4050 Portfolio Management Final Exam Flashcards
1902 - Charles Dow suggests ___________________________.
using stock prices to forecast business conditions.
1922 - William Hamilton extend’s Dow’s theory and suggests that ______________________.
stock prices can be used to forecast the stock market.
1932 Robert Rhea extended Dow’s theory and suggests that ____________.
Stock prices can be used to forecast stock prices.
Essay: Explain the evolution of technical analysis using dates, names and suggestions.
What does Dow Theory state?
There are three types of movements present in the market
- Major or primary trends
- Intermediate or secondary trends
- Minor or short run trends
How long does a major or primary trend last under Dow Theory?
May last several years
How long does an intermediate or secondary trend last under Dow Theory?
May last several months
How long does a minor or short run trend last under Dow Theory?
May last several weeks
Essay: Explain what Dow Theory states and the types of trends observed under it.
What is a support level according to Dow Theorists?
The support level is the price level that investors will begin to buy the stock creating a surge in demand and a rise in price.
What is a resistance level according to Dow Theorists?
The resistance level is the price level that investors will begin to sell the stock creating a surge in supply and a fall in price.
In the near term, where do Dow Theorists expect the price of a stock to stay?
Between the support level and resistance level.
Essay: Explain support and resistance levels in words.
Essay: Explain support and resistance levels using an illustration.
What is an up trendline?
An up trendline is a line drawn up and to the right connecting successive rising market bottoms.
What is a down trendline?
A down trendline is a line drawn down and to the right connecting successive falling market peaks.
What is required to draw a trendline versus validate or test a trendline?
A third point is necessary to validate or test a trendline.
Draw an example of an up trendline.
Drawn an example of a down trendline.
Essay Question:
A) Explain what an up or down trendline is.
B) What is necessary to draw versus validate or test a trendline?
C) Explain trendline testing, validation and violation
D) Explain channel lines
E) What happens when a channel line is violated?
F) Illustrate an up and down trendline include labels of
- Direction
- Support / Resistance
- Test, Validation, Violation
A) An up trendline is a line drawn up and to the right connecting successive rising market bottoms.
A down trendline is a line drawn down and to the right connecting successive falling market peaks.
B) While it may take two points to draw a trendline, a third point is necessary to validate or test a trendline.
C)
Everytime a trend line is touched it is said to be”tested.”
If it is touched and it bounces off it is said to be “validated.” The more times a trendline is tested and validated, the more significant it becomes.
If the trendline is touched and goes through it is said to be “violated. Once a trendline is violated it is redrawn with new peaks or troughs.
D) Channel lines are drawn parallel to trendlines but away from the price action. If the market was trending up,the channel line would be drawn above the up trendline, and represents the resistance level. If the market was trending down, the channel line would be drawn below the down trendline, and represent the support level.
D) If a channel line is violated, the chartist has the option of moving the channel line further away from the trendline, or redrawing both the trendline and channel line once two new peaks or troughs have been established.
What does it mean for a trendline to be tested?
Every time a trendline is touched it is said to be “tested”
If a trendline is touched and it bounces off it is said to be _________.
validated
The more times a trendline is tested and validated, the more _____________.
significant it becomes.
If a trendline is touched and goes through it it is said to be _________.
Violated
Once a trendline is violated it is ______________
redrawn with new peaks and troughs.
Channel lines are drawn _________ to trendlines but away from the ___________.
Parallel, price action
If the market was trending up, the channel line would be drawn _________ the up trendline, and represent the ________ level.
above, resistance
If the market was trending down, the channel line would be drawn _________ the down trendline, and represent the ________ level.
below, support
What happens when a channel line is violated?
Chartist can either:
- Redraw channel line further from the trendline
- Redrawn both channel and trendline when new peaks or troughs are established
Reversal patterns let you know when the stock market has ___________.
Changed directions
The best known reversal pattern is the _____________
head and shoulders.
What does a head and shoulders pattern consist of?
A left shoulder, head and right shoulder
Creating a “neckline”
For a head and shoulders pattern, if the right shoulder falls below the neckline, the market is expected to move from an _____ market to a _______ market
up , down
For a head and shoulders pattern, if the right shoulder rises above the neckline, the market is expected to move from a _____ market to a _______ market
down, up
There are many reversal patterns, they are all __________.
equally bad
What is the nature of technical analysis?
