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CFA Level 1 > Portfolio Management > Flashcards

Portfolio Management Flashcards

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CFA flashcards
1
Q

Portfolio Perspective

A

Evaluating individual investments by their contribution to the risk and return of an investor’s portfolio (diversification)

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2
Q

Modern Portfolio Theory

A

Equilibrium expected returns for securities and portfolios that are a linear function of each security’s or portfolio’s market risk

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3
Q

Diversification Ratio

A

Ratio of the risk of an equally weighted portfolio of n securities (standard deviation of returns) to the risk of a single security selected at random from the n securities

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4
Q

Endowment

A

Fund that is dedicated to providing financial support on an ongoing basis for a specific purpose

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5
Q

Foundation

A

Fund established for charitable purposes to support specific types of activities or research (long horizon, high risk tolerance, little need for liquidity)

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6
Q

Banks

A

Earn more on the bank’s loans and investments than the bank pays for deposits (low risk, adequate liquidity)

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7
Q

Insurance Companies

A

Invest customer premiums with the objective of funding customer claims as the occur (life insurance long horizon, P&C shorter)

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8
Q

Investment Companies

A

Manage the pooled funds of many investors

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9
Q

Mutual Funds

A

Manage pooled funds in particular styles (index, growth, bond, etc.) and restrict their investments to particular subcategories of investments or regions

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10
Q

Sovereign Wealth Funds

A

Pools of assets owned by a government

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11
Q

Defined Contribution Pension Plan

A

Retirement plan in which the firm contributes a sum each period to the employee’s retirement account (based on factors such as years of service, age, compensation, etc.). Investment decisions left to employee

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12
Q

Defined Benefit Pension Plan

A

Firm promises to make periodic payments to employees after retirement (based on years of service and employee’s compensation at or near retirement). Employer assumes investment risk

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13
Q

Planning Step

A

Analysis of investor’s risk tolerance, return objectives, time horizon, tax exposure, liquidity needs, income needs

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14
Q

Investment Policy Statement

A

Details investor’s investment objectives and constraints. Specify objective benchmark. Update every few years, or when investor’s objectives change significantly

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15
Q

Execution Step

A

Analysis of the risk and return characteristics of various asset classes to determine how funds will be allocated to the various asset types

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16
Q

Top Down Analysis

A

Examine current economic conditions and forecasts (GDP growth, inflation, interest rates)

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17
Q

Bottom Up Security Analysis

A

Identify individual names within an industry that appear undervalued

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18
Q

Feedback Step

A

Over time, investor circumstances change, as will asset class performance (actual weights of assets in the portfolio will change with asset prices). Measure portfolio performance and evaluate to benchmark and IPS

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19
Q

Rebalance

A

Adjust allocations of various asset classes over time back to their desired percentages

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20
Q

Pooled Investments

A

Single portfolio that contains investment funds from multiple investors

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21
Q

Mutual Funds

A

Each investor owns shares representing ownership of a portion of the overall portfolio (NAV of assets/shares issued is NAV of each share). Charge a fee for management

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22
Q

Open End Fund

A

Investors can buy newly issued shares at the NAV. Newly invested cash is invested by mutual fund managers. Sold at NAV once a day (closing asset price)

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23
Q

Redeem

A

Investors can sell back shares to fund at the NAV

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24
Q

No Load Funds

A

Do not charge additional fees for purchasing shares (up front fees) or redeeming shares (redemption fees)

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25
Q

Load Funds

A

Charge either up front, redemption fees or both

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26
Q

Closed End Funds

A

Professionally managed pools of investor money that do not take new investments into the fund or redeem investor shares. Shares trade like equity shares. Management fees. Can reinvest dividends in additional shares

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27
Q

Money Market Funds

A

Invest in short term debt securities and provide interest income with very low risk (NAV set to one currency unit)

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28
Q

Bond Mutual Funds

A

Invest in fixed income securities. Differentiated by maturities, credit ratings, issuers, types

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29
Q

Index Funds

A

Passively managed. Constructed to match the performance of a particular index

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30
Q

Actively Managed

A

Management selects individual securities with the goal of producing returns greater than those of their benchmark indexes (higher management fees). Higher turnover of portfolio securities

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31
Q

Exchange Traded Funds

A

Purchases and sales are made in the market, usually passively managed, keep market prices very close to NAV. Can be sold short, purchased on margin, traded at intraday prices. Less cap gains liability

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32
Q

Separately Managed Account

A

Portfolio owned by a single investor and managed according to that investor’s needs and preferences. Single investor owns entire account

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33
Q

Hedge Fund

A

Pools of investor funds that are not regulated to the extent that mutual funds are. Limited to the number of investors who can invest in the fund (high minimum investment, qualified investors only)

