L1 SH: Equity Funds Flashcards
What are equity funds?
A portfolio of shares
What is a PLC?
A company that has been created to invest money in other shares
Describe a specialist portfolio
Specialist: a portfolio that is deliberately constructed to cover firms of a particular type, e.g.: geographic, small cap firms, sector of the industry
They usually have a clue in their name, not fully diversified
Describe a diversified portfolio
sometimes called ‘tracker’ funds –> they track a particular index e.g. FTSE-100, Dows Jones, S&P-500
They are very well diversified (apart from sometimes the index gives a small sample)
What is a group rotation portfolio?
Equities are grouped on the basis of different characteristics e.g. risk, industry, growth rates
The fund manager moves their money from one group of shares to another to get a better risk-return combination
What is an income fund?
Specialises in creating a stream of income for their investors
E.g. might be invested in company’s that regularly dividend
Describe B-values
B value = 1 - portfolio moves the same as the market
B value < 1 - portfolio moves slower/less aggressively than the market
B value > 1 - portfolio moves faster/more aggressively than the market
On a graph of Return of the investments (y) x Return of the Market (x), what would:
a) dots scattered around both sides of the B-value line?
b) dots scattered around one sides of the B-value line?
a) no timing
b) timing
How would managers mould their B-values?
Each share tends to have a fixed B-value. However since portfolios are many shares, manager can change the B-value of their portfolio by adding or removing shares with high or low B-values
Why would managers mould their B-values?
- if a manager has insight into where the market is going e.g. i its rising then get a higher B-value
- to maximise gains and minimise loses
If the dots (share returns) are scattered around the B-value line, and the line is straight, what does this mean?
NO MARKET POWER (the portfolio cannot predict where the market is going)
What does curvature of the line mean?
Can be treated like a quadratic:
Simple: Ri = y1 + y2Rm
Curved: Ri = y1 + y2Rm + y3(Rm)^2
Curved lines indicates market timing ability - and should result in statistically significant, positive, estimates of y3
If y3 is:
a) positive and statistically significant
b) small or not significant
a) t-value is greater than or equal to 2, line is curved and market timing ability
b) straight line because in this equation
Ri = y1 + y2Rm + y3(Rm)^2
we can ignore the y3 section
What are the 2 most important models for risk?
- Capital market line (CML) - measures risk as the SD of returns
- Capital asset pricing model (CAPM) - measures risk as the B
What is meant by CAPM and CML being expectational models?
- hold risky assets in the expectation of better returns
- this expectation rises in a linear way
What is the equation for the Sharpe ratio?
rp - rf / total risk
rp = return on portfolio rf = rish free rate (e.g. government bonds)
rp - rf = ‘risk premium’
this equation gives a single number, so therefore very risky portfolios and very stable ones can be compared
Describe the Sharpe Ratio
the SR is an investment measurement that is used the calculate the average return beyond the risk-free rate of volatility per unit
AKA: measures the actual return from an investment, adjusted for by the riskiness of the investment
For the Sharpe ratio what does each mean?
a) <1
b) 1-1.99
c) 2-2.99
d) 3+
a) <1 = not good
b) 1-1.99 = okay
c) 2-2.99 = good
d) 3+ = exceptional
These are only useful when comparing to another Sharpe measure
Describe the Treynor Ratio
This is the ‘reward to volatility’ ratio
Measures the volatility in the market, to calculate the risk of certain investments
E.g. many investment rise in value purely because the market is unstable - this doesn’t mean the investment is good or the company is good
The treynor ratio tries to un-bias this
How is the Treynor ratio the same or different to the Sharpe ratio?
It is similar to the Sharpe Ratio BUT it uses the portfolios B-value as the risk measurement
By comparing B-value to volatility of entire stock market, investors can asses risk of the entire investment
What is the formula for the Treynor?
average portfolio return - average risk free rate / B of the portfolio
Give a drawback of the Treynor ratio
the B-value can be negative
Define the Jensen Index/Alpha
the measure of portfolio performance, under the condition that the portfolio is well diversified to leverage unsystematic risk
When do financial analysts use the alpha?
When they want to find the highest return with the lowest risk
How is alpha evaluated?
In comparison to the benchmark (assuming the return on investment isn’t related to the market like B)
If alpha = 0, the portfolio is perfectly correlated to the benchmark
What is the equation for alpha?
rp - (rf + B(rm - rf))
= portfolio return - risk free rate - portfolios B( market return - risk free rate)
