Final Flashcards
What is the Weak Form of EMH?
Future asset prices cannot be predicted using historical price and volume data. Such information is widely available from the business press and on investing websites such as Google Finance or Yahoo Finance.
Current price reflects all information we know.
O: Fundamental Analysis
O: Insider Info
What is the Semi-Strong Form of EMH?
Asset prices adjust immediately to all publicly available information, including that which reflects the company’s fundamentals like financial disclosures.
This prohibits fundamental analysis if correct, but you can make money through Insider Information.
X: Fundamental Analysis
O: Insider Info
What is the Strong Form of EMH?
Asset prices adjust immediately to reflect all relevant information, including that available to insiders.
If this is true, it’s impossible to make money other than holding market portfolio. This is the least convincing as we’ve see people make money through insider information.
X: Fundamental Analysis
X: Insider Info
What does lower P/E Ratio indicate?
Low PE ratios correspond with higher returns. PE ratio is very predictive and refutes the semi-strong EMH.
What is Grinold’s Fundamental Law?
Performance = Skill * Sqrt(Breadth)
Performance, Skill, Breadth
IR = IC * Sqrt(Breadth)
What is IR?
Information Ratio - The Sharpe Ratio of the skill component of return of portfolio calculation
mean(alpha_p(t)) / stdev(alpha_p(t))
What is IC?
Information Coefficient
Correlation of manager’s forecasts to returns. Ranges 0 to 1.
What is Breadth?
Number of trading opportunities per year.
What is risk?
Volatility
Standard Deviation of historical daily returns
What is Mean Variance Optimization?
Inputs: Expected Return, Volatility (historically how volatile assets have been), Covariance (matrix between assets), Target Return (Max return asset to min return asset)
Output: Asset weights for portfolio that minimizes risk
What is the Efficient Frontier?
No portfolios past frontier and if within line, it’s suboptimal in some way.
Tangent line from origin to frontier, where it intersects is max Sharpe Ratio portfolio for all assets.
Which version of EMH is correct?
It is likely that different versions apply in different markets. The strongest versions apply in the largest, most transparent, most liquid markets such as for US large cap stocks.
What is an option?
An option is a contract which gives the buyer the right, but not the obligation, to buy or sell the underlying stock at a specific price on or before the expiration date
PROs of Options?
- Can’t lose more than premium paid up front
- Leverage (get most upside potential, cap downside to premium paid, tie up less money and can use it elsewhere)
CONs of Options?
- Premium is lost money
- Expiration dates - add a layer of complexity
- You don’t own the stock
