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IMC- Investment Practice > 13- Portfolio Theory > Flashcards

13- Portfolio Theory Flashcards

1
Q

What are the 3 key characteristics of the efficient market hypothesis (EMH)?

A

-Information freely available to all
-Information correctly priced into security
-Rational investors

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2
Q

What are the 3 forms of the efficient market hypothesis?

A

-Weak form
-Semi-strong form
-Strong form

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3
Q

What are the 3 informations cumulatively reflected in share price through the EMH forms

A

-Historic share prices
-All publicly available info
-All private info

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4
Q

What is Technical analysis?

A

Analysis of historic prices and volumes and the use of graphs to identify repeatable patterns

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5
Q

What is Fundamental analysis?

A

The use of both quantitative and qualitative data about a company in an attempt to assess an intrinsic value.

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6
Q

What is stratified sampling for a tracker fund?

A

Buying the most influential shares in the benchmark from each sector

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7
Q

What is the formula for tracking error?

A

Tracking error = σ(Total portfolio return - total benchmark return)

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8
Q

What is the Holding Period Return (HPR) formula?

A

HPR = (Val1 - Val0)/Val0

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9
Q

What is the Money Weighted Rate of Return (MWRR)?

A

Equivalent to IRR of portfolio, designed to take account of cash inflows and outflows but can still be affected by timing and size of flows

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10
Q

What is the formula for MWRR?

A

PVinflow - PVoutflow = 0

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11
Q

What is the Time weighted rate of return (TWRR)?

A

This separates the returns into separate holding periods and calculates geometric mean over the period

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12
Q

What is the TWRR formula?

A

TWRR = (HP1end/HP1start x … x HPnend/HPnstart) - 1

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13
Q

What is the formula for Total Risk?

A

Total Risk = sqrt(VarMktrisk + VarSpecificRisk)

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14
Q

What is the difference between systematic and systemic risk?

A

Systematic risk is FX liquidity etc, systemic is entire market collapses

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15
Q

What is the beta formula?

A

Beta = Cov(Rm,Rx)/VarRm

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16
Q

How do you calculate portfolio beta?

A

Weighted average of the betas of each holding

17
Q

What is Value at Risk (VaR)?

A

The maximum potential change in value of a portfolio of financial instruments with a given probability over a certain horizon

18
Q

What is the Capital Asset Pricing Model (CAPM)?

A

The CAPM calculates the expected return from a security given its systematic risk

19
Q

What are the 5 main CAPM assumptions?

A

-Risk free weight equal for all
-All investors have well diversified portfolios
-No tax or transactional costs
-Rational investors
-Investors have same risk/return expectations

20
Q

What is the CAPM formula?

A

E(Rp) = Rf + βp(Rm-Rf)

21
Q

What is the market risk premium formula?

A

Rm-Rf

22
Q

What does arbitrage pricing theory do?

A

Attempts to derive a rate of return that will be used to price assets, by breaking the market into risk factors and creating a beta for each one

23
Q

What 3 risk factors does arbitrage pricing theory take?

A

-Inflation
-Interest rates
-Liquidity

24
Q

What is Jensen’s Alpha?

A

Difference between portfolio return and CAPM predicted return
Rp-Rcapm

25
Q

What is the Sharpe ratio equation?

A

Sharpe ratio = (Rp-Rf)/σp

26
Q

What is the Treynor ratio equation?

A

Treynor ratio = (Rp-Rf)/βp

27
Q

What is the difference between the Sharpe and Treynor ratios?

A

Sharpe uses total risk as it assumes portfolio is not diversified, whereas Treynor does so it uses systematic (β)

28
Q

What is the Information ratio formula?

A

Information ratio = (Rp-Rb)/σ(Rp-Rb)

29
Q

What is Beta?

A

Expression of a portfolio’s sensitivity relative to its benchmark

30
Q

How do you calculate portfolio duration?

A

Weighted average of the duration of each bond

31
Q

What is relative duration?

A

Duration of bond (portfolio) / Duration of market
Dp/Dm

32
Q

What is the CAPM formula for bonds?

A

E(Rp) = Rf + (Dp/Dm)(Rm-Rf)

33
Q

What is a cash matched/dedicated portfolio?

A

Where the fund manager chooses bonds that generate cash flows of the same size and timing as the fund’s liabilities

34
Q

What is Immunisation?

A

Matching the duration of its constituent bonds with the duration of its liabilities

35
Q

What is a Bullet?

A

All bonds have a duration close to the duration of the liability

36
Q

What is a Barbell?

A

The portfolio has a weighted average durations that matches the liability

37
Q

What is a Liability Driven Investment (LDI)?

A

Investment strategy of a company or individual based on the cash flows needed to fund future liabilities

38
Q

What is Policy switching in active bond management?

A

Switching between two different bonds to take advantage of market conditions

IMC- Investment Practice (17 decks)

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