Introduction: Risk, Return, and Historical Record | Financial Markets and Instruments Flashcards
What are the three major asset classes?
Equity
Fixed income
Derivatives
What are examples of equity assets?
stocks (small, medium, large-cap, growth vs value, winners vs losers)
What are examples of fixed-income assets?
Currencies
money market instruments
bonds (zeros vs coupon bonds, fixed vs floating, government vs corporate, investment grade vs junk, high vs low duration
Mortgages
What are examples of derivative assets?
Options
Futures
Forwards
Swaps
Swaptions
Forward Rate Agreements (FRAs)
Credit Default Swaps (CDS)
What is asset allocation?
The optimal balance between risk and return subject to:
risk aversion, taxes, liquidity constraints, transaction costs, and investment horizon
What is a strong indicator of the returns of a fund?
The asset allocation
Are there reliable models of how to optimally invest in major asset classes?
No
What is the single most important decision to have a favorable return?
Asset allocation
What is excess return?
it is the difference between the asset return and the return on some reference asset
What is the reference asset used to calculate the excess return?
It is usually a risk-free asset, but it doesn’t have to be
What is the expected return also known as?
the risk premium on the asset
What rate of return is more convenient for statistical modeling purposes?
Continuously compounding returns
What does CDO stand for?
collateralized debt obligation
What is a CDO
a security backed by a diversified pool of one or more of these debt obligations:
Bonds, bank loans, distressed debt…
What is securitization?
a way that loans can increase much faster than deposits. Banks sell mortgages to special purpose vehicles (SPVs), service the loans, but they would not have them on their balance sheet anymore