“Trend is my friend”, not designed to pick changes in trend
Even the most well known market pundits typically get only __________ predicted changes in trend correct.
2 out of 5
Draw an illustration of an up to down market head and shoulders pattern.
Draw an illustration of a down to up market head and shoulders pattern.
.
Essay:
A) What does a head and shoulders pattern consist of?
B) Discuss movements in a head and shoulders pattern and their meaning.
C) Draw an illustration of an up to market head and shoulders pattern.
Draw an illustration of a down to market head and shoulders pattern.
Include labels of:
- Direction
- Neckline
- Head, Right/Left Shoulders
- Reversal signal
A)
A left shoulder, head and right shoulder
Creating a “neckline”
B)
For a head and shoulders pattern, if the right shoulder falls below the neckline, the market is expected to move from an up market to a down market
For a head and shoulders pattern, if the right shoulder rises above the neckline, the market is expected to move from a down market to a up market
For trend analysis, we use the _____________ of past stock prices as an indicator of the trend.
moving average
How do you calculate moving average?
(200 is N)
What are the 2 ways signals can be generated in trend analysis using moving average?
- Compare the daily closing price to a moving average
- Compare 2 or more moving averages
The ______ the moving average the more sensitive it will be to price changes
shorter
Illustrate a trend analysis chart using moving daily closing price compared to moving average.
Illustrate a trend analysis chart using moving daily closing price comparing 2 moving averages.
What is a bollinger band?
- Derived from moving average
- Upper and lower band +/- standard deviation around the moving average
- Upper band denotes resistance, lower ban denotes support
When analyzing bollinger bands, a closing price that starts at the top band and crossed through the moving average is considered a _________.
Sell signal
When analyzing bollinger bands, a closing price that starts at the bottom band and crosses through the moving average is considered a _________.
Buy signal
When analyzing bollinger bands, sharp price changes tend to occur after the _____________ , _____________.
bands tighten, after volatility lessens
When prices move outside the bollinger bands, a ____________ of the current trend is implied.
continuation
Essay:
A) What is a bollinger band?
B) What are the signals of a bollinger band and what do they suggest?
A)
- Derived from moving average
- Upper and lower band +/- standard deviation around the moving average
- Upper band denotes resistance, lower band denotes support
B)
When analyzing bollinger bands, a closing price that starts at the top band and crossed through the moving average is considered a sell signal.
When analyzing bollinger bands, a closing price that starts at the bottom band and crosses through the moving average is considered a buy signal.
When prices move outside the bollinger bands, a continuation of the current trend is implied.
What does the relative strength approach suggests about security prices in different markets?
- The prices of some securities rise faster in a bull market, or decline more slowly in a bear market than other securities.
- Said to have relative strength
Technicians believe that a security that has exhibited relative strength in the past will ________________
exhibit relative strength in the future
How is relative strength measured in our case?
Price - Industry Average
Price - Market Average
Industry Average - Market Average
Find the relative strength of:
Price - Industry Average
Price - Market Average
Industry Average - Market Average
How do you calculate a confidence index and what is it used for?
Measures investor confidence by comparing the respective average yields of high-quality bonds to lower quality bonds.
What does breadth of market mean in technical analysis?
The relation between the number of shares advancing in price relative to the number of shares declining in price.
What are the 2 measures for breadth of market?
Haurlan Intermediate Index
Arms Index
In terms of breadth of market, explain the Haurlan Intermediate Index
In terms of breadth of market, explain the Arms Index
- Flat Market:
A = D
Vol A = Vol D
Arms Index = 1 - Bullish Market:
Vol A > Vol D
Arms Index < 1 - Bearish Market
Vole A < Vold D
Arms Index > 1
Why are options and futures contracts often referred to as derivatives?
Because their value is derived from the price action of an underlying primary security.
What is another term for a derivative?
Contingent claims,
Because their payoff is contingent on the price movement of a primary security
A call option gives you the right to _____ a security at a specific ________ by a specific _________.
buy, price, date
A put gives you the right to _____ a security at a specific ________ by a specific _________.
sell, price, date
To the option buyer, an option is a ________, to the option seller an option is a _________.
right, potential obligation
How is an option differentiated from a futures contract?
To the option buyer, an option is a right, to the option seller an option is a potential obligation.