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34
Q

Long/Short Fund

A

Buy securities that are expected to outperform the overall market and sell securities short that are expected to underperform overall market

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35
Q

Equity Market Neutral Funds

A

Long/short funds with long stock positions that are just offset in value by stocks sold short (profitable in both up and down markets as long as longs outperform shorts)

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36
Q

Bias

A

Long/short fund dedicated to a larger long position relative to short sales, or greater short position relative to long positions

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37
Q

Event Driven Funds

A

Invest in response to one time corporate events (mergers and acquisitions)

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38
Q

Fixed Income Arbitrage Funds

A

Take long and short positions in debt securities, attempt to profit on minor mispricings while minimizing effects of interest rate changes

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39
Q

Convertible Bond Arbitrage Funds

A

Take long and short positions in convertible bonds and equity shares they can be converted into in order to profit on relative mispricing between the two

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40
Q

Global Macro Fund

A

Speculate on changes in international interest rates and currency exchange rates, using derivatives and leverage

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41
Q

Buyout Funds (Private Equity)

A

Buy entire public companies and take them private. Funded with significant increase in firm’s debt (leveraged buyout). Fund reorganizes firm to increase cash flow, pay down debt, increase equity value, then sell firm or parts in public offering or to another company (3-5 years)

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42
Q

Venture Capital Funds

A

Invest in companies in their start up phase, with intent to grow them into valuable companies that can be sold publicly via an IPO or sold to an established firm

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43
Q

Holding Period Return

A

Percentage increase in the value of an investment over a given time period

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44
Q

Arithmetic Mean Return

A

Simple average of a series of periodic returns

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45
Q

Geometric Mean Return

A

Compound annual rate. Less than arithmetic mean when rates of return vary each period

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46
Q

Money Weighted Return

A

Internal rate of return on a portfolio based on all of its cash inflows and outflows (dividends and interest are outflows –> negative), beginning value and deposits are inflows)

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47
Q

Gross Return

A

Total return on a security portfolio before deducting fees (commissions are deducted)

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48
Q

Net Return

A

Return after fees have been deducted

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49
Q

Pretax Nominal Return

A

Return prior to paying taxes

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50
Q

After Tax Nominal Return

A

Return after tax liability is deducted

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51
Q

Real Return

A

Nominal return adjusted for inflation. Measures the increase in an investor’s purchasing power

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52
Q

Leveraged Return

A

Return to an investor that is a multiple of the return on the underlying asset (gain or loss on the asset as a percentage of an investor’s cash investment)

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53
Q

Covariance

A

Extent to which two variables move together over time (positive move together, negative move in opposite directions)

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54
Q

Correlation

A

Standardized measure of co-movement (covariance divided by products of standard deviations)

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55
Q

Correlation Coefficient

A

Pure measure of co-movement of two stocks’ returns bounded by -1 and +1

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56
Q

Minimum Variance Portfolios

A

Portfolios that have the lowest standard deviation of all portfolios with a given expected return

57
Q

Minimum Variance Frontier

A

For each level of expected portfolio return, vary the portfolio weights on the individual assets to determine the portfolio that has the least risk

58
Q

Efficient Frontier

A

Portfolios that have the greatest expected return for each level of risk (the top portion of the minimum variance frontier)

59
Q

Global Minimum Variance Portfolio

A

Portfolio on the efficient frontier that has the least risk

60
Q

Utility Function

A

Represents investor’s preferences in terms of risk and return (degree of risk aversion)

61
Q

Indifference Curve

A

Plots combinations of risk (std. dev.) and expected return among which an investor is indifferent (assume these are the only two things investors care about). Utility is same for all positions across curve

62
Q

Risk Aversion Coefficient

A

More risk averse investor will have a steeper indifference curve (more risk averse requires relatively greater increase in expected return to compensate for increase in risk)

63
Q

Two Fund Separation Theorem

A

All investors’ optimum portfolios will be made up of some combination of an optimal portfolio of risky assets and the risk free asset

64
Q

Capital Allocation Line

A

Line representing possible combinations of risk free assets and the optimal risk free asset

65
Q

Market Portfolio

A

Investors may choose different portfolio weights for the risk free and risky asset, but all investors will use the same risky portfolio (all investors that hold any risky assets hold the same portfolio of risky assets)

66
Q

Capital Market Line

A

Optimal capital allocation line for all investors under the assumption of homogeneous expectations (plots only efficient portfolios, std. dev. on x axis)

67
Q

Market Risk Premium

A

Difference between the expected return on the market and the risk free rate

68
Q

Passive Investment Strategy

A

Investors believe market prices are informationally efficient (invest in index of risky assets that serves as proxy for market portfolio, and allocation portion to risk free asset)

