Monitoring and Investment Portfolio

Question 1

How to construct a new index?

Answer 1

Free-float weighted arithmetic index, timely updated with capitalisation changes.
Make sure all required information is available

Question 2

What other information should be reported alongside the index level to enhance an indexes utility?

Answer 2

Total return version – gross and net of tax.
Subdivided into different sectors
Income/xd subseries
Part of a global/regional series.
P/E ratio.
Dividend yield
Its constituent weights and details of key ratios.
All expected changes to constituents in timely manner for index-trackers and others

Question 3

What does monitoring the investment protfolio actually mean

Answer 3

Reviewing the investment performance of the fund manager, relative to their mandate, that is to outperform some index or some benchmark portfolio.
Want to estimate the risk undertaken also to produce a risk adjusted return measure.

Question 4

What should the term of analysis be

Answer 4

Analysis like this over a sufficiently long term
You must monitor rolling years periods - length of time depends on investments

Question 5

What plays a big factor in the investment strategy chosen and hence the benchmark

Answer 5

Investment strategy depends on purpose - pension strategy need very close to benchmark, steady returns

Question 6

What are investment indexes and what is a total return index

Answer 6

Investment index – one number to summarise how the market is performing or the average return of market.
Need info on capital return, income return, dividend yields.
Indices calcs can be weighted arithmetic indices, unweighted arithmetic indices or geometric indices.
Index is total return means they do reinvest dividends continuously and we should try and replicate this.
Index must also have a long history as I want it to estimate my benchmark

Question 7

What are the uses of indices

Answer 7

A measure of short-term market movements.
A measure of long-term market movements – stochastic analysis
Analysing sub-sectors
To help estimate/forecast/model future movements -scientific study
To use them as a benchmark
As a basis of index funds or ETFs
As a basis to create derivative securities

Question 8

What are common weights used in weighted arithmetic indices

Answer 8

Common weights adopted are total market capitalisation or free float

Question 9

Whats a rights issue

Answer 9

A rights issue is when a company offers its existing shareholders the chance to buy additional shares for a reduced price.

Question 10

When might weights in a weighted arithmetic index change and how is this dealt with

Answer 10

Ex: rights issue or share split
Use Chain-linking – change weights to reflect new relative weights without a discontinuity in the value of the index at the time of the change
If there’s a capital change I calculate up to instant before, then there is a pause, then immediately after
You close the gap by calculating the jump and pulling future prices down to close the gap. Called chain linking

Question 11

Why and when are weighted arithmetic index good?

Answer 11

Weighted arithmetic indices are best, with suitable weights, because they accurately record the capital return to an investor holding those stocks in the given weights.

Question 12

Give an example of an unweighted or price weighted arithmetic index and what this means

Answer 12

Ex: Dow Jones Industrial Average (DJIA) – used to be price weighted!!: Value time t was value of shares/ no of shares.
Means large share prices will dominate - return on higher priced shares get more of the weight then. In reality the price of a share has nothing to do with its return.

Question 13

What can an unweighted or price weighted arithmetic index be used for

Answer 13

DO NOT USE unweighted indices to monitor portfolios/historical research

Question 14

Describe geometric index and their uses and issues

Answer 14

Index is geometric/harmonic mean of the relative price changes.
Geometric index lags a corresponding arithmetic index.
Unsuitable to monitor portfolios
It’s on the conservative side.
When a share price goes to zero however there’s an issue - the whole index goes to zero

Question 15

FTSE (Actuaries) Share Indices what info do they have

Answer 15

Average net dividend cover; gross and net yields, P/E ratio.

Question 16

Name some FTSE UK index

Answer 16

FTSE 100 – top 100 companies (by market capitalisation), giving 70% coverage of the total market. Quoted continuously.
FTSE 350 – combination of FTSE 100 & FTSE 250 (about 90% of market captured), published daily
FTSE SmallCap Index – below the top 350 but with market cap above a certain limit.
FTSE All-Share – FTSE 350 plus FTSE SmallCap, giving about 98% of the market. Published daily

Question 17

Name some index with Global regional and nation coverage

Answer 17

Morgan Stanley Capital International Indices (MSCI) – total returns are published both gross and net.
FTSE All-World Index; FTSE Global Equity Index
S&P Global 1200…a real time global index capturing 70% of market capitalisation.

Question 18

What is S and P 500 index qualities and the dax qualities

Answer 18

Standard & Poor’s Composite (also known as S&P 500) – remember this is a cap.-weighted price index with reasonable sub-sector indices
DAX – total return index, cap. weighted arithmetic index of the German market available in real time.

Question 19

Explain dirty price

Answer 19

Dirty price is the price of a bond including any interest that has accrued since issue of the most recent coupon payment.

Question 20

What are the qualities of FTSE Actuaries Gov. Securities UK Indices

Answer 20

Market-capitalisation weighted arithmetic indices with complete coverage of all fully paid
Chained-linked to allow for capitalisation changes/ new issues/ redemptions/ shorteners/ sliders
Subdivisions: Conventional, index linked (all split then by term and all stocks)

Question 21

How does a market cap weighted bond index work?

