RPA2 Flashcards
Investing with Ethical objectives in mind - human rights, child labour, environmental considerations ect.
Socially Responsible Investing (SRI)
Physical Assets on a balance sheet
Real Assets
Conflict of interest between shareholders (principals) and executives (agents). Execs are more concerned with advancing their own interests rather than aligned with shareholders.
Agency Problem
turning non-liquid or non-marketable assets into marketable securities (i.e. mortgages, loans)
Securitization
Reward to variability ratio. How much excess return investors earn per additional unit of risk (over the risk free rate) taken on
Sharpe
Method used to measure and quantify the level of financial risk within an investment portfolio over a specific time frame.
Value at Risk (VAR)
Short-term, marketable, liquid, low-risk debt securities sometimes called “cash equivalents” because of their safety and liquidity.
Money Market
Includes longer-term, riskier securities such as stocks and bonds.
Capital Market
Short-term debt obligation backed by the federal government with a maturity of less than one year.
Treasury Bill
Calculation of the interest rate paid by a bond using the APR (simple interest rate) formula
Bond Equivalent Yield
Calculation of the interest paid by a bond using a compound interest formula
Effective Annual Yield
Quoted on an annual percentage rate basis rather than as an effective annual yield. This is calculated by determining the semi-annual yield and then doubling it.
Yield to Maturity
A unit of equity investors receive in exchange of an ownership stake in the Company.
Common Stock
Same ownership interest as common stockholders, but they do not have the right to vote. In exchange for giving up their right to vote, they are given a preferred claim over common shareholders to any dividends declared by a corporation.
Preferred Shares
Instruments which provide payoffs that depend on the value of other assets, such as commodity or bond/stock prices or on market index values.
Derivative Market
Derivative contracts which give the buyer the right, but not the obligation, to buy or sell a specific number of securities for a specific price on or before a specific expiration date, an the seller the corresponding obligation to buy or sell the securities for that price if they are trading at or above/below that price.
Call and Put Options
The assumption of considerable business risk in obtaining commensurate gain
Speculation
The risk premium, the incremental expected gain from taking on a risk (a positive expected profit beyond that provided by the risk-free alternative).
Commensurate Gain
An investment prospect with a risk premium equal to zero
Fair Game
The difference between the expected return on a risky asset and the rate of return available from risk-free assets.
Risk Premium
A score an investor assigns to alternative investment portfolios based on their respective expected returns and risks.
Utility Value
A tool for selecting investments based on the expected returns and variances of those returns.
Mean-Variance Criterion
This curve connects all portfolios with the same utility according to their expected return & standard deviation points. It presents the risk-return requirements of the investor at a certain level of utility.
Indifference Curve
The total amount a portfolio includes of “risky” and “risk-free” assets
Complete Portfolio
Risk-free Assets
money market or T-bills
A line showing the expected return and risk as measured by standard deviation of every single combination of risk-free and risky assets available to an investor for capital allocation
Capital Allocation Line (CAL)
The slope of the capital market line which increases with each unit of risk added
Sharpe (Reward to variability ratio)
A line representing a passive investment strategy comprising virtually risk-free, short-term T-bills and a fund of common stock mimicking a broad market index
Capital Market Line (CML)
A portfolio in which the risk-reward combination yields the max returns possible (i.e provides the highest utility to the investor) under the current and anticipated circumstances.
Optimal Portfolio
Expected return of a portfolio in proportion to the amount of risky and risk-free assets it holds
Expected return of Complete portfolio
The best returns available for the lowest level of volatility or risk - the optimized portfolio’s expected return
Expected return of Optimal portfolio
The standard deviation (square root of variance) of a portfolio in proportion to the amount of risky/risk-free assets that it holds.
Standard Deviation of a Complete Portfolio
The standard deviation (square root of variance) of the best returns available for the lowest level of volatility/risk - the optimized portfolio’s expected return
Standard deviation of Optimal portfolio return
The process of spreading funds available for investment accross assets.
Diversification
Risks inherent in the WORLD economy/financial system that can’t be entirely diversified away from
Systemic risk
This determines the degree of similarity between two random variables/the extent to which the returns on two assets move together.
