Portfolio Management Flashcards
Which type of mutual fund trades at it’s net asset value per share?
Open-ended mutual fund
Investors can buy newly issued shares of mutual funds
Open-ended mutual fund (@ NAV)
Mutual fund pruchased for market determined prices:
Closed-ended mutual fund
Small minimuim investment required
Which type of mutual fund trades at premium or discount?
closed-ended funds & ETFS
professionally managed pools of investor money that do not take new investment into the fund or redeem investor shares
Closed-ended fund:
Traded: OTC or exchange traded
Which type of pooled investment vehicles are least likely to have a capital gains distribution?
ETF
there might be a cap gain/loss on the shares sold, but the gain/loss from the sale is not a distribution
Passively managed pools of funds, that are invested to match a particular index
ETF
attempts to profit from arbitrage opportunities in interest rate securities
fixed income arbitrage
Make only a few large investments in private companies with the intent of selling the restructured companies in three to five years
buyout funds/private equity firms
The key difference between a wrap account and a mutual fund is that in a wrap account:
the assets are owned directly by the individual
A more diversified portfolio will have a diversification ratio that is:
Lower ratio, compared to less diversified portfolio
Low ratio: A portfolio containing the highest number of securities from different industries will be the most diversified and will have the lowest diversification ratio
High ratio: A portfolio of stocks from the same industry is likely to have a higher diversification ratio than a portfolio of stocks from different industries.
The ratio of an equally weighted portfolio’s standard deviation of return to the average standard deviation of the securities in the portfolio is known as the
diversification ratio
acquires entire public companies, takes them private, and reorganizes the companies to increase their value
private equity fund/buyout fund
Modern portfolio theory concludes that an investor should:
-evaluate potential investments from a _____ perspective
-consider how the investment will affect the _______ of an investor’s portfolio as a whole
portfolio level
risk and return characteristics
This return measure uses the IRR of the inflows and outflows of a portfolio:
Money-weighted return
The discount rate that makes the PV of cash inflows = PV of cash outflows
This return measure measures compound growth; the rate at which $1 compounds over a specific performance horizon:
Time-weighted return
When the manager does not direct the flow of cash into and out of the account, the preferred return measure is:
Time-weighted reutrn
When the manager controls the money flows into and out of an account, the return measure that is most appropriat is:
money-weighted return
Would be best used for someone who makes frequent additions/withdrawals; Money-weighted return takes the cash flows and their timing specifically into account and conveys to the client the average growth rate of all money invested in a portfolio.
Return adjusted for inflation
real return
Measures the increase in an investor’s purchasing power; how much more goods or services can she purchase at the end of the year due to the increase in value of her investments
Real return
For two stock, their prices will tend to move together over time and they will tend to produce rates of return greater than their mean returns at the same time and produce rates of return less than their mean returns at the same time, if they are:
positive covariance
The portfolio on the minimum-variance frontier with the lowest standard deviation is:
the global minimum-variance portfolio; attainable but not the optimal risky portfolio
With respect to the mean–variance theory, the optimal portfolio is determined by each individual investor’s
risk preference
If given the standard deviation of the portfolio, we are given the weighted average average, meaning the correlation between the securities =
1 (perfectly positively correlated)
= Actual return – expected risk-adjusted return
Abnormal return
Plots expected return against the standard deviation of return (total risk):
Efficient frontier
Describes the risk/return tradeoff of various combinations of the market portfolio and a riskless asset, for efficient portfolios:
CML
Describes the risk/return tradeoff for individual securities or portfolios
SML
The slope of the security market line (SML) is best derived from the:
Market risk premium (MRP)
The risk free rate is the intercept term
the risk that extreme events are more likely than the organization’s managers/analysis have assumed
tail risk/downside risk; usually a result of model risk- using inappropriate model assumptions
The probability of extreme negative outcomes in the tail of a distribution
Value at risk VAR (Measure of tail risk)
Conditional VaR is the expected value of a loss, given that the loss exceeds a minimum amount.
The magnitude of extreme negative outcomes in the tail of a distribution.
Conditional value at risk (Measure of tail risk)
uncertainty about whether the counterparty a transaction will fulfill its contractual obligations
credit risk (financial risk)
uncertainty about market prices of assets (stocks, commodities, and currencies) and interest rates
Market risk (financial risk)
Buying insurance is best described as a method for an organization to:
Transfer a risk
the risk that the organization will run out of cash and therefore be unable to continue operating
Solvency risk
arises from faulty processes or human error within the organization
Operational risk
The process of:
Identifying an organization’s risk tolerance, identify the risks it faces,
and monitor or address these risks.
