Portfolio Management and Investment RIsk Flashcards
Involves investing a fixed-dollar amount at regular intervals without regard for the market price of the security
Dollar Cost Averaging
This method is most effective when valuing a mature company that pays significant dividends, such as a utility company
Dividend Discount Model
Have a high price-to-earnings ratio, but a low dividend payout
Growth Stocks
Event risk
Systematic (non-diversifiable) risk
The degree to which different investments move in the same direction in the market in which they trade
Correlation
Explores the relationship between risk and reward and also focuses on diversifying across asset classes
Modern Portfolio Theory
Method of estimating the price of an investment, typically a bond
Discounted Cash Flow
If a security’s actual return is higher than its beta than the security has what alpha?
A positive alpha
Try to use an active strategy to alter the portfolio’s asset mix in an effort to take advantage of anticipated economic events
Tactical asset allocation
Liquidity risk
Unsystematic (diversifiable) risk
Provides the greatest return for a given amount of risk
Optimal portfolio
Investors can use fundamental analysis (financial metrics) to identify stocks that are undervalued or overvalued in a
Weak-form efficiency market
Includes stocks of 30 of the largest publicly traded US corps
DJIA
A systematic approach to investing
Dollar cost averaging
All past market prices and data are fully reflected in securities prices and that price changes are the result of the random release of new information
Weak-form efficiency
The asset is more volatile and expected to outperform the market when the market is up, but underperform when the market is down
If an asset’s beta is greater than 1.00
Investors commonly use the rate of return on a three-month Treasury-bill (T-bill) as the
Risk-free rate
Taxable interest rate x (100% - Tax Bracket %)
After-Tax Yield
Risk-Free Rate + (Beta x Risk Premium)
Alpha
The additional return, above the risk-free, that’s necessary to induce investment in riskier asset classes
Risk Premium
Involves taking all future cash flows and discounting them to their present value
Discounted cash flow
The ratio indicates the amount of return earned per unit of risk
Sharpe Ratio
Market risk
Systematic (non-diversifiable) risk
Regulatory risk
Unsystematic (diversifiable) risk
An identical concept to an internal rate of return. It essentially solves for the rate of return that makes the present value of an investment exactly equal to the present value of the future cash flows
Dollar-weighted Return
Measures the performance of all stocks in the US includes small-, mid- and large-cap companies
Wilshire 5000
Future value
_____________
(1+ rate of return)^number of compounding periods
Present value
The sum of all of the possible returns multiplied by the probability of each possible return
Expected return
The rate of return attributed to an investment with zero risk
Risk-free return
Attempts to describe the relationship between risk and expected return for securities, while also providing some insight into the nature of risks
Capital Asset Pricing Model (CAPM)
Credit risk
Unsystematic (diversifiable) risk
What an investor needs to invest today
Present Value
Stocks that remain stable and have consistent earnings
Defensive stocks
The measure of risk as evidenced by the variability between returns
Standard deviation
Sum of the discounted cash flows less the investment
Net present value
A strengthening US dollar against foreign currencies will become
More expensive for foreigners and result in an increase in foreign goods being imported into the US
Portfolio’s return from period I - Risk-free rate of return for period I
__________________________________________________
Standard deviation of the portfolio during period I
Sharpe Ratio
An investor will be able to buy more shares when the price is low, but fewer shares when the price is high. As a result, the investor’s average cost per share should be lower than the average of the prices at which the investor purchased the shares
Dollar cost averaging
Modern portfolio theory suggests that an optimal portfolio is one that’s diversified with assets that are
Not all correlated with each other
The internal rate of return needed for an investment to double over a given number of years
Rule of 72
Includes 500 stocks of large publicly held companies that trade on either the NYSE or Nasdaq
S&P 500
A way to value the price of a stock by using an estimate of future dividends and discounting them back to present value
Dividend Discount Model
Includes 400 stocks of mid-sized companies that are publicly traded and have market capitalizations that range from $2B to $10B
S&P 400
Currency (Exchange-Rate) Risk
Unsystematic (diversifiable) risk
Tactical asset allocation is considered an
Active investment method
Measures the performance of 2,000 small- and mid-cap companies
Russell 2000
Analysts determine this premium for the market as a whole by subtracting the risk-free rate from the return of the S&P 500
Risk premium
Expected return, standard deviation, and correlation are the basic components that are important to
Modern portfolio theory
The price of a stock incorporates all of the current information about that security, including both public and non-public information. Investors may not increase their returns no matter how much research and analysis they conduct.