A futures contract is an obligation to both.
Only _______ options have intrinsic value.
in the money
All options have ___________ value.
Speculative value
How do you calculate the intrinsic value of a call or a put?
Illustrate a bought call option position using a chart.
Illustrate a sold call option position using a chart
Illustrate a bought put option position using a chart.
Illustrate a sold put option position using a chart.
Illustrate the effect of intrinsic value decay as a long call moves towards expiration using a chart.
Illustrate a primary long position using a chart.
- What is a synthetic long position?
- What are the advantages of a synthetic long?
- Illustrate a synthetic long position using a chart
Illustrate a primary short position using a chart.
- What is a synthetic short position?
- What are the advantages and disadvantages of a synthetic short?
- Illustrate a synthetic short position using a chart
What is a straddle position in options?
- Purchasing an equal number of puts and calls, same exercise price and expiration.
- Exercise price is the same at the market price
Illustrate a long straddle position using a chart.
Illustrate a short straddle position using a chart.
What is a strangle position in options?
- Purchasing an equal number of puts and calls, same expiration.
- Exercise prices away from the market price.
Illustrate a long strangle position using a chart.
Illustrate a short strangle position using a chart.
What is a bull spread in options?
Buying a call at a certain exercise price, and selling a similar call with a higher exercise price, both same expiration.
Illustrate a bull spread position using a chart.
What is a bear spread in options?
Selling a call at a certain exercise price, and buying a similar call with a higher exercise price, both same expiration.
Illustrate a bear spread position using a chart.
What is a short butterfly spread in options?
Selling a call at a low exercise price, buy two calls at a middle
exercise price, and sell a call at a high exercise price, same expiration
Illustrate a short butterfly spread position using a chart.
What is a long butterfly spread in options?
Buying a call at a low exercise price, sell two calls at a middle exercise price, and buy a call at a high exercise price, same expiration.
Illustrate a long butterfly spread position using a chart.
What is portfolio insurance?
An investment strategy designed to keep the portfolio from losing value in a market downturn, while maintaining the portfolio’s ability to benefit from an upturn.
What is the simplest form of portfolio insurance?
Stop loss order
Illustrate a protective put position with charts.
Answer in Chapter 16 Solutions Doc
A short hedger in a futures contract is the one who _________.
Sells the futures contract
A long hedger in a futures contract is the one who ________.
Buys the futures contract
What is the role of a clearinghouse in a futures contract?
Once the price is agreed on, a clearinghouse becomes the middleman. Becoming the buyer for the seller and the seller for the buyer.
What type of risk does a clearinghouse take on with futures contracts and how do they protect themselves from it?
Performance Risk
- Impose performance margin requirements
- Mark to market
- Impose variation margin requirements
What is the basis in a futures contract and how is it calculated?
The basis quantifies the difference between the current spot price and the futures price.
Basis = Current Spot Price - Futures Price
What are the several theories or hypotheses that are used to predict the relationship between the expected spot price and the futures price.
1) Expectations Hypothesis
2) Normal Backwardation Hypothesis
3) Normal Contango Hypothesis
What does the Expectations Hypothesis say about the relationship between expected spot prices and the futures price?
The futures price is an unbiased predictor of the expected spot price.
Futures Price = Expected Spot Price
What does the Normal Backwardation Hypothesis say about the relationship between expected spot prices and the futures price?
The futures price is a downward biased predictor of the expected spot price.
Futures Price < Expected Spot Price
What does the Normal Contango Hypothesis say about the relationship between expected spot prices and the futures price?
The futures price is an upwards biased predictor of the expected spot price.
Futures Price > Expected Spot
Illustrate the 3 Hypotheses / Theories about the relationship between expected spot prices and futures prices.
What are Dr. A’s assumptions for the world of certainty in futures?
- All wheat is harvested instantly once a year.
- The size of the harvest is known
- The carry cost is unaffected by the amount of wheat stored
- Carry costs are unaffected by the price of the commodity
What is carry cost comprised of, and what is the largest* component of carry cost?
Foregone interest*, insurance and storage.
Draw graphs explaining a farmer’s inventory vs. wheat prices that explains when you’d store vs sell wheat.
In terms of a Mutual Fund’s Cash Position: Low is _________, high is _________.
Bullish, Bearish
In terms of Credit Balances on Account: Low is _________, high is _________.
