Investing, Trading and Measuring Return and Risk

Question 1

WHAT IS INVESTMENT

Answer 1

Committing money today in the expectation of receiving future benefits

Question 2

what are Financial assets

Answer 2

ownership rights to a real asset or income generated by the real asset.
– Also referred to as financial instruments and financial securities.

Question 3

what is real asset

Answer 3

Land, buildings, equipment and knowledge that can be used to produce goods and services.

Question 4

Financial markets play the following roles

Answer 4

Capital allocation
Consumption timing
Allocation of risk
Separation of ownership and control

Question 5

Whenconstructingtheirportfolioinvestorswillmake decisions on

Answer 5

Asset allocation = allocation of portfolio across a range of asset classes.

Security selection = choice of securities to hold in each asset class.

Question 6

Two main forms of portfolio construction are

Answer 6

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.

Question 7

nvestors will buy and sell financial securities in financial markets

Answer 7

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.

Question 8

A placement

Answer 8

An issue of new shares to a group of specific investors (e.g. institutions and wealthy investors).

Question 9

A share purchase plan (SPP)

Answer 9

An issue of new shares is offered to existing shareholders. It is not based on the size of their current share holding.

Question 10

A dividend reinvestment plan (DRP)

Answer 10

Existing shareholders are offered the opportunity to reinvest part or all of their dividend payments back into company in return for more shares.

Question 11

A rights issue

Answer 11

Existing shareholders are given the right to purchase more shares in the company based on the size of their current share holding.

Question 12

Terms used in an auction market

Answer 12

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

Question 13

Transaction costs

Answer 13

total costs of making the financial market transaction.

Question 14

Margin trading

Answer 14

borrowing money to finance the purchase of securities.

Question 15

Short selling

Answer 15

selling securities that you borrow from someone.

Question 16

What is involved in short selling

Answer 16

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.

Question 17

The three operators are

Answer 17

expected return (value), variance and covariance.

Question 18

Expected return

Answer 18

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

Question 19

How do you measure a rate of return?

Answer 19

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):

Question 20

Variance

Answer 20

The risk of an investment is determined by ts possible future returns. Variance (sigma squared)

Question 21

Correlation

Answer 21

measures how strongly two random variables are related -1 to 1 as it is standardised