Risk, Returns & Asset Allocation (Ruby May 18, 2015) Flashcards
Currency Hedging
Is a tactic used to reduce the currency risk for an investment dominated in a specific foreign currency by purchasing an instrument that permits the fund manager to purchase an equivalent amount of the domestic currency at a fixed price in the specific foreign currency.
Hedge to CAD
means that the ETF has a currency hedge to the Canadian dollar.
Unique risk
Is the risk that results from a mutual fund investing in a very narrow segment of the market
Tracking fund and tracking risk
is a fund that has its return linked to the performance of one or more recognized indices, shares of another mutual fund or to a basket of securities by either directly purchasing the appropriate securities or by entering into forward contracts and other derivative instruments.
Tracking risk is the risk that a tracking fund may not be able to track the performance of its corresponding reference index, reference fund, or reference security.
While the manager of a currency hedged international fund would hedge the fund’s exposure to a foreign currency by entering into currency forward transactions, there is no assurance that these currency forward transactions will be effective. In addition, these currency forward transactions would involve derivative investments, and therefore, expose the fund to derivative risk.
Coefficient variation
is a statistic that compares the standard deviation to the mean in order to measure the dispersion of returns around the mean. The high the coefficient, the high the risk.
Calculated as: Standard Deviation/mean
Calculation to determine the range an investment return, with 95% probability.
(mean return - (2 x standard deviation) and
mean return + (2 x standard deviation
What does beta measure?
Beta is used to compare the expected return on an investment to the return that the market experiences as a whole. The best for the market as a whole is 1.0, and is the standard against which individual betas are measured.
An individual beta above 1 suggests that the stock is more volatile than the market as a whole, while a beta of less than 1.0 suggests that the stock is less volatile. For example, a stock with a beta of 1.5 would be expected to earn a return that is 50% greater than the market as a whole when the markets are rising, but such a stock would also drop more quickly than the market as a whole when the markets are falling.
Cyclical company
Is a company whose financial results are sensitive to changes in economic conditions. A cyclical stock refers to the common shares of a cyclical company. As the business cycles mores into an expansionary phase, the return of a cyclical stock tends to increase at a faster than than the market as a whole.
Conversely, as the economy slows and enters into a recession, the return of a cyclical stock tends to decrease in value at a faster rate than the market as a whole. A cyclical company usually has a beta greater than 1. Companies that manufacture building materials or process raw materials, durable consumer goods, and cars are all examples of cyclical companies.
Non cyclical company
Is a company whose financial results are not sensitive to changes in economic conditions. A non-cyclical stock refers to the common shares of a non-cyclical company. Non-cyclical companies sell products that are in demand regardless of the state of the economy, such as food or heating fuel. A non-cyclical company usually has a beta of less than 1.
Counter cyclical company
Is a company whose financial results are inversely sensitive to changes in economic conditions. Counter cyclical companies, such as discount retailers and companies, such as discount retailers and companies that produce do-it yourself products, tend to do very well during economic slowdowns.Usually has a beta of less than 1.0.
Defensive stock
is a stock with a beta of less than 1. A defensive stock offers protection against the falling returns in a market downturn.
Total return or holding period return
measures the return on an investment as the combined cash flow from capital gains, interest, and dividends, divided by the total principal invested. This measurement of return is particularly useful when comparing investments that produce different types of investment returns.
Unfortunately, it is only useful in certain cases because of some shortfalls. The calculation of total return can be misleading because it does not consider the time period required to earn a return. The time value of money concept incorporates these calculations. The total return does not take into account the fact that any cash flows generated by an investment over the course of the year can be reinvested, thereby generating additional investment income. Over a period of several years, this could seriously affect the return on an investment.
What doe the Sharpe Ratio measure?
The risk and reward of an investment can be measured by the Sharpe Ratio.
(Portfolio return - risk free return)/standard deviation.
Higher sharpe ratio means less risk per percentage of return.
Required rate of return
Is the return that will provide her with adequate compensation for the risk of making the investment. An investor’s required rate of return is made up of the return that he could make on a risk free investment, and an added premium for taking the risk of investing in the stock market. When investing in the stock market, each investor must determine her required rate of return. If the total expected return on an investment is less than the investor’s required rate of return, it is not a suitable investment for that investor.
How to calculate expected rate of return
(((Current year dividend x (1 + dividend growth rate)/
Current price)
+
dividend growth rate)