Bullish, Bearish
In terms of a put - call ratio: Low is _________, high is _________.
Bullish, Bearish
In terms of a yield curve: Up and to the right is ___________, down and to the right is ___________.
Bullish, bearish
In terms of the vix index: a low vix is ___________ and a high vix is _________.
Bullish, bearish
What is Delta’s or Hedge Ratio and how do you calculate it for a call or put?
The change in the value of an option for a $1 increase in the price of the stock
Delta(Call) = N(d)
Delta(Put) - = 1 - N(d)
Speculators in futures contracts are risk _________.
Neutral
What are the 4 advantages to investing in real assets?
1) Serve as an inflation hedge
2) Serve as a hedge against the unknown or feared
3) An excellent portfolio diversifier
4) More fun
What are the 4 disadvantages to investing in real assets?
1) Often do not have a large, liquid or efficient market.
2) Likely to have higher dealer spreads or commissions
3) Generally receive no income
4) Values less likely to react to hype or overreaction
What are the “real assets” that are available?
Real Estate
Precious Metals
Commodities
Precious Gems
Other Collectables
What amount of households in the U.S. own real estate?
65%
What is often the largest holding in an investment portfolio?
A home
How do you access real estate investment?
Direct investment
REITs
Partnerships
What is one of the most volatile real investment alternatives?
Precious metals
When does the price of precious metals typically rise?
When the rest of the market falls
How do you access precious metal investment?
Gold stocks
Gold futures
Gold ETFs
Commodities typically move _________ of the rest of the market
Opposite
How do you access commodity investment?
Commodity stocks
Commodity futures
Commodity ETFs
Precious gems are ____________ , but popular with the _____________.
not a good investment, Europeans
What is “private equity” investment?
Investing in companies that are not public
What is the goal of private equity investment?
Buying private companies that are currently private and helping them go public
What do private equity managers cite as an indication of their effectiveness?
The number of “exits” they’ve have and the returns on exits.
There is a high correlation between:
Private equity activity and IPOs + exits
How will most people access private equity?
A limited partnership fund
The manager of a LP Fund in private equity is the _________ partner, while investors are _________ partners.
general, limited
Typically investment investments in limited partnerships is restricted to _________ clients, usually these clients have a net worth in excess of __________.
qualified, $500,000
Private equity can be seen as a ____________ form of public equity.
less efficient
The gains to be made in the ________ market cap sectors of private equity are often _________ then than the public sector.
lower , higher
It has been shown that the performance of larger cap sectors of private equity is _______________ than the smaller cap public equity sectors.
not substantially larger
What are the ways a private equity increase the value of a company for shareholders?
1) Improving EBITDA
2) Leverage
3) Buy low and sell high
How can private equity increase the EBITDA of a company?
Improve efficiency, grow revenue, cut costs, shorten sales cycle
How can private equity use leverage to increase the value of a firm?
Use the debt to increase assets
How can a private equity firm make money “buying low and selling high”
Making money on the share prices of the company appreciating at the time of IPO
What is the danger of a private equity firm relying on multiple expansion to profit?
Not typically repeatable, better to increase business fundamentals
What is the J curve effect?
When you invest in private equity, the general partner will immediately start taking their fees. As such a private equity fund will typically have negative returns at the beginning of an investment before becoming positive.
What is the typical timeline for a private equity purchase to exit?
7 years
In slower economic times, a private equity purchase to exit timeline will likely be affected how?
+2 years
In stronger economic times, a private equity purchase to exit timeline will likely be affected how?
-2 years
How long does the J curve effect typically last?
2-3 years
What is the illusion of misstated volatility in private equity?
Because a private equity investment does not strike a daily NAV, the volatility of private equity appears less than public equity.
This is an illusion, private equity has greater volatility than small cap public equity.
What does a typical private equity fund fee structure look like?
1-2% committed capital
20% performance fee on everything over 0
What are the differences between venture capital and private equity?
- Investing in startups, not established businesses
- Higher failure rate 2-3 / 10
- Need for understanding of tech or science
- Lack of regional diversification
- Longer periods until firms become cash flow positive
- Need for additional capital injections to avoid dilution
Illustrate the life of a typical private equity INVESTMENT (1 company).
Illustrate the life of a private equity FUND.
Illustrate the J curve effect using a chart
