Investment Strategies & Analysis

Question 1

What are the assumptions Capital Market Theory?

Answer 1

Efficient Investors
Investors borrow/lend money at the risk-free rate relating to debt instruments
The time horizon is equal for all investors
All assets are infinitely divisible
No taxes and transaction costs
All investors have the same probability for outcomes
No inflation exists
There is no mispricing within the capital markets

Question 2

What is the Capital Asset Pricing Model (CAPM)?

Answer 2

used to identify the expected risk-adjusted return of a security

RF + beta(market return-RF)

Question 3

What is correlation?

Answer 3

measures the degree to which the prices of 2 securities move in relation to one another

Question 4

What is the correlation coefficient?

Answer 4

a statistical measure of the strength of the relationship between the price movement of two securities

Question 5

What is Modern Portfolio Theory?

Answer 5

a method that can be used by risk-averse investors to construct diversified portfolios that maximize their returns without unacceptable levels of risk

Question 6

What is the efficient frontier?

Answer 6

a set of optimal portfolios that offer the highest return for a defined level of risk or the lowest risk for a given level of expected return

Question 7

What is Efficient Market Hypothesis?

Answer 7

states that markets are efficient with respect to value and pricing

all factors have been priced into the market and nobody can obtain an investing advantage because all trends and information have already been factored in

says that no one can gain an advantage by using analysis or trends to beat the market

Question 8

What is the weak hypothesis?

Answer 8

disregards past history of any security as an indicator for future performance

refutes theories of technical analysis

Question 9

What is the semi-strong hypothesis?

Answer 9

disregards fundamental analysis

all known information about a security is an indication of performance

Question 10

What is the strong hypothesis?

Answer 10

disregards all information about a security

rejects both technical and fundamental analysis

Question 11

What is Strategic Asset Allocation?

Answer 11

portfolio management strategy where the investor sets target allocations for various asset classes & rebalances the portfolio periodically

target allocations are based on factors like the investor’s risk tolerance, time horizon, and investment objectives

portfolio is rebalanced when the original allocations deviate significantly from initial settings due to differing returns

Question 12

What are the 3 asset classes?

Answer 12

Stocks, Bonds, and cash

Question 13

What is rebalancing?

Answer 13

the strategy of bringing a portfolio back to its original asset allocation mix

ensures the portfolio does not overemphasize one or more asset categories

achieved by selling off appreciated investments from over-weighted categories and using the proceeds to purchase investments in under-weighted categories

Buy Low, Sell High

Question 14

What is Active Management?

Answer 14

a detailed, hands-on approach to security selection, asset allocation and rebalancing

the manager is constantly engaged in market research and regularly executes trades

these have a higher turnover rate

more costly due to research and trading expenses

Question 15

What does “Alpha” mean in relation to a portfolio manager’s performance?

Answer 15

a number that represents the value brought to the portfolio from the active management

a positive or high number indicates that management is adding value

Question 16

What is the “buy and hold” strategy?

Answer 16

more passive management strategy

selecting assets and holding them long term rather than engaging in short term trading

with less trading and generally less demanding research, this style results in lower expenses and a lower turnover rate

Question 17

What is tactical asset allocation (market timing)?

Answer 17

this strategy involves market timing, investing in currently hot industry sectors and active management to achieve immediate short-term results

Question 18

What is Indexing?

Answer 18

a passive management strategy for investing that has its primary objective matching the performance of a particular stock index such as the S&P 500

very little research or trading - low expenses and low portfolio turnover

they do not pay large capital gains and are considered tax efficient for investor

Question 19

How is Bond Interest taxed?

Answer 19

at ordinary income rates

in the year received unless in a tax deferred account

Question 20

How are stock dividends taxed?

Answer 20

at ordinary income rates

in the year received unless in a tax deferred account

Question 21

How are short-term capital gains taxed?

Answer 21

at the ordinary income tax rate

in the year they are received or generated unless held in a tax-deferred account

Question 22

How are long-term capital gains taxed?

Answer 22

At the preferential rates depending on the investor’s taxable income and filing status

in the year received or generated unless the securities are held in a tax-deferred account