Major Investment Theories Flashcards
What does the standard deviation show?
The extent to which a return varries from expected or average return. (Volitility)
What does a high standard deviation imply?
That return varies wildly from expected return, meaning higher risk
Under normal distribution, what % would be expected to fall between the mean and +/- 1 deviation? And 2 deviation?
1=68%
2=95%
What is kurtosis?
The real-life non symmetrical deviations that accrue when ploting on a graph.
What is corelation?
The degree to which to assets will co-vary
What scale can corelation be measured?
Between +1 to -1
What does a positive correlation mean?
As one investment moves up/down, the other will move with it.
What does a negative correlation mean?
If a stock moves up/down, the other will move down/up
This protects against risk.
How can you use put options to hedge?
These allow the right but not the obligation to sell at a certain price in the future.
If your investment falls, you can sell an option at the agreed price.
How can futures be used to hedge?
These allow a stock to be sold at a specific time for an agreed upon price. If your investment drops, the future will be sold when the time elapses protecting the investment. No option not to sell so can result in markets moving the wrong way.
This is an open-ended obligation
What is the efficiency frontier?
Grapgh showing risk vs returns.
What problems come with using efficiency frontiers to pick portfolios?
Standard deviation is not always precise
The model relies on past performance
The model does not include costs and charges
An investor does not pick their portfolio on risk alone,
It assumes the portfolio is made up of index funds
What are the two elements of risk?
Systemic (market) risk
Non-systemic (investment) risk
What can diversification not do?
Prevent Systemic Risk.
Major theories of risk look at what and why?
Systemic risk because they believe individual risk will be covered by diversification.
How many securities need to be held to effectively manage risk?
35
What should you get on top of the risk-free return for risky stocks?
Risk premium
What does CAPM cover, and what is it known as?
Systemic risk
BETA CAPM
How does the price of a security move in relation to movement in the price of the market.
What BETA rating is the market given?
1
What do the BETA ratings of securities mean
1 moves with the market
>1 to <0 moves slower (less volatile)
<1 moves faster (more volatile)
What are the assumptions made by the CAMP model?
All assets have the same term
Risk is the only factor in the investor making decisions.
There are no liquidity issues, and no one individual can affect the market price.
The market is transparent.
Risk -free return is freely available to investors.
No costs, taxes or restrictions on short selling.
What key problems are there to CAPM
Risk free return are not always available
Different markets have different BETAs
BETAs are based on past performance
US study showed no correlation to CAPM
Studies suggest both systemic and non-systemic risk are being valued in the market.
What is used to counter when there is no risk-free return in the market?
Goverment treasury bills due to very low defult risk and because they are short term with low interest and inflation risk.
What does APT seek to do?
Price the assets correctly by looking at systemic risk but taking it further and more flexible than CAPM
Uses factor specific BETA to look at different factors of the market.
