INVESTMENT PROCESS Flashcards
What is Asset Allocation?
The choice to invest in whichever broad asset category (bonds, shares, real estate)
What is Security Selection?
The choice of which particular securities to hold within each
asset class
What are the 2 ways of doing portfolio construction?
Top-down, Bottom-up
What is the difference between top-down and bottom-up portfolio construction?
Top-down starts with asset allocation and bottom-up starts with security selection
Which is easier to value: bonds or stocks?
Bonds are easier to value: stocks depend too much on the condition of the issuing firm
What are the downsides of a bottom-up strategy
It can lead to too much focus on one sector (like fintech). However, it focuses on the assets that offer the most attractive opportunities
What Is Risk-Return Tradeoff?
There are higher expected returns when the risk is higher
=> if higher returns were achievable without risk, the price of high-return assets would rise until the return isn’t up to par with riskier assets
=> If returns were independent from risk there would be a rush to sell high-risk assets. Their prices would fall (improving their expected future rates of return) until they eventually were attractive enough to be included again in investor portfolios
What remuneration is an investor entitled to?
It’s a function of the risk involved: the higher the risk, the higher the remuneration. Remuneration is usually presented afterwards
What is considered to be a risk-free rate?
When an investor is certain to be remunerated and repaid the principal according to established terms (depends on the maturity relative to the investment horizon)
=> €STR overnight
What is a long risk-free rate equivalent to?
Geometric mean of expected short term rates
What can affect a risk-free rate?
Maturity and Duration (period after which its profitability is not affected by changes in interest rates due to coupons already received.)
How do you find PV?
FV/(1+r)^n
How do you find FV?
PV*(1+r)^n