Risk management process;
The goal is not to minimize or eliminate risks
modeling the effects of changes in multiple inputs at the same time
Scenario analysis
examines the effects of changes in a single input
Stress testing
refers to managing a risk by modifying the distribution of outcomes.
Risk shifting; usually with a derivatives contract
A security’s beta is best estimated by the slope of:
the Security’s characteristic line
Securitity’s characteristic line is based on the market model, Ri = α + βi (Rmkt – Rf)
Measures the market risk of an asset or portfolio
Beta
Beta= systematic risk
measures the interest rate sensitivity of the value of a fixed-income security or portfolio
Duration
measures the interest rate sensitivity of the value of a derivative
RHo
senior management’s oversight of the organization’s risk management
Risk governance
The process of defining a level of risk to be taken, with the goal of maximizing the portfolio’s value
Risk management process
the top-down process and guidance that defines risk tolerance, provides risk oversight and guidance to align risk with enterprise goals
risk governance
a process that addresses a common set of factors within different organizations
risk management framework
Provides top decision-makers with a forum for considering risk management issues, at the operational level
Risk committee; part of the risk governance structure, at the operational level
Risk tolerance an risk exposure should be:
kept in alignment; part of the risk management framework
includes the qualitative assessment and evaluation of risk
Risk identification & measurement
This process forces the firm to consider risk tradeoffs, so that the firm can invest where the return per unit of risk is the highest
Risk budgeting
Indicates the minimum loss that will occur over a period with a specified probability:
VaR
If a company has a one-day 5% Value at Risk of $1 million, this means:
5% of the time the firm is expected to lose at least $1 million in one day.
Weighing costs versus benefits in light of the organization’s risk tolerance.
The choice of Risk-modification methods
Looks for changes in intrinsic value; forward looking
fundamental analysis: what prices should be based on DCF
Tries to predict future price changes in past trade prices and volume
Technical analysis
In a candle stick chart, if the bar is open it signifies that:
the stock closed at a higher price than the open, on that trade day
Downtrend line connects:
Uptrend line connect:
downtrend connects highs: lower highs & lower lows
uptrend connects lows: higher highs, higher lows
Price where buying pressures limits a downtrend: Demand > Supply
Support (at the bottom-floor)
Price where selling pressure limits an uptrend: Demand < Supply
Resistance (at the top- ceiling)
A higher sharpe ratio indicates:
Higher excess return per unit of risk
Risk and Expected return have a relationship:
Positive relationship; given by the upward sloping SML & CML
Concludes that expected returns are a positive (linear) function of systematic risk:
CAPM
E(R)= Rf + B(R(m) - Rf))
Beta is systematic risk of the market
Ensuring the quality of data—for example, by adjusting for bad or missing data
Ex: An analyst adjusts daily stock index data from two countries for their different market holidays.
Curation
Refers to a perceived tendency for breached support levels to become resistance levels and breached resistance levels to become support levels:
Change in polarity
Decreasing volume on each of the high prices in a head and shoulders pattern suggests:
(or each of the low prices in an inverse head and shoulders)
Weakening in the supply and demand forces that were driving the price trend
Firm invests the majority of a portfolio passively and uses active strategies for the remaining portion:
Core-satellite approach
Example: A firm that invests the majority of a portfolio to track a benchmark index, and uses active investment strategies for the remaining portion
Specifying the percentages of a portfolio’s value to allocate to specific asset classes
Strategic Asset Allocation
Allocating a portfolio’s overall permitted risk among strategic asset allocation, tactical asset allocation, and security selection:
Risk budgeting
- Liquidity
- Legality
- Time horizon
- Tax
- Unique needs
IPS- Constraints
- Risk
- Return
IPS- Objectives
Absolute & relative guidelines
Jensen’s alpha is based on:
Systematic risk (market risk)
Measures excess return per total risk
Sharpe ratio
(Measure of risk-adjusted return)
Total Risk: standard deviation
Measures excess return per systematic risk
Treynor
(Measure of risk-adjusted return)
Systematic risk: beta risk
Excess return is:
The return in excess of the Risk-free rate
Difference in percentage return on a portfolio and the expected return on the market, for a portfolio that has the same risk:
M-squared
(Measure of risk-adjusted return)
Measures the difference between the actual return on the portfolio & the expected return on a portfolio, given the same systematic risk:
Jensen’s alpha
(Measure of risk-adjusted return)
Given the beta of the portoflio, How did the portfolio do compared to the expected return for that beta
SML
Measures based on systematic risk (beta) are appropriate for:
Well diversified portfolio
- Treynor Measure
- Jensen’s alpha
Measures based on total risk are appropriate for:
Concentrated portfolios
- M-squared
- Sharpe Ratio
Total Risk: standard deviation
Risk-adjusted return measures of excess return per unit of total risk:
Sharpe Ratio
M-squared
Total risk= standard deviation
Used for undivisified portfolios
Risk adjusted return measures of excess return per unit of systematic risk:
Jensen’s alpha
Treynor Measure
Systematic risk= market risk= beta
Used for well diversified portfolios
High beta stocks and low beta stocks will:
High beta: increase the systematic risk of a portfolio
Low beta: decrease the systematic risk of a portfolio
The collection of large quantities of data from a variety of sources in multiple formats:
Big Data
A primary driver of fintech is the increasingly ____ nature of data that firms must process:
Unstructured
tweets, texts
A primary driver of fintech is the increasingly ____ nature of data that firms must process:
Unstructured
tweets, texts
- Market prices reflect all known information.
