Quantitative Investment Concepts Flashcards

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1
Q

Normal Probability Distribution

A
  • characterized by a single peak in the center, which is the location of the arithmetic mean of the series of observations.
  • also known as the bell curve
  • assuming a normal distribution, an actual rate of return on investment will occur 68% of the time within one standard deviation of the arithmetic mean, 95% of the time within two standard deviations, and 99% of the time within three standard deviations of the mean.
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2
Q

Lognormal Probability Distribution

A
  • a probability distribution in which the series of observations is skewed to the left of the arithmetic mean.
  • implies that there is a 50% chance that an observation selected at random will fall to the left of the mean.
  • assumed whenever the investor is analyzing the ending or future value of a portfolio.
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3
Q

Skewness

A
  • measures how far the actual outcomes of a probability distribution deviate from the arithmetic mean.
  • effectively, what is being measured in decimal terms is how far the median return is from the mean return.
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4
Q

Positively Skewed

A
  • the median return is less than the mean return
  • exposes an investor to the possibility of a greater number of returns below the mean return than does an investment with positive skewness.
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5
Q

Negatively Skewed

A
  • the median return is greater than the mean return

- investor assumes more total (including downside) risk with a negatively skewed investment

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6
Q

Kurtosis

A
  • measures the degree of “fatness” in the tails of a probability distribution
  • greater fatness or less peaked distribution, means that more returns with large deviations from the mean return have occurred than with a normal distribution i.e more total risk.
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7
Q

Correlation Coefficient (R)

A

-measures how the returns of two assets are related and ranges in value from -1.0 to +1.0

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8
Q

if R = +1

A

the two securities are perfectly positively correlated; the two securities move together exactly and there is no reduction of portfolio risk

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9
Q

if R = -1

A

-the two securities are perfectly negatively correlated; the two securities move in exactly opposite of each other; risk is completely eliminated

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10
Q

if R = 0

A

-there is no correlation between the price changes of these securities; that is, they move completely independent of one another; portfolio risk is unaffected.

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11
Q

Coefficient of Determination (R squared)

A
  • measures the proportion of the variation in one variable explained by the movement of other variables.
  • can be used in comparing the movement of one stock to the market as a whole and the extent to which the portfolio is diversified.
  • return is not measured, only risk
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12
Q

Example of R Squared

A
  • correlation is .81 between two securities
  • .81x.81 = .656 or 65.6%
  • this means that exactly 65.6% of the variation in the return of security A may be explained in the return of security B. The remaining 34.4% of the variation in Security A is due to other factors.
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13
Q

Coefficient of Varitaion

A
  • reflects the relative dispersion of one security to another on the basis of total risk per unit of expected return.
  • CV = Standard Deviation/Expected or mean return
  • choose the investment with the lower coefficient of variation (less total risk per unit of expected return).
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14
Q

Standard Deviation

A
  • an absolute measure of the variability of the actual investment returns around the average or mean of those returns.
  • there is a direct relationship between standard deviation and risk; often standard deviation is used as a measurement of the risk that is assumed by an investor with respect to any asset (or portfolio), also known as total risk.
  • assuming a normal probability distribution, it can be used to predict the expected return of an investment based on historical performance of the asset or portfolio.
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15
Q

Beta

A
  • relative measure of an asset’s or portfolio systemic risk.
  • best used as a measure of risk for a diversified portfolio or a portfolio that has no unsystematic (or diversifiable) risk.
  • it measures the volatility of a particular securities rate of return or price relative to the volatility of the market as a whole.
  • beta of 1.2 is 20% more risky than the market.
  • an asset with a negative Beta may assist greatly in protecting the investor from a significant decline in the value of their portfolio during a down market.
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16
Q

Covariance

A
  • measures the extent to which two variables move together (positively) or opposite of each other (negatively).
  • best described as the relationship between or among stocks that includes not only the individual stock’s variability but also its impact on and interaction with other portfolio securities
17
Q

Semi-Variance

A
  • measures only the series of risks of historical returns that are below the mean or average return.
  • a better measure for a risk averse investor
18
Q

Indifference (utility) Curves

A
  • measure the risk/reward preferences that an investor is willing to make along the efficient frontier.
  • the steeper the curve, the greater the investors aversion to risk