Correlation
Risk specific to individual assets. Company-specific risk, unique risk, diversifiable risk
Non-Systemic Risk
The value that expresses the correlation between variables; falls between the range of 1 and -1
Correlation coefficient
Measure of EXTENT TO Which returns on two risky assets change in tandem
Covariance
A set of portfolios with the maximum return for a given standard deviation.
Markowitz Efficient Frontier
Predictable continuing trends in security returns that are impossible in the efficient market.
Market Anomalies
Returns of stocks with low P/E ratios are higher than stocks with high P/E ratios, even after adjusting for risk.
Price Earning (P/E) effect
Average annual returns are consistently higher on small market capitalization firms.
Small-firm effect
Stocks that tend to do well will REVERSE & underperform the market for as long as a year. Underperforming stocks begin outperforming for an extended time period.
Reversal Effect
While conventional financial theories presume that investors are rational, this theory assumes they aren’t
Behavioural bias
When people give too much weight to recent experience vs. prior experience when making forecasts, tending to make forecasts too extreme
Forecasting error
When people are too slow (too conservative) in updating their beliefs in response to new information.
Conservatism bias
When people overestimate their abilities and the precision of their beliefs/forecasts
Overconfidence error
Assuming a small sample is representative of a large population. Incorrect patterns can be inferred and trends are extrapolaed too far into the future
Representativeness error
Instead of rationally viewing every current and future dollar as identical, individuals divide their current/future funds into separate categories & assign different levels of utility to each category of funds.
Mental accounting
Assumes that losses/gains are valued differently. Investors make decision based on perceived gains instead of perceived losses.
Prospect Theory
Simultaneous purchases & sale of an asset to profit from a difference in the price (a zero-risk, zero-net investment strategy that still generate profits)
Arbitrage
The risk that the price doesn’t eventually converge to intrinsic value or don’t do so fast enough is an arbitrage opportunity
Fundamental Risk
Rolling average of stock prices based on a short, intermediate, or long period. Ratio of average volume in declining issues to average volume in advancing issues.
Trin Static
This theory holds that small investors tend to miss key market turning points. They buy stock after a bull market has already run its course/sell too late in a bear market. This can be identified by amount of orders numbering less than 100 shares.
Odd Lot Trading Index
Total return received from holding an asset (income + changes in value) over a period of time asset is held (time horizon).
Holding - Period Return (HPR)
Sum of a series of numbers/count of that series of numbers vs. formula used specifically for compounded investments
Arithmetic Average vs. Geometric Average (time weighted)
Incorporates size/timing of cash flows. An effective method to calculate return on an investment portfolio with sizable cash inflows and outflows throughout the year
Internal Rate of Return (IRR) (Dollar weighted rate of return)
Measures a portfolios excess return per unit of risk but uses beta (instead of standard deviation) as the measurement of risk
Treynor Ratio
Analyzing portfolios based on the characteristics of underlying securities vs. comparing portfolio’s total returns to total returns of various indexes and making inferences based on how closely the portfolio returns resemble those of he indexes.
Holding based vs return based analysis
NAV (net asset value) struck once per day. Purchases and redemptions may involve a “load” which is a sales charge paid to the seller
Open-ended fund
Doesn’t redeem or issue shares. Shares are traded on organized exchanges and can be purchased through brokers just like other common stock.
Closed End Fund
Funds which invest in money market securities, including gov. & corporate issues. The NAV of a share is fixed so there are no tax implications such as capital gains or losses.
Money Market Fund
Fund that specialize in the fixed income sector
Fixed Income Fund
Funds which hold both equities & fixed income securities in relatively stable proportions.
Balance and Income Fund
These funds invest primarily in stock, but may hold fixed income/other types of securities and some money market securities to provide liquidity necessary to meet potential redemption of shares.
Equity fund
Funds which try to match the performance of a broad market index by buying securities included in a particular index in proprotion to the security’s representation to that index.
Index Fund
A marketable security that tracks an index, commodity, bonds, or basket of assets like an index fund. It owns the underlying assets and divides ownership of those assets into shares.
ETF Exchange Traded Funds
Alternative to investing in individual securities
Commingled fund
Arises because hedge funds report returns to database publishers only if they choose. They may do so only when prior performance is good.
Backfill bias
Structured as private partnerships & subject to minimal regulations; involve investment pooling.