- Market prices exhibit trends and countertrends that tend to persist.
- Market prices exhibit patterns and cycles that repeat themselves in predictable ways.
Key principles of Technical Analysis
Investors may give themselves credit for recent market advances, fueling overconfidence bias:
Hindsight bias
Asset bubbles
May cause investors to believe recent market highs are rational and keep them in the market even as market prices or company fundamentals have started to decline:
Anchoring
Maintaining ownership records for physical assets by using distributed ledger technology:
Tokenization
Record & maintain ownership titles using distributed ledger technology
Contracts that execute automatically when certain conditions are met:
Smart contracts
Subset of distributed ledger technology:
Blockchain
Irrational resistance to change due to comfort with an existing situation, is a type of emotional bias:
Status quo bias
Outcomes: endowment bias & regret aversion
In choosing asset classes for establishing strategic allocation across assets, the manager would most prefer that:
Correlations of asset returns within an asset class > correlations of asset class returns
Correlation of stocks vs stocks > correlation of stock vs bonds
The lower the correlation between two securities the:
Greater the risk reduction to a portfolio
A risk-averse investor would prefer the portfolio with correlation coefficient that is:
Lowest Correlation
A chart that displays the price of an asset relative to the price of another asset or benchmark over time
Relative Strength Chart
This chart is most useful for intermarket analysis:
Relative strength chart
Useful for demonstrating whether one asset class or market has outperformed or underperformed another
These charts are most useful for analyzing a single asset or market over time:
Candlestick
Volume Chart
Bias that results from the likelihood that some anomalies will show up by chance in a large enough number of tests:
Data snooping
For a single security alpha is the:
risk-adjusted/abnormal return for the period
When estimating the risk adjusted (abnormal) return on a single stock, we use:
Jensen’s alpha
When the forecasted stock return is less than the CAPM return, the stock is:
Overvalued
The security is returning less than the CAPM fair return
All of the below are considered:
- Inflation
- interest rates
- economic cycles
- politics
- natural disaster
Elements of systematic risk
An unexpected price is a non-systematic element
Which type of asset allocation?
The decision to deliberately deviate from the policy portfolio:
Tactical asset allocation
Asset allocation strategy that attempts to take advantage of temporary dislocations from the market conditions and assumptions that drove the policy portfolio decision:
Tactical asset allocation
In terms of market bubbles, which behavioral bias is most strongly associated:
Overconfidence and excessive trading
self-attribution (form of overconfidence)
Bubbles & crashs are well-known and well-documented yet, represent:
Market anomolies
The halo effect is an example of:
Representativeness
Algorithmic trading has increased:
trading destinations
global financial markets
Streamlining post-trade processes is a benefit of:
DTL
real time clearing and settlement of securities trading
When comparing stocks in the CAPM pricing model, there are no assumptions about the impact on expected return from a stock’s:
Unsystematic risk; Standard deviation
Compared to a normal distribution, historical returns on major asset classes in developed markets have exhibited:
More frequent large negative deviations
positive excess kurtosis & negative skew
The theory that bearing unsystematic risk will provide no additional expected return, assumes that unsystematic risk can be diversified away at:
no cost
An investor willing to sell for 60, but would buy for 50, is showing:
endowment bias
valuing something you own more than you would if you didn’t own it
