General Flashcards
What is Quantitative Analysis (QA)?
Using mathematical and statistical modeling, measurement, and research to understand behaviour
What is the aim of quants and how do they attempt to achieve it
Quants aim to forecast where the market is headed by using mathematical and statistical techniques to analyse financial data
What is Regression Analysis
A statistical analysis technique which helps in understanding relationships between variables
What is time series analysis
A statistical analysis technique which looks at data points collected or recorded at a specific time
What are Monte Carlo simulations
A statistical analysis technique that allows you to account for uncertainty in your analyses and forecasts
What is Risk Modeling? List 3 methods
Involves creating mathematical models to measure and quantify various risk exposures within a portfolio
- Value at Risk (VaR)
- Scenario Analysis
- Stress Testing
What are derivatives and what is derivatives pricing?
Derivatives are financial contracts whose value is derived from other underlying assets such as stocks or bonds.
Derivatives pricing involves creating mathematical models to evaluate these contracts and determine their fair prices and risk profiles
What is Portfolio Optimisation
Constructing a portfolio in such a way that yields the highest possible expected return for a given level of risk
What does Qualitative Analysis focus more on compared to QA
Qualitative analysis focuses more on the underlying aspects of a company or a financial instrument, which may not be immediately quantifiable
Give examples of qualitative data
- reputation
- regulatory insights
- employee morale
Common uses of qualitative analysis
- Management evaluation
- Industry analysis
- brand value and company reputation
- regulatory environment
List some drawbacks and limitations of QA
- Data dependency
- complexity
- lack of subjectivity
- over-reliance on historical data
- overfitting
What Is Value at Risk (VaR)?
A statistic that quantifies the extent of possible financial losses within a firm, portfolio, or position over a specific time frame
How does one measure VaR? Give an example
One measures VaR by assessing the amount of potential loss, the probability of occurrence for the amount of loss, and the time frame.
For example, an asset that has a 3% one-month VaR of 2% represents a 3% chance of the asset declining in value by 2% during the one-month time frame
What is the Historical VaR Method?
Looks at one’s prior returns history and orders them from worst losses to greatest gains - following from the premise that past returns experience will inform future outcomes
What is the Variance-Covariance VaR method?
- Assumes that gains and losses are normally distributed.
- potential losses can be framed in terms of standard deviation events from the mean
- works best for risk measurement in which the distributions are known and reliably estimated
What is the Monte Carlo VaR method?
- Use of computational models to simulate projected returns over thousands of possible iterations
- assesses the impact of loss occurrences across the varying occurrence probabilities
Advantages of VaR?
- it is a single number, expressed as a percentage or in price units
- easily interpretable and widely used by financial industry professionals
- VaR computations can be compared across different types of assets or portfolios
Disadvantages of VaR
- no standard protocol for the statistics used to determine risk
- the assessment of potential loss represents the lowest amount of risk in a range of outcomes
What is a Black Swan
An extremely rare event with severe consequences
What is an Investment Time Horizon (Time Horizon)
the period of time one expects to hold an investment until they need the money back
What is marginal VaR?
- a calculation of the additional risk that a new investment position will add to a portfolio or a firm
- simply, an estimate of the change in the total amount of risk
What Is Scenario Analysis?
the process of estimating the expected value of a portfolio after a given period of time, assuming specific changes in the values of the portfolio’s securities or key factors take place, such as a change in the interest rate
What does the technique of scenario analysis involve
computing different reinvestment rates for expected returns that are reinvested within the investment horizon
Advantages of Scenario Analysis
Its biggest advantage is that it acts as an in-depth examination of all possible outcomes, which allows managers to test decisions, understand the potential impact of specific variables, and identify potential risks
Disadvantages of Scenario Analysis
- incorrect assumptions lead to incorrect models
- susceptible to biases of the user
- tends to be heavily dependent on historical data
What is Stress Testing
A computer-simulated technique to analyse how banks and investment portfolios could fare in drastic economic scenarios
What is a Hedge?
An investment that is made with the intention of reducing the risk of adverse price movements in an asset
How does a hedge works
Using a hedge is somewhat analogous to taking out an insurance policy
What is the risk-reward tradeoff inherent in trading with Hedges
While it reduces potential risk, it minimises potential gains
What is a “perfect hedge”
- One that eliminates all risk in a position or portfolio.
- the hedge is 100% inversely correlated to the vulnerable asset
- more an ideal than a reality on the ground
What is Basis and Basis Risk?
Basis Risk refers to the risk that an asset and a hedge will not move in opposite directions as expected.
“Basis” refers to the discrepancy
What is delta with regards to hedging with derivatives?
The effectiveness of a derivative hedge is expressed in terms of its delta, sometimes called the hedge ratio.
Delta is the amount that the price of a derivative moves per €1 movement in the price of the underlying asset.
Total value of AIB’s assets (2023)
$142 billion
What is Historical Stress Testing
The business, asset class, portfolio or individual investment is run through a simulation based on a previous crisis
What is Hypothetical Stress testing
It is more specific, focusing on how a particular company might weather a particular crisis
What is Simulated Stress Testing
Used for modeling probabilities of various outcomes given specific variables
What is the Modern Portfolio Theory (MPT)?
A practical method for selecting investments in order to maximise their overall returns within an acceptable level of risk
What is a key idea in understanding MPT?
The theory argues that any given instrument’s risk and return characteristics should not be viewed alone but should be evaluated by how it effects the overall portfolio’s risk and return
What is the Acceptable Risk assumption in MPT?
assumes that investors are risk-averse, meaning they prefer a less risky portfolio to a riskier one for a given level of return
Benefits of MPT
- diversified portfolios
- more efficient portfolios
List criticisms of the MPT
- portfolios are evaluated based on variance rather than downside risk