Answer 21

Bigger the bonds in issue, the more weight
Higher indebted people are weighted more in the index.
When it comes to bonds surely I don’t want the company that issued the most bonds. After a certain threshold they might say equal weights.

Question 22

Name 3 International bond indices

Answer 22

Merrill Lynch, Salomon Brothers, and JP Morgan all have good bond indices

Question 23

Give Problems in getting a reliable index for property

Answer 23

Lack of reliable up-to-date market prices
Uniqueness of each property
Estimation of values is subjective and expensive
Can be a long time ago since even similar property sold- Time value of money
Sometimes prices are kept secret

Question 24

What are two types of property index

Answer 24

Portfolio-based indices
Barometer type indices

Question 25

Explain Portfolio-based indices

Answer 25

based on performance of actual portfolio of properties (as comprehensive as possible) These indices tend to overestimate property. Tend to be houses very well furnished and new etc

Question 26

Explain Barometer type indices

Answer 26

Estimating full price on hypothetical rack-rented properties. More timely but more inaccurate than the former type.

Question 27

What information is needed to calculate the return on funds - MWRR

Answer 27

Market Valuation at start and end of period.
Amounts & dates of cash flows in and out.
Whether it is investment income flow or ‘new money’ flows
Tax
Expenses

Not a simple calculation!!

Question 28

Why does fund manager not want to be assessed based on MWRR

Answer 28

Fund manager doesn’t have any control over the cash flows.
What I actually want to compare with the market I want the time weighted average rate of return- Money market rate of return doesn’t account for timing of cash flows
Time weighted returns you can chain link but can’t for money weighted returns.
Money weighted rate of return is the real return essentially but time value allows to assess the fund a manger?

TWRR removes the effect of external cash flows, focusing solely on the performance of the investments themselves. Fund managers might prefer TWRR when they want to isolate the performance of their investment decisions from the influence of investor cash flows. It’s often favored for assessing the skill of the manager in selecting investments

Question 29

Define excess returns

Answer 29

Excess returns are defined as the return on the fund less the return on the benchmark fund. This is the fund manager’s added value relative to the benchmark (referred to as ‘alpha’)

Question 30

Define alpha

Answer 30

This is the fund manager’s added value relative to the benchmark

Question 31

Define the tracking error

Answer 31

The standard deviation of the excess returns is called tracking error.
Tracking error gives us an estimate of the risk the manager takes in deviating from the benchmark.

Question 32

Define the information ratio

Answer 32

In short, the information ratio is the excess return of an active manager over an appropriate benchmark, divided by the standard deviation of excess returns.
Information Ratio = Excess Return/Tracking Error

Question 33

What’s a good information ratio

Answer 33

0.5 mean I have a good fund manager, if 0.75 this is amazing . 1 probably too good to be true.

Question 34

What’s the sharpe measure formula

Answer 34

(Rp-r)/stdev portfolio

Question 35

When to use st dev vs beta

Answer 35

Where the portfolio represents the investor’s total wealth then use standard deviation as measure of risk. This gives added return per unit of risk.
If only part of the portfolio then use the beta of the portfolio. This gives the added return per unit of systematic risk.

Question 36

Whats the risk free return?

Answer 36

In alot of formula is the rate for treasury bills risk free rate - but in reality should be the matching asset

Question 37

Explain ex post risk

Answer 37

Refers to a risk measurement technique that uses historic returns to predict future risks associated with an investment.

Question 38

Explain ex ante risk

Answer 38

Refers to the future projected risks of a portfolio.

Question 39

What are the two types of exchnage?

Answer 39

Order driven system and quote driven system

Question 40

What is an order driven system

Answer 40

Order-driven system – buyers and sellers list the price and quantity they wish to deal and
they are electronically matched, e.g., NASDAQ

Question 41

What are the pros and cons of an order driven system

Answer 41

The order-driven system might highlight the lack of liquidity of market.
It may take a long time for trades, in which case the investor will have to continually monitor his order in case new information comes to light.
Order-driven system is probably cheaper to trade in

Question 42

What is a quote driven system?

Answer 42

Quote-driven system – market makers quote two-way prices in stocks in which they are
prepared to deal up to certain limits (the Normal Market Size or NMS), e.g. NYSE, LSE
(since 1997 in parallel with an order-driven system).

Question 43

What are the pros and cons to the quote driven system

Answer 43

The quote-driven system may have an NMS below the typical trade size, so not
giving the required liquidity.
The spread between bid and offer is visible and might be disencouraging large.
However it will give good information on marginal prices. Allowing to price unit funds, etc. Does give limited liquidity
The large foreign institutional investor will be familiar with both systems.

Question 44

How to accommodate small local investors on new stock exchange?

Answer 44

Exchange might incentivise private companies to offer collective investment vehicles at reasonable cost to investors.
These vehicles could be ETF or investment trust or unit trusts.
If they were index-trackers this would reduce costs: ensure that there are index-tracking ETFs listed, and encourage and authorise market makers in such instruments. Free information on the indices?
Lower fees for listing investment trusts or ETF.
Give information to small investors in suitable form…free on web