Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

CFA > Portfolio Management > Flashcards

Portfolio Management Flashcards

You may prefer our related Brainscape-certified flashcards:
CFA flashcards
1
Q

Intro

What is the purpose of portfolio investing?

A

To maximise an investments expected rate of return for a given level of risk (or minimise risk for a given rate of return), through diversification.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Intro

Endowment or Foundation

Definition

A

This is an investment fund set up by an institution from which regular withdrawals are made to fund ongoing operations.

Often set up by universities, hospitals or churches.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Intro

Steps

What are the 3 steps in portfolio management?

A
  • Planning step - understand clients needs and develop an Investment Policy Statement (IPS)
  • Execution step
  • Feedback step - including rebalancing the portfolio, and adjusting the IPS if necessary
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Intro

Fund Charges

Load fund

Redemption fee

Use of annual fees

A

A load fund is one with initial sales commission charges.

A redemption fee is a back-end load, a charge to exit the fund.

All funds charge annual fees

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Portfolio

Standard deviation of portfolio of 2 shares

A
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Portfolio

Standard deviation of portfolio of 3 shares

A
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Portfolio

2 assumptions in investment analysis

A
  • Returns are normally distributed
  • Markets are operationally efficient
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Portfolio

Utility Theory

Definition

A

Utility theory involves allocating a utility score to each investment based on a function of the expected return and variance.

eg Utility Score = Expected Return - 0.5*A*σ2

In this case A is the risk aversion coefficient, positive for risk averse investors, zero for risk neutral and negative for risk seekers.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Portfolio

Utility Theory

What are indifference curves in the context of utility theory?

A

Based on the utility score/formula used, an indifference curve can be drawn for a given risk aversion level (based on risk aversion coefficient A). This reflects investments which would be equivalent for that investor, based on the expected return and standard deviation levels.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Portfolio

Capital Allocation Line

Definition

Formula

Name of the slope/ratio

A

This represents the relationship between E(rp) and σp, the expected return and standard dev of a portfolio.

E(rp) = rf + E(ri - rf) * σp/σi

This is in the situation where we invest w1 in risk free asset rf and the rest in risky asset ri.

Exp portfolio return is E(rp) = w1 * rf + (1-w1) * E(ri)

and standard dev is σp = (1 - w1) * σi

So in short, the expectation of the portfolio is a linear function of the standard deviation of the portfolio, with slope E(ri - rf)/σi being the Sharpe measure, or reward-to-variability ratio.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Portfolio

Optimal Capital Allocation

Given the capital allocation line and indifference curves based on utility theory, how is optimal capital allocation determined?

A

Select the highest (i.e. most return for variability) indifference curve which touches the capital allocation line. The point at which the CAL touches the indifference line is the optimal capital allocation.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Portfolio

Covariance

Relationship between covariance and correlation coefficient

A

The correlation coefficient is the standarised version of covariance, calculated as follows:

p(1,2) = cov(1,2)/σ1σ2

Correlation coefficient represented by greek letter phi and ranges between -1 and 1.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Portfolio

Covariance

How do you calculate covariance from probability data?

A

Σpi*(Ri(A)-E(A))*(Ri(B)-E(B))

In the below example:

35%*(10%-4.8%)*(7%-2.05%) +

35%*(-4%-4.8%)*(4%-2.05%) +

30%*(-9%-4.8%)*(-6%-2.05%)

=0.0714%

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

Portfolio

Efficient Frontier

What is it?

A

The Minimum-Variance Frontier is built by using a computer to calculate the portfolio weighting with the lowest variance for each given level of expected return.

The efficient frontier is the upper section of that line, above the minimum-variance point. The lower section will never be chosen since for the same level of variance a higher return can be achieved with a different weighting.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Portfolio

Optimal Portfolio

What happens when the efficient frontier portfolios are combined with a risk free asset?

Name of the new line produced?

A

A combination of a portfolio on the efficient frontier and risk free asset Rf produces a new capital allocation line.

Choosing the portfolio to create a CAL tangential to the efficient frontier produces a new optimal set of portfolios which dominate the efficient frontier.

The final line produced is the Capital Market Line (CML).

Note the risk free asset has expected return Rf and σf = 0.

Note the point to the right of P represents borrowing at the risk free rate to leverage investment in the portfolio.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Portfolio

Optimal Portfolio

How does a risk investor finally choose a portfolio with a combination of optimal portfolio and risk free asset?

A

The point on the highest indifference curve (for the relevant risk aversion level) tangential to the new CAL is chosen.

This will be a better result than the equivalent portfolio without the risk free asset, on the efficient frontier.

17
Q

Portfolio

Capital Market Theory

What is the CML

What portfolio do individual investors choose?

A

Capital Market Line

This is the line representing possible return/variance pairings achievable with a weighting between a portfolio on the efficient frontier and the risk free asset.

