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UoM Shiz Yaheardme > Investment Analysis > Flashcards

Investment Analysis Flashcards

1
Q

What is the expected return formula?

A
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2
Q

What is the excess return formula?

A
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3
Q

What is the Sharpe ratio?

A

A measure of the performance of an investment such as a security or portfolio compared to a risk-free asset, after adjusting for its risk

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4
Q

What is the Sharpe ratio formula?

A

*Solving the maximisation problem

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5
Q

What is the capital allocation line?

A

A line created on a graph that contains all of the possible combinations of risk-free and risky assets

Also known as Capital Market Line

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6
Q

What is the formula for rate of return of a portfolio?

A
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7
Q

What is the formula for variance?

A
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8
Q

What is the correlation coefficient?

A
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9
Q

What is the utility function?

A

Shows level of satisfaction associated with all possible outcomes, whether they result in shortfall or surplus

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10
Q

What is the utility function formula?

A
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11
Q

What is an optimal complete portfolio?

A

A portfolio where the utility of the investor is maximised
(Dependent on Risk Averse coefficient A)

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12
Q

What is an optimal risky portfolio?

A

A portfolio that offers the highest reward-to-risk (reward to volatility) ratio among the feasible portfolios
Sharpe ratio is maximised

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13
Q

What doesn’t matter when constructing an optimal risky portfolio?

A

Risk averse level
(Separation property)

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14
Q

What is separation property?

A

Clients all use same optimal risky portfolio as their investment vehicle
Risk averse clients invest in the risk-free asset more than risky
Optimal complete portfolio reflect’s clients risk aversion level - optimal risky doesn’t
Risky managers can design optimal portfolio without considering client risk aversion

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15
Q

What is the solution for two risky assets?

A

Where Wd + We = 1

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15
Q

What is the solution for two risky assets?

A

Where Wd + We = 1

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16
Q

For an optimal risky portfolio, what is the optimal Sharpe ratio?

A

Markowitz procedure is the generalised version of this process

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17
Q

For an optimal risky portfolio, what is the optimal Sharpe ratio?

A

Markowitz procedure is the generalised version of this process

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18
Q

What is the formula for the optimal capital allocation line? (CAL)

A

We assume that asset allocation is already done and we are working with the optimal CAL

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19
Q

What is the formula for the optimal capital allocation line? (CAL)

A

We assume that asset allocation is already done and we are working with the optimal CAL

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20
Q

What are the steps for working out the optimal complete portfolio?

A
  1. Specify return characteristics (expected returns, variances)
  2. Establish risky portfolio (asset allocation - Calculated optimal risky portfolio and properties using weights from the ORP)
  3. Allocate funds between risky portfolio and risk-free asset
    - Calculate fraction of complete portfolio allocated to risky portfolio and risk-free
    - Calculate share of the complete portfolio invested in each risky asset and risk-free asset
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21
Q

What is numerical optimisation?

A

Letting the computer solve for optimal weights

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22
Q

What is risk-return analysis?

A

Analyse the assets to be included in the risky portfolio and derive estimates for expected returns and covariance matrix (estimates used are for the Opimtal Sharpe ratio)

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23
Q

What is the minimum variance frontier?

A

It is the graph for the lowest possible portfolio variance that is attainable for a given portfolio expected return

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24
Q

What is the global minimum variance portfolio?

A

The portfolio with lowest variance among all feasible portfolios

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25
Q

How to find the complete portfolio?

A
  1. Identify risk-return combinations available from the set of risky assets
  2. Identify optimal portfolio of risky assets by finding weights that result in highest Sharpe ratio (steepest CAL)
  3. Choose appropriate complete portfolio by mixing the risk-free asset with optimal risky portfolio
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26
Q

How do you find the covariance matrix using excel?

A

Data -> Data analysis -> Covariance fills in the lower half
Need to adjust for degree of freedom -> 60/59

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27
Q

How do you find the efficient frontier and optimal CAL?

A
  1. Find global minimum variance portfolio G (find minimum variance portfolio)
  2. Complete efficient frontier (load setting efficient frontier)
  3. Calculate the optimal CAL
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28
Q

What’s a drawback of the Markowitz procedure?

A

There are too many estimates needed
(50 stocks = 1325 estimates / 3000 stocks would need 4.5 million estimates)

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29
Q

What do we need to estimate for the Single-index model + its formula?

A

Regression equation

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29
Q

What is the single-index model?

A

Alternative to the Markowitz procedure that requires less (3n+2) estimates compared to 5 for each

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30
Q

What is the relationship between expected excess return and beta?

A

Beta focuses on shares systematic risk - they have a positive relationship

31
Q

What is the formula for total risk?

A

Total risk = Systematic Risk + Firm-specific risk

32
Q

What is the formula for covariance? (In regards to Betas and market-index risk)

A
33
Q

What is the correlation formula? (in regards to the market index)

A
34
Q

What is the index model?

A
35
Q

What does (3n+2) estimate?

A

n estimates of extra-market expected returns (ai)
n estimates of the sensitivity coefficients (betai)
n estimates of the firm-specific variances (sd^2 (ei))
1 estimate for market risk premium E(Rm)
1 estimate for the variance of the macroeconomic factor

36
Q

What are some pros of the single index model?

A

Less estimates needed
Allows for specialisation of effort in security analysis

37
Q

What are some cons of the single index model?

A

Over-simplifcation of real world uncertainty
Ignores industry specific events (model assumes correlation of residuals always = 0 -> but they can be correlated)

38
Q

How can you figure out the intrinsic value of a stock?

