Advanced Portfolio Concepts

Question 1

Sharpe Ratio

Answer 1

Tells an individual how efficient their portfolio is operating.

It tells them how much they are receiving in return for each unit of investment

Expected Return - Risk-Free Return / the portfolios Standard Deviation

Question 2

Risk-Free Return

Answer 2

the 90 day T-bill

The risk-free rate of return represents the interest on an investor’s money that would be expected from an absolutely risk-free investment over a specified period of time.

Question 3

R Squared (or R2)

Answer 3

Tells the investor how much of the return of that portfolio is tied to the return of the market as a whole. Will be from 0-100 or 0-1. An index fund would have a r2 of 100 or 1 because its very close to matching that index

Question 4

Expected Return

Answer 4

The weighted sum of all possible outcomes

Opinion	Expected Return	Probability	Weighted Return
Out Preform	20%	25%	5%
Market Preform	10%	50%	5%
Under Preform	5%	25%	1.25%
Expected Return			11.25%

Weighted return = probability *(Expected Return/100)
Expected Return = all weighted returns added up

Question 5

Present and Future Value

Answer 5

(don’t have to calculate with on the test just need to know)
See TestGeek
The longer the time period, the greater the future value will be

Question 6

Dividend Discount Model

Answer 6

Assumes all quarterly dividends payed out by a company will be the same

Question 7

Dividend Growth Model

Answer 7

Assumes quarterly dividends will be going up

All you need to know for the test is that the dividend growth model predicts a higher current stock price

Question 8

Dollar Weighted Return

Answer 8

Used when an investor is going to be adding/withdrawing from the account

Question 9

Time-Weighted Return

Answer 9

Used when the investor is not going to be adding/withdrawing from the account

Question 10

Total Return

Answer 10

the profit and loss on a security plus or minus the income received

(Dividends make the return of an investment greater and need to be calculated into the equation)

Question 11

Portfolio Rebalancing

Answer 11

Efficient Frontier

Systematic Rebalancing

Active

Question 12

Efficient Frontier

Answer 12

All portfolios should operate equal to the efficient frontier (they are operating in line with their risk tolerance)

Question 13

Systematic Rebalancing

Answer 13

Passive investment approach reinvesting every so often to keep it inline with portfolio goals

Question 14

Active

Answer 14

Tactically Trading

Question 15

Perpetual Income Accounts

Answer 15

To create one you need to know how much money the investor wants to generate each year and what the interest rate available to that investor is. This will show you how much they need to invest.

Ie:
Monthly Income Desired	2000
Annual Income	24000
Interest Rate	6%
Calculation	24000/.06
Amount to be invested	400000

Question 16

The Rule of 72

Answer 16

How many years it will take for an investment to double
72/Rate of return

OR

What rate of return will be required to double your money in X amount of years
72/Number of Years

Question 17

Convexity

Answer 17

Measures the bonds price sensitivity to a large change in interest rates. Convexity will tell you how much your bond changed in value after the change in interest rates

Mortgage-backed Securities have negative convexity. When interest rates fall the value of the bonds will not go up by as much as they would fall given an equal change in interest rates. This is because when you have a drop in interest rates, people tend to refinance their mortgages and this causes these types of securities to be paid off more quickly.

Normal bonds = Convexity
Mortgage-backed Securities = Negative Convexity

Question 18

Duration

Answer 18

Duration shows the number of years it takes the cash flow to pay back the bonds principle

Higher coupon bonds have shorter duration

Higher duration = greater interest rate risk

Question 19

Mean

Answer 19

the actual average of all price observations of a security. It’s the average

Question 20

Median

Answer 20

The absolute middle of all price observations take the absolute lowest price and the absolute highest price divide it by 2 and you get your median

Question 21

Mode

Answer 21

The most frequent price observation. Which ever one shows up most frequently

Question 22

If they ask you a question like which portfolio performed best

Answer 22

Pick the one that has the highest difference between the mean and the median where the mean is greater then the median.

Question 23

Standard Deviation

Answer 23

How far the data is from the mean (average)

You want your return as close as possible to the standard deviation