All investors will invest in the same portfolio, since it is the most efficient, but achieve their desired level of risk by selecting the appropriate weighting of the risk free asset.

18
Q

Portfolio

Capital Markets Theory

Market Portfolio

Proportion of each asset held

A

Represented by point M on the chart. All investors should hold this portfolio. In equilibrium all risky assets will be held in the portfolio, since all investors should be holding the same portfolio.

All assets in portfolio M should be held in proportion to their market value (assuming efficient markets).

19
Q

Portfolio

Capital Markets Theory

What is the effect of a risk-free rate spread on the Markowitz efficient frontier?

(i.e. you can invest at the risk free rate but must borrow at a slightly higher rate)

A

There are two tangential points on the efficient frontier. To the left you can reduce investment in the portfolio F and invest at the risk free weight, to the right you can borrow at the higher rate to leverage portfolio K.

The area on the efficient frontier between portfolios F and K is also on the overall Markowitz efficient frontier.

20
Q

Portfolio

Risk

Systematic and unsystematic risk

Which has a value reflected in higher returns?

A

Total risk is the standard deviation of security returns.

Systematic risk is the risk inherent in the market which cannot be diversified away. Factors include global GDP growth.

Unsystematic risk is the risk which can be diversified away and reflects factors unique to the industry or security.

Systematic risk is reflected in the price since it can’t be diversified away, unsystematic risk is not rewarded.

21
Q

Portfolio

Return-Generating Models

Definition

Three types

A

A return-generating model is a model or formula which estimates the expected return of a security based on certain parameters (eg market model, CAPM).

  • Macroeconomic factor models include factors such as surprises in GDP, rates and inflation.
  • Fundamental factor models include factors like market cap, PE ratio, financial leverage, earnings growth rate.
  • Statistical factor models select factors which best explain historical return covariances (factor analysis) or variances (principal-components).
22
Q

Portfolio

Beta

Description of beta

Formula

A

Beta reflects a securitys covariance with the market portfolio (Covi,M), which is an absolute measure.

Beta is infact the standardised version of this covariance:

since Covi,j = pi,j * σi,j

ß = Covi,M / CovM,M = Covi,M / σM2

23
Q

Portfolio

CAPM

CAPM assumptions

A
  • All investors are Markowitz efficient, want to target points on the efficient frontier depedent on their risk-return utility function
  • Markets are frictionless (no transaction costs)
  • All investors have the same one-period time horizon (eg one year)
  • All have homogenous expectations (identical probability distributions for returns)
  • Investments infinitely divisible
  • All investors are price takers (trades can’t affect security prices)
24
Q

Portfolio

CAPM

Formula

Market risk premium

Security risk premium

A

E(Rstock) = Rf + [E(RM) - Rf] * ßstock

Market risk premium = E(RM) - Rf

Security risk premium = [E(RM) - Rf] * ßstock

25
Q

Portfolio

CAPM

Security Market Line (SML)

A

Similar to the Capital Asset Line, however this is the relationship between return and beta, and is obviously linear.

Where the CAL represents expected returns on efficient portfolios, the SML examines expected returns on individual assets based on their level of systematic risk (beta).

The slope of the SML is the market risk premium.

26
Q

Portfolio

CAPM

Alpha

A

Alpha is when there is a difference between the expected and required return (per CAPM and the SML). It reflects additional return expected above the CAPM expectation.

27
Q

Portfolio

CAPM

What is the beta of a portfolio?

A

Simply the weighted average of betas of the components of the portfolio.

28
Q

Portfolio

CAPM

Treynor Ratio

Sharpe Ratio

A

The Treynor Ratio measures the excess return on an investment which has no diversifiable risk:

(RP - Rf) / ßP

The Sharpe Ratio measures the excess return per unit of risk

(RP - Rf) / σP

Sharpe is more relevant if the portfolio is not fully diversified, but Treynor is more relevant if it is since then only systematic risk matters.

29
Q

Portfolio

CAPM

Jensen’s Alpha

A

This is the excess of return over the expectation per the CAPM model:

alphaP = RP - [Rf + ß(Rm - Rf)]

30
Q

Portfolio

CAPM

Security Characteristic Line

A

Similar to the Security Market Line (SML), the SCL graphs the relationship between excess market return and excess security return, using formula:

Ri - Rf = alphai - ßi(Rm - Rf)

So it intercepts y axis at alphai (since this is the excess security return when there is no excess market return) and rises with a slope of ß.

31
Q

Portfolio Management

Are investors objectives expressed in terms of risks or returns.

A

Investors objectives are expressed in the terms of both risks and returns, since the investment decision is a trade off between the two.

An analysis of risk tolerance should precede any discussion of return objectives.

CFA (10 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions