Chapter 9: Investment Management Flashcards
How is Expected Return Calculated?
Taking the probability of each scenario and multiplying them by the Scenario Return.
What are the Main 9 Risk Types?
think hard
- Market or Systematic Risk
- Inflation Risk
- Interest Rate Risk
- Reinvestment Risk
- Exchange rate risk
- Political and legal risk
- Regulatory Risk
- Default Risk
- Liquidity Risk
What is Forward-looking Risk Analysis?
forcasts probabilites and asses the liklehood of each possible state of the world occuring and estimare the returns and values arising given that particular outcome.
What is Backward-looking Risk Analysis?
Studying historically observed returns and associated freqeuncies on the assumption that this past data will be representative of the future.
Are Equities considered risky?
Yes.
What is the Equity Risk Premium and How is it Calculated?
A higher rate of return that is required to entice investors to take on the risk of owning shares.
If the total return of a stock is 10%, and the risk free rate is 4% the equity risk premium is 6%.
What are the Benefits of Money Market Instruments?
What is also wrong with them?
For investors that do not want their money tied up for long periods, they are predictable and very liquid.
They however do not provide great scope for capital growth.
What is the desire to move into government issued short term paper in times of terror known as?
Flight to safety
What makes fixed-income securities attractive?
The security and regular pre determined coupons
When might capital loss be incurred from fixed income securities?
If the issuer defaults or the bond is sold when the value is below the nomial before maturity.
How do Equities, commodities and Property cope with Inflation?
Relatively well as they can adjust their prices.
What is Classified Investment Grade ? Ratings Above
BBB for Fitch and S&P or Baa for Moodys
What can occur if a ratings agency changes the rating of the bond? for the holder
They can demand a greater coupon for the now greater risk incurred.
What is Credit Enhancement?
It is where a bonds will receive a sovereign guarantee (or some other form) thus reducing credit risk and boosting the bonds rating.
What are the Risks Associated with Overseas Equities and Bonds?
Currency Risk and Political and legal risks.
What does risk holding not perfectly positively correlated assets in a portfolio remove?
Unsystematic risk
How is diversification maximised?
By holding investments with uncorrelated returns, this does not need to be investments that are uncorrelated
What risk cannot be diversified away?
Market and systematic risk
What is one of the key issues when hedging with futures contracts?
Knowing when to enter and exit the trade
Will seperate accounts generally be required for future hedges?
yes due to operational considerations
What is the risk taken by the purchaser of the put?
The premium of the option
What are Contract for Differences?
Is a contract (derivative) that allows an individual to benefit of the price movement without actually owning the underlying asset/
Are CFDs margin traded?
Yes. These are geared positions that mean the investor does not need to invest the full amount of capital.
Is commission paid on CFDs?
Yes
Are CFDS risky, why?
Because an adverse price movement can warrant heavy margin calls, which can impact the value of the position it is aiming to hedge.
What are the 2 types of margin traded on a CFD?
* Initial Margin: normally between 5 and 30% for shares and 1% for indicies and FX
*Variance or Maintenance Margin: The CFD will be marked to the market at currently prevailing prices and if the position has moved beyond the amount taken as initial margin - additional margin would be required.
What is the Liquidation Preference?
The amount that must be paid to preference shareholders, such as venture capital ot angel investors, before distibutions can be made to common stock holders.
What do Pension Funds tend to Invest In?
Long term higher risk assets, such as equities
What is a Defined Contribution Scheme?
Pension funds where the return is derived from contributions made and investment performance.
What is a Defined Benefit Scheme?
Pension funds that define the benefits they will pay out.
What is a Term Assurance Policy?
In exchange for a regular premium, only pay out if the individual dies before the end of the set policy term.
What is a Whole of life policy?
Simply pay out on the death in exchange for regular premiums
What is an Endowment Policy?
Term assurnace policy with significant investement element that depends on the performabce of the insurance companies fund,
What are Single Premium Life Assurance Bonds?
As the name suggests
Single premium endowments, again they have a signifcant investment element.
Are the Long term high risk investments associated with Life Assurance Funds subject to tax?
Yes
What do General Insurance Funds Invest In?
Are they subject to tax?
Short term low risk assets, such as money market instruments
They are subject to tax
What is a banks Approach to Risk when selecting securities?
Short term low risk
What are examples of Mutual Funds?
Collective investment vehicles, can either be authorised or unauthorised.