69
Q

Active Portfolio Management

A

Invest more than the market weights in securities believed to be undervalued and less than market weight in securities believed to be overvalued

70
Q

Unsystematic Risk

A

Risk that is eliminated by diversification (unique, diversifiable, firm-specific)

71
Q

Systematic Risk

A

Risk that cannot be diversified away (nondiversifiable, market risk)

72
Q

Return Generating Models

A

Estimate the expected returns on risky securities based on specific factors (estimate sensitivity of returns to each specific factor) –> macroeconomic, fundamental, statistical

73
Q

Multifactor Models

A

Use macroeconomic factors (GDP, growth, inflation, consumer confidence) and fundamental factors (earnings growth, firm size)

74
Q

Factor Sensitivity

A

Expected excess return for Asset i is sum of each of the betas for Asset i multiplied by the expected value of that factor for the period

75
Q

Single Index Model

A

Excess return is product of the factor weight, Beta and rhe risk factor

76
Q

Market Model

A

Estimate a security’s (or portfolio’s) beta and to estimate a security’s abnormal return based on the actual market return

77
Q

Beta

A

Sensitivity of an asset’s return to the return on the market index in the context of the market model 9covariance of the asset’s return with the market’s return)

78
Q

Regression

A

Estimation procedure that fits a line to a data plot

79
Q

Least Squares Regression

A

Line that minimizes the sum of the squared distances of the points plotted from the line –> line of best fit

80
Q

Security Characteristic Line

A

Regression line where the slope is the beta of Asset i

81
Q

Security Market Line

A

Line plotted using the relationship between risk and the return for individual assets using systematic risk (covariance between the asset and the market) –> CAPM Beta on the x axis
Above SML: Undervalued (buy)
Below SML: Overvalued (sell or short)
On SML: Properly valued

82
Q

Sharpe Ratio

A

Excess returns per unit of portfolio risk. Higher ratio indicates better risk adjusted performance. Sharpe ratios of all portfolios along the CML are the same. It is the slope of the CAL

83
Q

M Squared

A

Same portfolio rankings as Sharpe ratio, stated in percentage terms. Excess return on levered portfolio over market portfolio

84
Q

Treynor Measure

A

Excess returns per unit of systematic risk

85
Q

Jensen’s Alpha

A

Percentage of portfolio return above that of a portfolio or security with the same beta that lies on the SML (difference between active manager’s estimate of security’s expected return and CAPM expected return)`

86
Q

Investment Policy Statement

A

Begin with investor’s goals in terms of risk and return. Expectations in terms of returns must be compatible with investor’s tolerance for risk

87
Q

IPS

A
  • Description of Client
  • Statement of the Purpose
  • Statement of Duties and Responsibilities
  • Procedures
  • Investment Objectives
  • Investment Constraints
  • Investment Guidelines
  • Evaluation of Performance
  • Appendicies
88
Q

Absolute Risk Objective

A

Stated in terms of the probability of specific portfolio results, either percentage losses or dollar losses, rather than strict limits on portfolio results (nominal terms or real returns)

89
Q

Relative Risk Objectives

A

Relate to a specific benchmark (can also be in terms of probability). Peer performance benchmarks frowned upon (no way to match investment return by portfolio construction before the fact)

90
Q

Ability to Bear Risk

A

Depends on financial circumstances (investment horizons, client assets vs. their liabilities, more insurance, secure job)

91
Q

Willingness to Bear Risk

A

Based on investor’s attitudes and beliefs about investments (risk aversion or risk tolerance)

92
Q

Investment Constraints

A

RRTTLLU: Risk, return, time horizon, tax liability, liquidity, legal restrictions, unique constraints

93
Q

Liquidity

A

Ability to turn investment assets into spendable cash in a short period of time without having to make significant price concessions to do so

94
Q

Time Horizon

A

Longer an investor’s time horizon, the more risk and less liquidity the investor can accept in the portfolio

95
Q

Tax Situation

A

Overall tax rate, and tax treatment of various types of investment accounts

96
Q

Legal and Regulatory

A

Trust, corporate and qualified investment accounts may be restricted by law from investing in particular types of securities and assets (may also be percentage allocation restrictions)

97
Q

Unique Circumstances

A

Specific preferences and restrictions on which securities and assets may be purchased (ethical, religious, diversification needs)

98
Q

Strategic Asset Allocation

A

Specifies the percentage allocation to the included asset classes (correlation of returns within an asset class should be relatively high, correlation between asset classes should be relatively low)

99
Q

Alternative Investments

A

Hedge funds, private equity, commodity funds, artwork, intellectual property rights

