Assignment 1 - Investment Management Flashcards
Type of investment approach that takes advantage of price differences in separate markets.
Index Arbitrage Method
Type of investment risk that reflects the relationship b/w the nominal rate of return on an inv. and the increase in the rate of inflation.
Purchasing Power Risk
Term for converting an inv. into cash in a short time period w/ very little loss in principal.
liquidity
- The slope of the line measured as a chg in vertical mvmt per unit of chg. in the horizontal mvmt.
- avg return on the portf. per 1% return on the mkt
Beta value
Term for an unsecured S/T note issued for the purpose of raising capital.
commercial paper
type of stock issued by companies whose earnings fluctuate w/ the business cycle and are accentuated by it.
cyclical stock
types of investment risk
- purchasing power
- business
- interest rate
- market
- specific
type of inv. risk
prospect of the corp. issuing the security suffering a decline in earnings power that would adversely affect its ability to pay interest, principal or divs.
Business Risk
type of investment risk
inverse relationship b/w i/r and l/t bond prices
int. rates increase = value of l/t bond decreases
interest rate risk
type of inv. risk
relationship of a chg in the market to stock prices (direct relationship)
however, the speed to which the mkt chg’s could be different than the speed that the stock chg’s
Market Risk
Why is the liquidity of an inv. important to a plan?
you may need to structure your plan to include some more liquid inv. in order to help during times that contrib. to partic. is questionable (downturns in business or the mkt)
(4) steps to effective performance management
- Definition: establ. of inv. obj and strat.
- Input: availability of reliable and timely data
- Processing: use of approp. statistical methods to produce relevant measurements
- Output: analysis of process and results presented in useful format
(2) alternative definitions for measuring return
- internal rate of return
- time-weighted rate of return
- type of definition for measuring return
- rate that accumulates all of the CFs of a portf. to exactly the MV of the ending balance.
- PRO - allows sponsor to determine whether the inv. is achieving the rate of return assumed for actuarial calc’s.
- CON - contaminated by the effects of the timing of inv. and w/drawals (inv. mgr doesn’t have control over this)
Internal Rate of Return
- type of measuring return
- geometric avg for the rates of subintervals, w/ each rate having a weight proportional to the length of time in its corresponding subinterval
subinterval = value is computed by dividing the interval into subintervals whose boundaries are the dates of CF’s into and out of the fund by computeing the IRR of each subinterval
Time-weighted rate of return
**this pricing model uses standard statistical techniques to analyze the relationship b/w the periodic returns of the portfolio and those of the mkt.
- a method of adjusting returns for the risk of the portfolio
- alpha value vs. beta value
capital asset pricing model
value that shows the avg. amt of return produced by the portfolio independent of the return on the mkt
portfolio’s alpha value
this can be used to measure risk-adjusted perf. and to compare portf. w/ different risk levels developed by actual portf. decisions
risk-adjusted rate of return
(5) types of money mkt instruments
- U.S. T-Bills and notes
- fed’l agency issues
- CD’s
- Comm Paper
- MMMF’s
- type of money mkt instrum.
- some have maturities of 91 to 360 days; others 1-5 years
- no default risk
- probability that either int. or principal pmts will be skipped = nearly 0
U.S. T-bills and notes
- type of money mkt instrum.
- s/t obligs = maturities range from 1 month to 10 yrs
- yield slightly more than Treas. oblig. with similary maturity
fed’l agency issues
why are bonds used to fund pension plan portf?
- fixed-$ benef. will be paid out over several years in the future = desire is to have assets that generate CF similar to the benef. pmt
- longer maturity = assumption of i/r risk is compensated for by higher yeld
(6) types of common stocks
- blue chip stk
- growth stk
- income stk
- cyclical stk
- int.-sensitive stk
type of stk issued by major companies w/ long and unbroken records of earnings and div. pmts
stable and safe
blue chip stk
type of stk issued by companies whose sales, earnings and mkt share are expanding faster than either the general econ. or ind. avg.
higher risk = higher return
pays small divs = decreased CF
growth stk
type of stock that pays higher-than-avg div. returns
attractive to pension plans that bought stock for current income (liquid)
income stocks
type of stock issued by recession-resistant companies
considered for plans that can’t afford major capital losses
defensive stks
type of stock whose prices are relative to the performance of interest rates
interest-sensitive stks
why choose MF’s as inv. vehicles?
- greater liquidity
- greater degree of diversification (and cheaper)
- easier means of portf. specialization
- daily update of holdings
- ease of meeting asset alloc. or mkt timing goals
- ease of ckg past perf. through studies
- inv. strat. of a broadly diversifed buy and hold portf. aimed at replicating the return on some broad mkt index at min. cost
- attractive to pension plan sponsors
- types: index funds; dedication
passive inv. strat.
- type of passive inv. strat
- uses bond mkt
- attempt to construct a bond portf. such that its CF can be used to fund specific plan liabilities = such as to pay benef. to group of retirees
dedication, immunization, and contingent immunization techniques
ERs and EEs role in plan inv. provisions of a DC plan
ER: structure approp. inv. prog.; select suitable inv. mgrs; monitor perf.; communicate to EEs
EE: decide how to invest acct balances; assume all risks associated w/ inv. perf.
BOTH: have sound understanding of basic inv. principles if to succeed in their parts.
Benefits to ER for successful inv. prog.
- low-cost fees
- ease of admin
- flexibility to make needed chg’s to inv arrangements
- improved recogn. of company as source of valuable benef.
Benefits to EE for successful inv. prog.
- increased participation
- improved returns
- lower costs
PPA’s effect on providing protection to and advanced efforts to improve inv. outcomes of DC plans
Provisions that :
- facilitate plan sponsors’ ability to provide inv. advice
- require inv. diversifcation for DC plans
- permit fiduciary exemption assoc. w/ auto-enrollment
ERISA section that provides fiduciary protection for partic. inv. selection provided requriements are met:
- min of 3 diversified inv. options
- qrtly or more frequent inv. chg’s
- partic. education
404(c)
replicates a partic. index such as the S&P 500 and is designed to generate a beta of 1.0
index fund
common measurement methods for portfolio risk
- total variability in absolute terms
- total variabiltiy in relative terms
- market-related variability
taxation of QDRO’s (qualified domestic relations order) pmts
taxable to the alternate payee (former spouse)