A

Cash flows from the investment determines the intrinsic value of a stock

39
Q

What are the cash flows from holding a stock?

A

Dividends
Selling (future) price

40
Q

Dividends can be either of these 3 things:

A

Constant
Grow at a constant rate
Grow at a non-constant rate

41
Q

What is the dividend discount model (DDM)? + what is it’s formula?

A

Allows investors to determine the intrinsic value for a stock based on an estimate of the amount of cash it will return in current and future dividends

42
Q

What is the constant-growth dividend discount model (DDM)? + what’s its formula?

A

Used to determine the intrinsic value of a stock based on a future series of dividends that grow at a constant rate

43
Q

When do you expect a positive return?

A

You expect a positive return if you believe the current price is lower than the intrinsic value
(you expect negative return if you believe current price is higher than intrinsic value)

44
Q

What does the intrinsic value of a stock depend on?

A

Dividend and earnings expected from the firm

45
Q

What is the semi-strong efficient market hypothesis?

A

That the security’s price movements are a reflection of publicly-available information (fundamental and technical analysis are useless in predicing a stock’s future price movement)

46
Q

What is market inefficiency?

A

Market won’t be perfectly efficient
Trend: the market takes time to absorb information
Reversal: market over-reacts to information which leads to an adjustment

47
Q

What can cause price to move in a perfectly efficient semi-strong form?

A

News
- Surpises
- Confirmations
- Resolution of uncertainties

48
Q

What is macroeconomic analysis?

A

Business success of the firm depends on broader aspects as well
- Global economic environment
- Domestic macroeconomic environment
- Economic policy

49
Q

What is Industry analysis?

A
  • Econonic factors affecting firm’s industry
  • The position of the firm within its industry
50
Q

What are the key domestic macroeconomic statistics that matter?

A
  • Gross domestic product (GDP)
  • Unemployment rate
  • Inflation rate
  • Interest rates
51
Q

What is evaluation: ex-post?

A

Evaluation measures are calculated from realised returns during the investment period

52
Q

What is optimisation: ex-ante?

A

Estimated returns and risk using information and data available before the beginning of the investment period

53
Q

What is the Treynor ratio? + formula?

A

Measures the excess returns a financial asset earns for every extra unit of risk assumed by the portfolio

54
Q

What is Jensen’s alpha? + formula?

A

A risk-adjusted performance measure that represents a portfolio’s return compared to the overall market

55
Q

How is performance attribution split up?

A
  • Allocation choices across broad asset classes weights on bonds (fixed-income, debt) vs stock (equity)
  • Security choice within each asset class (which companies’ bond)
56
Q

How do you attribute performance to components?

A
  1. Set up benchmark (index portfolio for each asset class)
  2. Calculate return on benchmark and your portfolio
  3. Explain the difference in return based on component weight or selection
  4. Summarise performance
57
Q

What are the attribution formulas for benchmark and portfolio return?

A
58
Q

What are the two components performance is attributed to?

A

Security selection
Asset class allocation

59
Q

How to achieve good performance via asset allocation?

A
  • Overweight assets in markets that perform well
  • Underweight assets in poorly performing markets
60
Q

What is the Capital Asset Pricing Model? + formula

A

A model that estimates the expected return of an investment based on its riskiness to the rest of the market

60
Q

How do you achieve good performance via security selection? (example slide 21 week 4-1)

A
  • Good performance (positive contribution) derives from overweighting high-performing securities
  • Also derives from underweighting poorly performing securities
61
Q

What is the security market line?

A

A line drawn on a chart that serves as a graphical representation of the CAPM

62
Q

How does CAPM come from Markowtiz?

A

If all investors use the same inputs to draw their efficient frontiers, they all arive at the same risky portfolio - the market portfolio

63
Q

What is the market portfolio?

A

The value-weighted portfolio of all assets in the investable universe
- Contains all assets
- Proportion of each asset is its market value as a % of total market value (portfolio defined by weights and contained assets - value doesn’t matter (see pic)

64
Q

What is capital allocation, and how does it relate to market portfolio? + formula

A

The investor chooses proportion a y, allocated to market portfolio M

65
Q

What are the assumptions for risk-free investment in CAPM?

A

Risk-free investment can be done by lending
- Investor A borrows from investor B
- Investor B lends to investor A
(representative investor considers A and B together as one investor)

66
Q

What is the net borrowing and lending across all investors?

A

Zero (y = 1)
- Representative investor does not invest in risk-free assets

67
Q

What is the proportion allocated to market portfolio M?

A

The risk premium on market portfolio will be proportional to its risk and the degree of risk aversion of the representative investor
A: representative investor’s risk aversion

68
Q

What is the risk-to-reward ratio? + formula?

A

In CAPM, investors are rewarded for taking on risk
- Reward: Risk premium (expected excess return)
- Risk: Variance

69
Q

What happens when the reward-to-risk ratio if the market is in equilibrium?

A

Reward-to-risk ratio of individual assets and that of market portfolio must be the same
- Famous CAPM is derived from this proposition

70
Q

What is the risk premium of individual securities?

A

All investors hold market portfolio
- Therefore appropriate reward from investing in an individual asset should depend on its contribution to the risk of the market portfolio

71
Q

What is the reward-to-risk ratio for investments in stock I?

A
72
Q

What is the reward-to-risk ratio for investment in market portfolio?

A
73
Q

Reward-to-risk ratio of stock I and the market portfolio should be:

A

Equal

74
Q

Formula for CAPM for portfolios:

A
75
Q

What does the Security Market Line?

A

UoM Shiz Yaheardme (3 decks)

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