investment thery Flashcards
standard deviation
- the volatility of returns
- how widely the actual return on an investment varies around its average or expected return.
- the greater the standard deviation the greater the volatility.
-the greater the standard variation the more volatile and hence risky the investment - based on the average returns and actual returns
- 68% of the time it between the standard deviation
- 16% below
hedging
- protecting an existing proposition by taking another position that will increase in value if the existing position falls in value.
- FTSE futures contracts mean the seller is committed to sell at a specificed future date.
FTSE 100 put option is right to sell at specified market value.
- puts are not required to sell
correlation
this is the correction between investments
- negative when prices and values move opposite ie umberall and a sun hat
- positive they move both together
- no correlation - not connected or banks and japenese retailers
diversity
- equities are more likely to do well as the economy grows
- fixed interest securities tend to outperform equities as recession looms.
- residential property values are closely related to people real earning
- different sectors
- oversees companies help invest in overseas market
efficient frontier
- this is MPT
- the relationship between the return that can be expected from a portfolio as measured by the standard deviation
- risk reward profiles of various portfolio and shows the best return that can be expected for a given level of risk. the inputs are
- return
- standard deviation
- correlation
- the portfolio is selected on client risk profile
limitations of efficient frontier
- it assumes standard deviation is the correct measures of risk and summers assets have normally distributed return .
- didn’t factor in ESG
- rely on historical
- no transaction cost
- assumed index fund
systematic
- interst rate
- tax changes
- attacks
non systematic
- a new competitor begins making essentially the same product.
- a change in the companies credit rating
- technological breakthroughs makes an existing product obselete
capital asset pricing
- capital asset pricing says that people should get a premium for risk
beta
Beta is the sensitivity of a security relative to the market in terms of its beta.
Market has 1 as its beta
- a beta if 1 means security should in sync
assumptions for CAPm
- investors are rational
- all investors have an identical holding period
- the market price many buyers and many sellers, and no one individual can affect the market price
- there are no taxes, no transaction or short selling
- information is free
- all investors can borrow and lend unlimited amounts of money
- quantity of risk securities in the market is fixed
disadvantages of CAPM
- uses uk securities with no default risk
- index are usually a national one
-best as are based on past performance and estimate instability. if they have been unstable their ability to measure future risk is questioned - CAPM suggests a direct relationship with beta. Some US securities our pier firm but it may be over time. Lower betas have performed better than CAPM
- even though it might not be correct it is still used and the fact it has predicted them is good
Fana and French
- expanded the existing theory to add in company size and strength
- small cap stock tends to do better than large cap stock
- value stocks those with a higher book price ratio tended to outperform growth stocks
- securities favoured tend to be more volatile than the stock market as a whole.
arbitrage
- secritues returns can be predicted through its relationship with a few common risk factors
- unlike CPAM it says prices are related to multiple risk
- like CPAM it’s systematic risk
- Unlike CPAM it assumed portfolios for each investor are unique
- doesn’t say which factors are relevant and they are likely to change overtime
- more vera’s have to be identified
- influences on security returns
- unanticipated inflation
- changed in expected level of industrial production
- changes in default risk premium in bonds
- unanticipated changed in return of long term government bonds over treasury bills
EMH
all about information priced in.
- all available information is already reflected in asset prices
- weak form - fully priced in - past performance trading prices can. my be used
- semi strong past performance and financial stemts can not be used to put perform as priced in
- strong efficient- past performance and insider information can’t be used as it’s priced in
Semi strong has dying factual support it’s not guaranteed. Strong does not as fund managers can often out perform standard if they have the knowledge.
- government bond markets are considered extremely efficient
- most researchers consider large capitalised stocks to be efficiently priced
- venture capitalist which does not have a liquidity market is less efficient.
Under EMH if market efficient then makes sense to pick passive funds. If market isn’t then doesn’t
- suggests it’s impossible to use analysis or stock picking as prices change when new info occurs - analysis not possible
- behavioural bias and anomilies don’t support it
- no such thing as undervalued asset. don’t pay for fund management
- supposed use of index tracking funds
cpam
- built on MPT
- the expected return of an asset doeneds on its beta sebsitivity to market movements and the markets expected return
-risky * x beta +risk free
- risk measure emothaises systematic risk rather than market risk
- output determines the cost of equity expected return for investors
differences between Mpt and CPAM
focus - MPT portfolio optimisation CAPM asset pricing
- risk - MpTtotal risk CAPM systematic beta
- purpose - CAPM predicting expected results
- key tool MPT efficient frontier CAPM Security market line
multi factor model
Fama and french
- they adapted Camp - took emphasis off beta
- additional calculation for size of company.
- generally able to make a more detailed prediction of returns
arbitrage pricing theory
- essentially states that stock prices are inflicted by more than one market.
- outside market forces also do ie interest rate and inflation
criticise the Efficient market hypothesis
- bit all information is out instantly
- active management can perform well
behaviour finance
- not rational
prospect theory / loss theory. investors feel more loss from a 5% decline than 5% increase. Play safe when faced with gain.
regret - mess willing to sell when got a loss. Feel sorrow or grief at having made a bad decision
overconfidence - underestimate poor outcome
