Advanced Investments Flashcards
NYSE
4:00pm previous day is last recorded rate but closing time to current days opening time at 9:30am stock price can change
Equity Return characteristics
- Ownership- voting rights and dividends
- Residual Claim- last in line for liquidation
- Limited liability- maximum loss is initial investment
Higher Order moments
Return distributions
- Mean
- Variance
- Skewness
- Kurtosis
Soreness
Lopsided around its mean
To left- more chances of realizing extreme negative returns
To right- positive skewness, more chances of realizing positive returns
Kurtosis
Distribution has fat tails
Bigger tail- bigger chances of realizing very negative returns and positive returns
- depends on personal preference
- normal kurtosis = 3
R-squared
Measures the amount of variation in the dependent variable (y) that is explained by the regression equation
Always between 0 and 1
T-stay
> 2 indicates the regression coefficient is statistically reliable
Regression coefficient
Is beta
SMB
HML
UMD
SMB - small minus big – buying small stocks and simultaneously selling short large stocks
HML - high minus low – high book to market ratio
High = value
Low = growth
UMD - up minus down – buy recent winner stocks and sell recent loser stocks
S&P 500 vs Dow Jones
Dow jones - 30 large blue chip corporations, oldest in U.S., price weighted average
S&P 500 - market value weighted
Arithmetic average vs Geometric average
- Arithmetic average will always be larger than geometric average as long as the variance is not zero
- Geometric average return describes the same cumulative performance as the sequence of ACTUAL returns
Investment return equation
= p[(GAR + 1)^n - 1] + p[(GAR + 1)^n - 1]
Successful diversification
- Make sure securities are from different sectors/industries
- Rebalance portfolio
- Hold more securities than standard textbooks due to more competition (>60 – average level of idiosyncratic risk has been increasing)
Two Fund Separation Theorem
- All portfolios on the frontier can be generated by a weighted combination of any two portfolios on the frontier
- Any weighted combination of minimum variance portfolios is also on the frontier
- We only need to find two portfolios on the minimum variance frontier and we can generate all portfolios on the frontier
Capital Market Line assumes
- There are no transaction costs
- A risk free security is available
- All investors have the same beliefs about returns and covariances
- All investors are rational mean-variance optimizers
= all investors will hold a portfolio that contains the risk free asset and the tangency portfolio on the efficient frontier
CAPM
- Market is in equilibrium - buyers find sellers, perfectly matched
- Linear relationship between stocks market Beta - security market line
CAPM equation intuition
E(r) = time value of moment + market risk x price of risk
R-squared
R-squared = (Bjm^2 x om^2)/oj^2
=systematic / total
Regression of one of stocks on return of portfolio beta and r-squared
Beta = Cov(r, r p)/ variance of portfolio
R-squared = [Cov(r, r p)/(Sd of k x Sd of p)]
If asset plots on the CML, the correlation between asset and market portfolio is
1
If asset plots on the SML, the correlation between asset and market portfolio is
+1 only if on SML at equilibrium
When CAPM is in equilibrium
The expected return is equal to the required return ALWAYS
In CAPM equilibrium assets with beta > 1 expose investors to firm specific risk when
Borrow and invest in market only
Hurdle rate
Determined by the projects beta not the firm beta