100
Q

Tactical Asset Allocation

A

Varying from strategic asset allocation weights in order to take advantage of perceived short term opportunities

101
Q

Security Selection

A

Deviations from index weights on individual securities within an asset class

102
Q

Risk Budgeting

A

Sets an overall risk limit for the portfolio and allocates a portion of the permitted risk to the systematic risk of the strategic asset allocation, tactical asset allocation, risk from security selection

103
Q

Core Satellite Approach

A

Invests the majority portion of the portfolio in passively managed indexes and invests a smaller portion in active strategies

104
Q

Risk Management

A
  1. Identify the risk tolerance of the organization
  2. Identify and measure the risks that the organization faces
  3. Modify and monitor these risks
105
Q

Risk Management Framework

A
  • Establishing processes and policies for risk governance
  • Determine risk tolerance
  • Identify and measure existing risks
  • Manage and mitigate risks to achieve optimal bundles
  • Monitor risk exposures over time
  • Communicate across the organization
  • Perform strategic risk analysis
106
Q

Risk Governance

A

Senior management’s determination of the risk tolerance of the organization, elements of optimal risk exposure strategy, framework for oversight

107
Q

Credit Risk

A

Uncertainty about whether the counterparty to a transaction will fulfill its contractual obligations

108
Q

Liquidity Risk

A

Risk of loss when selling an asset at a time when market conditions make the sales price less than the underlying fair value

109
Q

Market Risk

A

Uncertainty about market prices of assets and interest rates

110
Q

Operational Risk

A

Risk that human error or faulty organizational processes will result in losses

111
Q

Solvency Risk

A

Risk that the organization will be unable to continue to operate because it has run out of cash

112
Q

Regulatory Risk

A

Risk that the regulation environment will change, imposing costs on the firm or restricting its activities

113
Q

Governmental/Political Risk

A

Risk that the political actions outside a specific regulatory framework (increased tax rates) will impose significant costs

114
Q

Legal Risk

A

Uncertainty about the organization’s exposure to future legal action

115
Q

Model Risk

A

Risk that asset valuations based on the organization’s analytics models are incorrect

116
Q

Tail Risk

A

Risk that extreme events are more likely than the organization’s analysis indicates (especially from incorrectly concluding distribution of outcomes is normal)

117
Q

Accounting Risk

A

Risk that organization’s accounting policies and estimates are judged to be incorrect

118
Q

Longevity Risk

A

Living longer than expected so that assets run out

119
Q

Standard Deviation

A

Measure of the volatility of asset prices and interest rates (risk on a stand alone basis)

120
Q

Beta

A

Measures the market risk of equity securities and portfolios of equity securities (risk reduction benefits of diversification)

121
Q

Duration

A

Measure of the price sensitivity of debt securities to changes in interest rates

122
Q

Delta

A

Sensitivity of derivatives values to the price of the underlying asset

123
Q

Gamma

A

Sensitivity of delta to changes in the price of the underlying asset

124
Q

Vega

A

Sensitivity of derivatives values to the volatility of the price of the underlying asset

125
Q

Rho

A

Sensitivity of derivatives values to changes in the risk free rate

126
Q

Downside Risk

A

Uncertainty about the probability of extreme (negative) outcomes

127
Q

Value at Risk (VaR)

A

Minimum loss over a period that will occur with a specific probability (minimum capital requirements)

128
Q

Conditional VaR (CVaR)

A

Expected value of a loss, given that the loss exceeds a minimum amount (measure of loss given default)

129
Q

Stress Testing

A

Examines the effects of a specific (usually extreme) change in a key variable such as an interest rate or exchange rate

130
Q

Scenario Analysis

A

What if analysis of expected loss but incorporates changes in multiple inputs

131
Q

Avoiding Risks

A

Not engaging in the activity with the uncertain outcome (comes from top management)

132
Q

Preventing Risks

A

Benefits of reducing or eliminating the risk are judged to be greater than the cost of doing so

133
Q

Diversification

A

Offers a way to more efficiently bear a specific risk

134
Q

Self-insurance

A

The means that the organization will bear any associated losses from the risk factors chosen to take on

135
Q

Risk Transfer

A

Another party takes on the risk (insurance) –> benefits of risk reduction are greater than the costs of insurance

136
Q

Surety Bond

A

Insurance company has agreed to make a payment if a third party fails to perform under the terms of a contract or agreement with the organization

137
Q

Fidelity Bonds

A

Pay for the losses that result from employee theft or misconduct

138
Q

Risk Shifting

A

Way to change the distribution of possible outcomes and is accompanied primarily with derivative contracts

CFA Level 1 (7 decks)

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