Definitions Flashcards
Contrarian investment style
A contrarian investment style implies doing the opposite to what most other investors are doing in the market – especially at market extremes in the belief that investors tend to overreact to news:
The belief is that if a share has performed well recently, the chances that the share is overpriced and will perform poorly in the coming months is greater.
The approach aims to take advantage of excessive volatility in the investment market.
Credit Default Swap (CDS)
The investor may buy a credit default swap which gives them the right to sell their private debt holding in the company to a counterparty at face value in the event that the company defaults on its debt obligations.
Credit events include bankruptcy, a ratings downgrade or cross default.
Credit-linked note
The investor could set up an SPV, which then sells credit-linked notes to other investors and uses the proceeds to buy government bonds (assumed to be risk free).
At the same time the SPV cells CDS based on the company private debt to the investor
In the case of default, the private debt investor would receive the government bonds, and the other investor would receive the company private debt
Credit spread
Credit spread is a measure of the difference in the yield on a risky and risk-free security. It’s a measure of the risk premium the risky corporate or sovereign entity need to pay to attract capital.
In this instance it refers to the excess yield on corporate bonds compared to government bonds of the same/similar term.
Financial covenant
Private debt investors are very focused on covenant protection because illiquid markets mean they ay be unable to sell their private debt investments in the event of a credit downturn.
Covenants generally impose requirements and restrictions on the activities of the borrower to safeguard the security of the loan.
Security afforded by covenants to the lender helps reduce the cost of the debt to the issuer.
Sustainable and socially responsible investment
Socially responsible investment incorporates environmental, social and ethical objectives into the decision-making process.
Sustainable investing implies considering environmental, social and governance factors that are consistent with the long-term sustainability of society and the environment.
Risk budgeting
Refers to the process of determining how much investment risk should be taken and where it is most efficient to take it to maximise returns.
Strategic risk
Refers to the risk of the strategic benchmark performing poorly relative to the value of the liabilities or the matched benchmark.
Active risk
Refers to the risk that an active manager will underperform compared to their allocated benchmarks.
Float adjustment
Refers to adjusting individual stocks included in the index to represent the number of shares that are available for trading.
It excludes shares that are held for strategic purposes and are unlikely to be sold.
Ensures the value of the index realistically reflects the available supply of these shares in the market/sector.
Rebalancing
The index establishes inclusion criteria that determines whether shares are included in the index to maintain the level of diversification and risk profile.
As the markets are dynamic and affect the market capitalisations of the shares, these inclusion criteria will detect breaches at frequent intervals, usually quarterly, and shares which no longer meet the criteria will be excluded and shares that do will be included to replace these.
Operational risk
The risk of losses due to fraud or misappropriation of funds by the investment management organisation itself, including the risk of loss from external events.
Growth equity management style
Investors look to invest in companies that they expect to grow faster than the average when compared to the market or industry in which the company operates.
Growth stocks may be trading on higher than average PE multiples when compared to other stocks, however investors believe these stocks will grow more rapidly or will be subject to a positive earnings revision in the future.
Value equity management style
Investors buy securities believed to be underpriced by some form of fundamnetal analysis.
Low price relative to book value has been widely used to identify value stocks but the definition today is less prescriptive.
Value investors believe the market overreacts to good and bad news, resulting in stock price movements that don’t correspond to a company’s fundamentals.
Prospect Theory
- Value is based on gains or losses relative to a reference point
- When faced with potential gains, investors are risk averse.
- When faced with potential losses, investors are risk seeking.
- Asymmetric reaction to gains and losses – investors suffer more pain from a loss than please from a gain of equal size.
- The decision made is therefore based on how a problem is framed.
Stratified sampling
Entails purchasing a sample of the stocks in an index so that the proportions of the fund in the specified industry categories matches that of the index
Full replication
All of the stocks in the index are held in proportion to their index weights.
Liability hedging
Where assets are chosen in such a way so as to perform in the same way as liabilities.
Liability Driven Investment
The terminology used to describe an investment decision where the asset allocation is determined in whole or in part relative to a specific set of liabilities.
Real rate swap
Allows the fund to invest the assets in a portfolio of fixed rate bonds (usually corporate bonds) and swap the fixed cashflows (coupon and redemption payments) from the bond portfolio in return for cashflows that match the timing and inflation characteristics of the pension payments.
Synthetic index-linked bonds
A variation of the real rate swap whereby the fund still holds fixed rate bonds (usually corporate bonds) but in this case swaps the fixed cashflows for payments that are indexed with CPI (i.e. a notional index-linked bond) in the same manner as the cashflows of an index linked government bond.
