Investing, Trading and Measuring Return and Risk Flashcards
WHAT IS INVESTMENT
Committing money today in the expectation of receiving future benefits
what are Financial assets
ownership rights to a real asset or income generated by the real asset.
– Also referred to as financial instruments and financial securities.
what is real asset
Land, buildings, equipment and knowledge that can be used to produce goods and services.
Financial markets play the following roles
Capital allocation
Consumption timing
Allocation of risk
Separation of ownership and control
Whenconstructingtheirportfolioinvestorswillmake decisions on
Asset allocation = allocation of portfolio across a range of asset classes.
Security selection = choice of securities to hold in each asset class.
Two main forms of portfolio construction are
Top-down approach = decide on the best asset allocation and
then decide on the securities to include in each asset class.
– Bottom-up approach = select the most attractive securities without regard to asset allocation.
nvestors will buy and sell financial securities in financial markets
Primary market: Companies raise funds by creating and selling new securities to the public via the primary market
Secondary market: This is where existing securities are traded. Trading in the secondary market does not create new securities or provide new capital to companies.
A placement
An issue of new shares to a group of specific investors (e.g. institutions and wealthy investors).
A share purchase plan (SPP)
An issue of new shares is offered to existing shareholders. It is not based on the size of their current share holding.
A dividend reinvestment plan (DRP)
Existing shareholders are offered the opportunity to reinvest part or all of their dividend payments back into company in return for more shares.
A rights issue
Existing shareholders are given the right to purchase more shares in the company based on the size of their current share holding.
Terms used in an auction market
Bid price: the price at which a trader is willing to purchase a
security
– Ask price: the price at which trader will sell a security
– Bid-ask spread: the difference between the bid and ask prices – Market spread: lowest ask price less highest bid price
Transaction costs
total costs of making the financial market transaction.
Margin trading
borrowing money to finance the purchase of securities.
Short selling
selling securities that you borrow from someone.
What is involved in short selling
An investor borrows securities from their broker and sells them at a later date they will return the same number of securities to the broker. The broker can charge interest on this loan. If it is a short-sale of shares, the broker will also require compensation if the shares pay dividends during the short sale period.
The three operators are
expected return (value), variance and covariance.
Expected return
The expected return on an investment can be calculated using historical rates of return or possible rates of return that could occur in different scenario
How do you measure a rate of return?
it will be based on the investments value at the start of the period, the end of the period and any cash payments received during the period (e.g. dividends, interest).
– It is often referred to as the holding period return (HPR):
Variance
The risk of an investment is determined by ts possible future returns. Variance (sigma squared)
Correlation
measures how strongly two random variables are related -1 to 1 as it is standardised
