Investment Management Flashcards
how is expected returns calculated?
by taking the probability of each and multiplying that by the scenario return and summing the results
what does variance measure?
the extent to which returns ‘vary’ from the average return
what is standard deviation/
the square toot of variance, used a statistical measure of risk that depicts the likely variation from ER levels
what are the different types of risks when investing?
- market/systematic risk
- inflation risk
- interest rate risk
- reinvestment risk
- exchange rate risk
- political and legal risk
- regulatory risk
- Default Risk
- Liquidity risk
what is forward looking forecasting?
forecasts and probabilities which asses the likelihood of each possible state of the world occurring and estimates the returns given that particular outcome
what is backward-looking forecasting?
study of historical data and frequencies under the assumption that this will be representative of the future.
what is the risk profile for equities?
they are generally considered to be risky however they offer potential to deliver high returns if held long-term
what is equity risk premium?
the higher rate of return that is required to entice investors to take on the risk of owning equity
what would prompt an investor to go into money markets?
if they have an investment horizon that is very short and want a low-risk, relatively secure form of storage for their cash
what is the attractiveness bonds?
that they offer a regular, pre-determined coupon combined with the relative certainty of the principal amount being repaid
what are the risks that could affect bonds?
- interest rate risk (can cause adverse movement to bonds)
- inflation risk (value of the investment held may fall)
- default risk (risk of the issuer defaulting on their payment)
what are the risks around overseas shares and debt?
- currency
- country
what is diversification?
can remove some of the market risk without having to removing all high-risk investments from a portfolio by combining securities that are not perfectly, positively correlated
what is correlation?
the level of association between movements in price and returns of each asset
what are the different types of diversification?
- asset class
- maturity
what is hedging?
attempt to reduce risk, usually via derivatives- objectives is to buy and sell to reduce the exposure to market fluctuations, done by taking the opposite position to what is held within the portfolio via a derivative
how can futures contracts be used to hedge?
can be used to hedge against equity prices falling- will remove any upside as well as downside
what are the advantages of using futures contracts to hedge?
lower cost, greater efficiency and less portfolio disruption
what are the drawbacks to using futures contracts to hedge?
- futures contract may not directly emulate (adversely) the performance of the relevant index/instrument
- investor must know when to enter/exit the futures hedge
- there are operational and regulatory considerations to be made
how can options be used to hedge?
investors can purchase put options on those positions, meaning they have the right but not the obligation to sell at a given right. - they can enjoy the upside whilst also being protected from excessive loss
what is a CFD and how is it used in hedging?
contract for difference- doesn’t confer right of ownership to the underlying asset. tracks the price of an underlying asset- asset or fund managers can use them to gain exposure to market movements
how are CFDs traded?
margin-traded, the investor doesn’t have to deposit the full value of the underlying asset with the CFD provider
what are the benefits of CFDs?
- allow investors to benefit from the downward movements of equity positions or index
- enable fund managers to retain positions in the instrument but have a derivative position as well which makes it equivalent to short-selling a stock
- given amount of capital can control a larger positon
what are the costs associated with CFDs?
- commissions built into each deal
- costs built into the spread of the CFD price
- subjected to daily financing charge, usually applied at previously published interest rate e.g., SOFR
- have to pay financing on long positions and receive funding on short positions
how much margin are investors required to maintain as part of a CFD?
1-30%
what is the effect of leveraged products?
maximum exposure is not limited to the initial investment- possible the investor looses more than the margin they put in- additional money must be paid in the form of margin calls
what are the different types of margins?
initial margin: normally between 5-30% for shares/stocks and 1% for indicies and forex
variation/maintainence margin: if the market position moves beyond the amount taken as initial margin- additional margin will be required
what are the levels of seniority when it comes to debt?
- senior
- subordinated
- mezzanine and payment-in-kind
lower the tier, the higher the interest rate to reflect the additional risk
how can active management be used in the bond market?
if the bond is considered mispriced then active management strategies can be employed to capitalise upon this
what is bond switching?
actively exchanging bonds perceived to be overpriced for those perceived to be under-priced- used by portfolio managers who believe they can outperform a buy-and-hold passive policy
what are the different types of bond switching?
anomaly switching: moving between two bonds similar in all respects apart from yield and trading price
policy switching: when an interest rate cut is expected but not implied by the yield curve, shorter-dated bonds are sold in favour of longer-dated bonds
inter-market spread switch: when it’s believed that the difference in the yield being offered between corporate bonds and comparable government bonds
what is smart beta (passive management)?
uses an alternative weighting systems e.g., weighting based on dividends, sales revenue etc.
what is immunisation?
passive management strategy technique employed by those bond portfolio managers with a known future liability to meet
what are the two strategies of immunisation?
cash matching: constructing a bond portfolio whose coupon and redemption payment cash flows are synchronised to match the liabilities that they have to meet
duration-based immunisation: constructing a bond portfolio with the same initial value as the present value of the lability- designed to meet at the same duration of the liability
what is the efficient market hypothesis?
theory stating its impossible to beat the market because stock market efficiency, means stocks will always trade at their fair value- impossible to purchase under/overvalued stocks. lends itself to passive management
what are the different criteria that can be taken into account when ESG investing?
- environmental
- social
- governance
what are the PRI?
principles for responsible investment
created by the UN to incorporate ESG issues into investment practice, made up of 6 principles
what is the role of the TCFD?
task force on climate-related financial disclosures, develop recommendations for more effective climate-related disclosures- published 4 recommended areas in 2017
what does the spectrum of investing take into account?
nature and extent to which ESG factors are included within an investment strategy
what are the advantages of ESG investing?
- better returns
- lower risk
- better reflect changing attitudes
what are the disadvantages of ESG investing?
- ethics may cloud judgement
- requires more research
- greenwashing