Can regulated funds use gearing?
Who can?
yes but hardly any, not like hedge funds who are free to
What are Hedge Funds AKA?
Absolute Return Vehicles, as they expect t make a positive retunr in all market conditions.
What is a Sovereign Wealth Fund?
State owned investment funds commonly established from balance of payment surpluses.
Do SWFs prefer returns of liquidity?
Returns.
What are Sovereign Wealth Funds Objectives?
- Protect and stabilise economic budget
- Diversifying from non renewable commmodity exports
- Earning greater returns than FX reserves
- Increasing savings for future generations
- Funding S and E development
- Promoting sustainable growth
What must a company do when it receives price altering information?
Inform a PIP, such as the LSE Regulatory New Service
What are examples of secondary information providers?
What do they do?
Bloomberg, Refinitv etc
They disseminate information to the wider financial market,
What are Specialist Strategies the Active Managers may employ?
Merger Arbitrage, option wirting, statistical abritrage etc.
What are Advantages of Active Management?
- Some actively managed firms may not be as correlated with the index due to range of investements, allowing an investor to further diversify their portfolio.
- Some investors may wish to follow a strategy that avoids or underweighs certain industries, compares to the market as a whole.
What are Disadvantages of Active Management?
- Fund manager may make bad decisions
- Higher fees
- Frequent trading warrants higher fees and tax
- ## The emergence of ETFs solves this issue so could be a better alternative (costs and liquidity)
What is a Pseudo-Tracker?
What do some fund managers do about this?
When a client is paying active management fees, for an effectively passive fund.
Some fund managers close their fund to new investors once it reaches a certain size, so they can avoid being so broadly diversified.
What are 2 example of funds that are “Actively Managed” with manager participation?
Hedge and Private equity Funds
What is Skin in the Game?
Where the fund manager has some of its own interests invested within the funds, i.e. Private equity or Hedge funds.
Who uses bond policy switching?
What do they do?
Bond fund managers who believe they can beat the buy and hold notion
Actively switching the overpriced bonds for the underpriced bonds
What is Anomoly Switching?
Moving between 2 bonds similar in all respects apart from the yield and price. This pricing anomoly is exploited.
What is Policy Switching?
When an interet rate cut is expected but not implied by the yield curve, shorter dated low duration bonds are traded for longer dated higher duration bonds.
By predicting the downturn they could massivley profit from the rate change,
What is the Inter-market spead switch?
When the in yield being offered between corporate and comparable government bonds, is excessive considering the percieved risk. This would involve swapping gilts for corporates
and vice versa
What is “Market Timing”?
When it is beleived that the markets view of interest rates are incorrect or have failed to be anticipated.
What is Riding the Yield Curve?
Active bond strategy that does not invol;ve seeking out price anomilies, but instead takes advantage of an upward sloping yield curve.
Benefits of Passive Management?
- Lower fees and tax (greater returns)
- Does not rely on a managers judgement
- Lower expense ratio
What happens if an actively managed fund becomes so large?
It can begin to mimic an index
What are disadvantages of passive management?
- Buyer must be content with index returns
- lack of control
- Lacks the potential to generate alphas
- cannot be specific about what industries or underwieghted sectors they want to avoid
What is an Alpha?
The outperfomance of a given benchmark
What is a Beta?
The beta is a statistic that measures the expected increase or decrease of an individual stock price in proportion to movements of the stock market as a whole.
What type of Management Strategies is Favoured for Emerging Markets?
Active
As the majority of their markets is still privately owned, so does not behave like a typical index.
What is a Smart Beta?
An investement strategy that does not use the typical mkt cap weighting system, but instead weights constiuents equally or based on dividends paid etc,
What is Immunisation?
Passive bond management technique, for those with a known future liability to meet. An immunised portfolio is one that is immune from future rate changes
What is Cash matching?
Constructing a bond portfolio whose coupon and redemption payment cash flows are synchronised to match those of the liabilities to be met.
What is Duration Based Immunisation?
What is a portfolio of the nature known as?
Constructing a PF with the same intial value as the present value of all the liabilities it is designed to meet and the same duration as this liability.
Bullet portfolio
What is the Barbell Strategy
If a bullet portoflio holds bonds to match a liability of 10 years, it may hold some at 5 or 15 years to hedge.
What is a Ladder Portfolio?
Constructed around equal amounts invested in bonds with different durations.