Hedge Fund
Strategies that attempt to predict price movements in either direction vs strategies that practice arbitrage to exploit price inefficiencies
Directional vs. Non-Directional hedge fund strategies
Investible ownership stakes in companies which are not publicly traded
Private Equity
Fees paid to cover commissions to selling agents & to deter investors from rapidly switching in/out of funds
Front End Load
Assets in pooled funds are segregated from insurers’ general funds & owned by investors in the fund
Pooled segregated fund offered by insurer
When unsuccessful funds tat cease operation stop reporting returns and leave a database, leaving behind only the successful funds.
Survivorship bias
Institutional fund managers provide services to pension plan sponsors that aren’t large enough/lack the resources to manage plan investments themselves.
Pooled fund offered by institutional pension fund manager
Leaves the initial investment intact until redeemed. May apply to the initial or final asset value.
Back End Load
Expresses the value of each share held in a managed fund. Investment companies pool assets of individual investors and divide claims to those assets among those investors.
NAV - Net Asset Value
A means of paying brokerage firms for their services through commission revenue, as opposed to through normal direct payments (hard-dollar fees
Soft Dollars
Outlines 6 responsibilities of plan sponsors: Determining Plan Design; Setting Benefit Structure; Establishing, amending & terminating the pension plan; Determining level/nature of benefits; developing/adopting a funding policy plan.
CAPSA Guideline #6
Outlines criteria for plan sponsor to consider when choosing accounts: Purpose of CAP, # of investment options to be made available, fees, CAP sponsor’s ability to periodically review options, diversity/demographics of CAP members, degree of diversification among options, liquidity of options, level of risk associated with options.
CAPSA Guideline #3
If plan admin. determines it doesn’t have structures, processes, resources, skills, knowledge & expertise in place, it would be prudent for it to delegate these tasks.
Prudent Delegation
After tasks are delegated, plan admin. remains responsible, should monitor activities to ensure they’re appropriately & prudently carried out.
Delegated activities
Document used to outline factors affecting pension funding/solvency, its ability to meet financial obligations & how those factors relate to plan’s investment policies
SIP&P - Statement Investment Policy & Procedures
5 criteria from federal legislation that the SIP&P must meet: Legislative reqs, prescribed elements, considerations for DB plans, considerations in managing investment risk & review, filing & disclosure requirements
Federal Investment Rules
Weighted portfolio based on index/combination of indexes. Used to monitor investment manger’s performance/set expectations for fund based on portfolio of investments chosen.
Benchmark Portfolio
5 step process to start/run a plan on an ongoing basis which differs slightly for DB and DC plans
Investment Cycle
Metrics of an investment portfolio that can be measured with #’s (% allocation permitted in derivative investments) vs. those which affect outcomes, but can’t be measured with precise #’s (credit quality of fixed income, style of manager)
Quantitative and Qualitative factors
An approach that starts with a broad international/national economic outlook, then compares relative attractiveness of markets.
Top down
An approach that starts with analysis of fundamentals (dividend yield, P/E ratio, earnings growth) of each security under consideration & places values on securities within the current economic/market/industry outlook.
Bottom Up
Criteria for evaluating investment in an company that examines environmental, social & governance aspects of the company beyond a traditional security analysis
ESG Factors (Environmental, Social and Governance)
Fess payable to an investment mgmt. firm for ongoing mgmt. of a portfolio. Can be asset based, performance-based, a combination of both.
Investment management fees
Combine multiple fees into one bundle & can include any combination of mgmt. transaction, custody, other admin fees
Investment management fees
An approach to investment that acknowledges relevance to investor of environmental, social & governance factors & long-term health & stability of the market as a whole
Responsible investing
Investments seeking to generate a market rate of financial return along with specific social, economic & environmental (SEE) benefits
Economically Targeted Investments
Avoiding concentration risk in a portfolio by spreading investments among different asset classes
Screening
Institutional investors are seen as part of a network of fiduciaries. Each investor performs specialized, complex functions in an interdependent marketplace.
Public Fiduciary Hypothesis
Funds which maintain a defined asset allocation. From aggressive to conservative.
Target Risk funds
Funds which target retirement year & change asset allocations from aggressive to conservative as date approaches. Final allocation sees member through retirement
Target retirement date fund
