
- 3rd side (hint)
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Diversification ratio
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standard deviation of returns of an equally weighted portfolio / risk (Standard dev) of a single security selected at random from the portfolio |
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Steps in the Portfolio Management Process (3)
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1) Planning - analysis of risk tolerance, return objectives, time horizon, tax exposure, liquidity and income needs 2) Execution- analysis of risk and return characterisicts to determine the asset class allocation 3) Feedback - over time investor circumstances wll change and the weights of the assets will change so may need to be adjusted / rebalanced |
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top down vs bottom up analysis
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Top down - looks at macroeconomic conditions to identify the classes that are most attractive Bottom - seek to identify individual securities that are undervalued |
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Risk management steps (3)
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1) determine the risk tolerance 2) identify and measure the risks the organization faces 3) modify and monitor these risks Note: Risk Uncertainty is not something that can be avoided, returns above the risk free rate are only earned by accepting risks |
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Financial risks
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Liquidity Risk - Risk of loss when selling an asset at a time when market conditions make a sales price less than the underlying fair value Market Risk - Uncertainty about market prices of assets and interest rates *** Everything else is a non-financial risk |
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Beta
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- Considers the risk reduction benefits of diversification and is appropriate for securities held in a well diversified portfolio, whereas standard deviation is a measure of risk on a stand alone basis |
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Standard deviation not useful for ____
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non-normal distributions, especially those with negative skew |
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Duration
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Measure of the price sensitivity of debt securities to changed in interest rates |
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Tail (Downside risk)
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and Conditional VaR (CVAR) - the expected value of a loss given that the loss exceeds a given amount Conditional |
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Covariance
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sum of (Return1 - Average Return1)* (Return2 - Average return2)...... Divided by (N-1) |
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Correlation of assets
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Covariance / Standard deviation 1 * Standard deviation 2...
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Portfolio variance 2 asset portfolio
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(w1*Var1)+(w2*Var2) +2*w1*w2*Covariance or (w1*Var1)+(w2*Var2) +2*w1*w2*stddev1*stdev2*correlation |
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Markowitz efficient frontier
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The set of possible portfolios that have the greatest expected return for each level of risk (Standard deviation) |
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indifference curve
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- Slope upward for risk averse because they will only take on more risk if compensated with greater return - |
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Capital Allocation Line
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In a plot of standard deviation (X axis) vs expected return (Y Axis) this line represents the possible combinataions of risk free assets and the optimal risky asset portfolio on this line is: 1) the risk free asset return (standard deviation 0) 2) Portfolio invested in a risky asset 3) The risky asset on its own |
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Systemic vs unsystemic risk
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** risk free assets have no systemic (market) risk unsystemic - unique, diversifiable or firm - specific risk (investors need to be compensated for unsystemic risk) ** well diversified (efficient portfolios have no unsystemic risk) some of these two equals the "total risk" |
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Security Market line
A return plot over the line is ______priced A return plot under line line is _______priced |
illustrates the equilibrium relationship between systemic risk and expected return A return plot over the line is underpriced A return plot under line line is overpriced |
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CAPM (Expected return) forumla
*****also used for required return |
expected return = RFR + [(Market - RFR) x beta]
*** this is the required rate of return |
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Return Generating models vs multifactor modesl
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Multifactor - Use macroeconomic factors such as GDP, growth, inflation, or consumer confidence along with fundamential factors such as earnings, earnings growth firm size and research |
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Multifactor model formula
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expected return - RFR = [Beta 1 x E(Factor 1)] +[Beta 2 x E(Factor 2)].... |
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market model definition and formula
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Return = Intercept + Slope coefficient(Market Return) + Abnormal return |
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Beta formula
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or (Correlation*standard dev asset*Standard dev market) / variance of the market |
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A return plot over the SML is _____priced A return plot under the SML is _______priced |
A return plot over the SML is under priced A return plot under the SML is over priced |
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What two measures measure excess return per unit of total risk? What two measures measure excess return per unit of systemic risk? |
What two measures measure excess return per unit of total risk? - Sharpe Ratio and M squared What two measures measure excess return per unit of systemic risk? - Treynor measure and jensens alpha |
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Important positions of portfolio construction (Investment Constraints) |
T - T - L -L - U
Liquidity
Time Horizon
Tax Situation
Legal and Regulatory
Unique Circumstances
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Capital allocation line |
Straight line from the risk free asset through the optimal risky portfolio |
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Expected portfolio return and standard deviations for portfolios ___ invested In market Porfolio |
Expected return =(1-market portfolio weight) x Rf + (market market portfolio weight) (expected rate of return)
Standard dev: market portfolio weight x market portfolio standard deviation |
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Lending vs borrowing portfolios |
Lending are below the CML borrowing above the CML |
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Beta (two ways) |
Covariance of assets return with the market return / variance of the market return
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Market index (asset standard dev / market standard dev) |
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CML vs SML main difference |
CML uses total risk on the x axis SML uses beta (systemic risk) on the x axis
So all properly priced securities in theory would plot on the SML |
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If estimated return plots over the SML the security is ____ valued of the security plus under the SML the security is _____ valued |
If estimated return plots over the SML the security is under valued of the security plus under the SML the security is over valued |
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Investment constraints for IPS |
R R T T L L U |
Risk, Return, Tax, Time Horizon, Liquidity, Legal and Regulatory, Unique Circunstances |
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Which index is rebalanced most often And how do you calculate it |
Equally weighted index
Sum of [(new price - old price) -1] for each stock raised to the number of stocks |
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Sharpe vs treynor vs Jensen |
Sharpe - excess return relative to standard dev
Treynor - excess return relative to beta (systemic risk)
Jensen alpha - excess return relative to return of return of portfolio on the SML that has same beta |
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Covariance in calculator |
1) Plug in data into data 2) Change Stat to Lin from 1 bar using 2nd set 3) multily sx *sy* r |
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Correlation of -1 means |
Zero variance in portfolio as assets are perfectly negatively correlated
Alternatively there are no benefits to diversification if correlation =1 or -1 |
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