Chapter 15: Introduction to the Portfolio Approach Flashcards
Expected Return of a Single Security Formula
Expected Cash Flow + Expected Capital Gain (or - Capital Loss) / Beginning Value
Transaction period longer or shorter than a year.
Holding Period Return
A rate of return that is expected. Helps to determine where funds should be invested
Ex-ante
A rate of return that is based on actual historical returns. Compares actual results against both anticipated results and market benchmarks
Ex-post
The rate that is essentially “risk free”, or zero risk. Yield is roughly determined by estimating the short term inflation rate and adding a real return, so all other securities must be greater than this to compensate for the added risk.
Risk free return
The risk that inflation will reduce future purchasing power and real return
Inflation rate risk
The risk that a company’s earnings will be reduced as a result of a labour strike, introduction of a new product to the market, or other factors.
Business Risk
Risk of unfavourable changes in government policies. Raising taxes, raising or lowering interest rates, risks to foreign investment, etc.
Political Risk
Risk that an investor will not be able to buy or sell the security at a fair price quickly enough because opportunities are limited
Liquidity Risk
Risk that interest rates will adversely affect investment
Interest Rate Risk
Risk of loss resulting from an unfavourable change in exchange rates
Foreign Investment Risk
Risk that a company will be unable to make timely interest payments or repay the principal amount of a loan when it comes due
Default Risk
Risk associated with investing in a capital market. Always present, cannot be reduced through diversification
Systematic Risk
The risk of a specific security changing in price or going in a different direction. Can be reduced through diversification
Non-systematic/specific risk
Measure of risk commonly applied to portfolios and individual securities within the portfolio. Gives the investor an indication of the risk associated with the portfolio.
Standard Deviation
Links the risk of individual securities or a portfolio of securities to the market as a whole.
Measures the degree to which the securities tend to move up and down with the market.
Beta
Expected Return of the Portfolio Formula
E(r) = (R1)(W1) + (R2)(W2)… (Rn)(Wn)
A statistical measure of how the returns on two securities move together over time, and therefore, how a change to the value of one security can predict the change in value of another.
Correlation
The additional movement and excess return on the portfolio. Equity portfolios often outperform the market have move more than expected from their beta.
Alpha
Goal is to outperform a benchmark portfolio on a risk-adjusted basis. Use either a top-down or bottom-up analysis
Active Investment Manager
Begins with a study of broad macroeconomic factors before narrowing the analysis to individual stocks
Top Down approach
Begins with the focus on individual stocks, then builds portfolios of the best stocks in terms of forecasted risk-return characteristics
Bottom up approach
Tend to replicate the performance of a specific market index without trying to beat it
Passive Investment
Consistent with the view that securities markets are efficient, meaning that the price of a security at all times reflects all relevant information on expected return and risk.
Buy and Hold Strategy
Involves buying and holding a portfolio of securities that matches the composition of a benchmark index
Indexing
Focus on current and future earnings of individual companies, specifically EPS. Stocks in this type of portfolio usually have lower dividend yield, or provide no dividend at all, and managers may turn over the securities more often.
Growth Managers
Focus is on stocks that are perceived to be trading for less than their true value. Turnover is typically low because these managers usually wait for a stock’s intrinsic value to be realized.
Value Managers
High Price-to-earnings, high price-to-book value, high price-to-cashflow.
Growth Portfolio
Low price-to-earnings ratio, low price-to-book value ratio, low price-to-cash flow ratio, high dividend yield.
Value Portfolio
Applies to a top down approach, focusing on analyzing the prospects for the overall economy. Managers invest in the industry sectors expected to outperform. Primary focus is to identify the current phase of the economic cycle, the direction the economy is headed in, and the various sectors affected.
Sector Rotation
Hold t-bills and short-term bonds with maturities less than five years. Portfolios holding these products are less volatile when interest rates rise because they have investments maturing that can be invested at higher rates
Short Term Managers
Select higher quality corporate issues to improve the yield without taking on much additional risk. Generally, the lower quality of the bond, the higher the yield it must have.
Credit Quality
High-yield bonds that are non-investment grade products.
Junk bonds
Some managers feel they can add value by anticipating the direction of interest rates and structuring their portfolios accordingly.
Interest Rate Anticipators
