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Investment Practice > Portfolio Management > Flashcards

Portfolio Management Flashcards

1
Q

What is the difference between ‘ex-ante’ measurements of risk and return, and ‘ex-post’ measurements?

A

‘Ex-ante’ measures take place before the investing period gets under way and ‘ex-post’ are the actual measurements. They can significantly differ.

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2
Q

What is the most common measure of risk used for securities and portfolios?

A

Ex-post standard deviation. This measures the dispersion of returns around the average return.

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3
Q

Why may standard deviation not be a good measure of risk?

A
  • Based on past returns.
  • It measures upside and downside returns, when managers are only interested in downside dispersion.
  • Volatility is not a complete measure of risk e.g. inflation.
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4
Q

What is semi-variance?

A

A measure of downside risk that only measures returns that fall below the average.

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5
Q

What is probability of shortfall?

A

A measure of risk that identifies the chance of return over a specific period falling below a target level. It only measures chance and not the value of the shortfall.

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6
Q

What is the expected shortfall?

A

A measure of expected loss at a given probability level.

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7
Q

What is Value at Risk (VaR)?

A

It is the amount by which the value of an investment/portfolio may fall over a given period of time, at a given level of probability.

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8
Q

What are the three methods of calibrating VaR?

A
  • Historical Return Approach: assuming that history will repeat itself.
  • Parametric (variance-covariance method): assuming that the daily returns follow a normal distribution.
  • Monte-Carlo Approach: Developing a mathematical model and using expected returns.
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9
Q

What is drawdown?

A

A measure of the amount by which a the value of an investment has fallen from its historic peak.

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10
Q

What is the advantage of using drawdown as a measure of risk?

A
  • It refers to an empirical reality.
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11
Q

What are the limitations of using drawdown as a measure of risk?

A
  • For two different time series with equal characteristics, the longer series tends to have a greater drawdown.
  • Maximum drawdown is a single number and will therefore have a large and uncertain error distribution.
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12
Q

What does the relative weight of an individual security in a portfolio refer to?

A

The value of that security in the portfolio divided by the monetary value of the portfolio itself.

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13
Q

What does active share measure?

A

How the relative weights of individual stocks in a portfolio differ from those of the benchmark.

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14
Q

What does unsystematic risk refer to?

A

The specific risk of an asset. This can be eliminated through diversification.

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15
Q

What does systematic risk refer to?

A

The risk present in multiple assets (market risk). This cannot be eliminated through diversification.

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16
Q

What are the four assumptions of the CAPM?

A
  • Markets are perfectly competitive, free of taxation and transaction costs.
  • Investors are rational and risk-averse.
  • Investors can borrow/lend at a risk-free rate of interest.
  • Investors all have the same expectations and knowledge.
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17
Q

What does the Securities Markets Line (SML) represent?

A

The possible risk/return combinations available from combing the risk-free asset and the market portfolio.

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18
Q

What can be incurred if an investment lies above the SML?

A

It offers a return higher than that required for its level of risk. It is undervalued.

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19
Q

What can be incurred if an investment lies below the SML?

A

It offers a return lower than that required for its level of risk. It is overvalued.

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20
Q

What is factor investing?

A

The construction of a portfolio with particular exposure to a set of macro factors by combining stocks with known macro-factor sensitivities e.g. momentum investing, value, growth etc.

21
Q

What does the Efficient Markets Hypothesis (EMH) state?

A

That because these markets are informationally efficient, it is very difficult for investors to outperform the market through active fund management.

22
Q

What the weak form efficiency of EMH?

A

Suggests that all historical share price information is fully reflected in the current share price.

This means that an investor who analyses historical share price information will not be able to find anomalies to exploit.

23
Q

What is semi-strong form efficiency?

A

Prices reflect all historical and publicly available information. All information that is released is immediately reflected in the share price.

This means that investors cannot profit through buying/selling upon the announcement of information.

24
Q

What is strong form efficiency?

A

All historical, public and private knowledge is fully reflected in the share price.

No-one can profit from price anomalies (not even with inside information).

25
Q

What are the limitations of Efficient Markets Hypotheses?

A
  • Assumes there are a large number of rational profit-maximising investors.
  • Evidence suggests that there is a degree of predictability in stock market.
26
Q

What does Model Portfolio Theory assume?

A
  • Investors are rational
  • Markets are efficient
  • Investors construct portfolios using mean-variance analysis
  • Expected returns are based on risk alone.
27
Q

What is memory bias/anchoring?

A

When a value scale is fixed by recent observations.

28
Q

What is confirmation bias?

A

When investors are quick to accept information if it reaffirms their opinions.

29
Q

What is conservatism/conservation bias?

A

When investors are slow to update their investment view, in the face of new information.

30
Q

What is the endowment effect?

A

Overvaluing held assets.

31
Q

What is the motivation behind immunisation/bond duration matching?

A

To create a portfolio to have an assured return over a specific time horizon, irrespective of IR changes. It matches a liability with a portfolio with the same weighted duration.

32
Q

How does ‘riding the yield curve’ work?

A

Purchasing bonds with maturities in excess of a liability’s time horizon, and then selling it after.

33
Q

Uncorrelated securities:

A

Show no relationship

34
Q

What does idiosyncratic risk refer to?

A

Unsystematic risk

35
Q

If the market crashes, what would we expect to happen to the share’s correlation to the market?

A

Move towards +1, as all shares fall together.

36
Q

The CAPM asserts that portfolio returns are best explained by:

A

Systematic risk: The model relates expected return to the relative systematic risk of the portfolio to the risk of the market portfolio (beta).

37
Q

A fund has a one week VAR of £1 million at a 95% level, what does this mean?

A
  • There is a 95% chance of losing less than £1m in any one week.
  • The fund is expected to lose less than £1m for 19 weeks in every 20.
  • There is a 5% chance the fund will lose £1m or more in any one week.
  • The fund is expected to lose £1m or more for one week in 20.
38
Q

What kind of gilt would a higher-rate taxpayer find most suitable to invest in if he expected interest rates to fall?

A

Low coupon longs: This is the most volatile bond, as it has the highest duration and thus gives the greatest capital gain.

39
Q

What is the best description of the long-term correlation between bonds and commodities?

A

Strong negative correlation.

40
Q

What is the main difference between UK private pension funds and European private pension funds?

A

UK pensions tend to have a higher percentage of equities in their fund than fixed income securities.
European pensions tend to have a higher exposure to fixed income securities.

41
Q

How is market timing best described?

A

It is a form of active fund management where the fund manager will attempt to alter the profile of the portfolio, in anticipation of any potential movements in the market. This can be achieved by altering the beta of an equity-based portfolio, or altering the duration of a bond portfolio.

42
Q

What is the difference between technical and fundamental analysis?

A

Technical: Focuses on past performance and trends
Fundamental: Focuses on a company’s financials and other detailed information.

43
Q

What is the settlement time for a UK debenture stock?

A

T+2

44
Q

What does a broker-principal dealer do?

A

Buys and sells shares on their own behalf and on the behalf of clients.

45
Q

How are UK bonds traded?

A

Through a market making system with no centralised market.

46
Q

How much commission is charged on gilt purchases over £1m?

A

None

47
Q

What is relative drawdown?

A

The drawdown relative to a benchmark.

48
Q

What is the link between monthly and daily standard deviations (where there are 20 working days in the month)?

A

σ day = σ month x √1/20

49
Q

What is the z-spread?

A

The spread between the yield of govt. bonds and swap rates for the same term.

Investment Practice (12 decks)

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