Investment Planning Flashcards
Systematic/Non-diversifiable Risks
Purchasing power risk
Reinvestment risk
Interest rate risk
Market risk
Exchange rate risk
PRIME
Unsystematic/Diversifiable Risk
Business risk
Financial risk
Default or Credit risk
Regulation risk
Sovereignty risk
Cannot be eliminated through diversification
Quantified by the beta statistic
Sharpe Ratio
Sp = (rp - rf) ÷ σp
rp = return of the portfolio
rf = risk-free rate of return
σp = standard deviation of the portfolio
What is measured: Risk-adjusted return
When to use: r2 <0.70
Value: relative
Relevant risk statistic: standard deviation
Treynor Ratio
Tp = (rp - rf) ÷ βp
Tp = Treynor Index
rp = return of the portfolio
rf = risk-free rate of return
βp = Beta of the portfolio being measured
What is measured: risk-adjusted return
When to use: r2 > 0.70
Value: relative
Relevant risk statistic: Beta
Covered Call Writing
Long the underlying stock - short the call
- Only considered covered if you own enough shares to cover ALL contracts sold.
- Used to generate income for the portfolio.
Naked Call Writing
Does not own the underlying stock - short the call
Writer bears UNLIMITED risk
Protective Put
Long the stock - long the put
This is the very essence of portfolio insurance.
Protective Call
Short the stock - long the call
Used to protect a short position in the stock.
Covered Put
Short the stock - short a put
Writer uses the stock put to cover their short stock position
Collar (Zero-cost Collar)
Long the stock - long the put - short the call
The put is used to protect against a stock price decrease, and the call premium is used to offset the cost of the put.
Straddle
Long a put and a call on the same underlying stock with the same expiration date and strike price.
Used to capitalize on volatility regardless of the direction.