Strong-form efficiency
Strategic asset allocation is considered a
Passive investment method
The basic idea is to determine how much an additional return is being received for the willingness to hold a risky asset over one that’s risk-free
Sharpe Ratio
Investors who subscribe to the Efficient Market Hypothesis and believe that market timing is ineffective usually favor
buy-and-hold strategies and engage in market indexing
CAPM considers this risk as one that may be nearly eliminated through diversification and by constructing a portfolio of relatively uncorrelated assets
Non-systematic/diversifiable risk
Interest rate risk
Systematic (non-diversifiable) risk
Considered a risk-adjusted return, represents the difference between an asset’s expected return and its actual return
Alpha
Dividend
_________
Discount Rate
Dividend Discount Model
Capital risk
Unsystematic (diversifiable) risk
Call risk
Unsystematic (diversifiable) risk
Complexity risk
Unsystematic (diversifiable) risk
Investors who believe that the prices of securities function according to a random process
Random walk
DCF Value - Market Price of the Bond
Net present value
Political risk
Unsystematic (diversifiable) risk
All known information about an investment is reflected in the current price, constantly outperforming the market is impossible and investing passively will outperform active investment strategies
Efficient Market Hypothesis
Inflation (purchasing-power) risk
Systematic (non-diversifiable) risk
Original Invesment amount ( 1 + the rate of return ) ^number of compounding periods
Future value
Tend to sell at a low price-to-earnings ratio
Value Stocks
When calculating the sharpe ratio, the time frame of the standard deviation must be
Identical to the time frame of the rate of return
The risk that’s specific to a particular security or sector
Non-systematic/diversifiable risk
Investment strategy that involves the movement of money from one industry or sector to another in an attempt to beat the market
Sector rotation
The greater a portfolio’s sharpe ratio, the
Better its risk-adjusted performance has been
Also known as market risk, is the possibility that changes in the economy and/or the entire market will be reflected in nearly every asset class
Systematic/non-diversifiable risk
A capital goal that needs to be achieved within a specific period
Capital needs
The possible return on the investment weighted by the likelihood that the return will occur
Expected return
Legislative risk
Unsystematic (diversifiable) risk
Business risk
Unsystematic (diversifiable) risk
Are a category of mathematical algorithms that are usually run by computers due to the significant volume of calculations involved
Monte Carlo Simulations
The relatively sensitivity of an investment (or portfolio of investments) to market risk is measured as
Beta
Estimates what an investment will be worth at a point in the future
Future value
Security prices reflect all publicly available information and not just past information. Investors can only generate excess returns through the use of non-public information
Semistrong-form efficiency
Performs risk analysis for a company or industry by first identifying a list of economic factors that may affect the investment and assigns each factor a range of values - a probability distribution
Monte Carlo Simulations
A negative sharpe ratio indicates that a
Riskless asset class will perform better
The approximate number of years that it will take for a principal amount to double at a given rate of return
Rule of 72
Suggests that investors should shift their attention from the hot stock of the day to building a portfolio that consists of various classes of assets
Modern Portfolio Theory
The asset is more stable and expected to underperform the market when the market is up, but outperform the market when the market is down
If an asset’s beta is less than 1.00
Reinvestment risk
Systematic (non-diversifiable) risk
Opportunity (Cost) risk
Unsystematic (diversifiable) risk
Tax-Free Interest Rate
_______________________
(100% - Tax Bracket %)
Taxable Equivalent Yield
(Ending Value - Beginning Value + Investment Income)
_______________________________________________
Beginning Value
Total Return
