Section 3 Flashcards
What is the main attraction of the CAPM model of risk but what is the expense of this
Simplicity of its predictions
expense is that simplicity is achieved at the expense of a realistic view of how financial markets work
What are the assumptions of CAPM
- Financial markets are perfectively competitive, free of taxation and transaction costs
- all investors agree on the same investment period and have the same expectations about the returns ad standard deviations of all assets
- Investors can borrow or lend at the same risk-free rate of interest
- Investors try to maximise their returns while simultaneously trying to minimise risk
what is the conclusion of CAPM?
The security market line
Who can expect additional return?
Investors who are willing to take additional risk
what does the security market line specify?
the relationship between systematic risk and the expected return on an investment
what is the market risk premium in the SML?
the amount of return which we expect about the return available from a risk-free asset that investors require in compensation for taking on market risk
what is the Beta co-efficient a measure of?
The systematic risk of a security relative to the systematic risk of the market portfolio (or index)
What are limitations of the CAPM model?
Knowledge of a company’s beta is not a useful predictor of returns relative to the market
What does arbitrage pricing theory hold?
the expected return of a financial asset can be modelled as a linear function of various macro-economic factors or theoretical market indices. The sensitivity to changes in each factor is represented by a factor specific beta coefficient and the sensitivity to a factor will be specific to an individual asset.
What is factor investing?
Designing a portfolio to have a particular exposure to a set of macro factors by combining stocks with known macrofactor sensitivities.
e.g. if have a strong view for outlook of oil prices then can create a portfolio which is particularly sensitive to this
what are the most popular single factors?
- low volatility
- momentum
- value
- quality
- high dividend
- size
what would a more ‘modern’ definition of a factor be?
attributes of securities which themselves have been associated with superior returns over historical period - these are security attributes
give e.g.’s of security attributes
size or market capitalisation of a stock, the dividend yield of a stock or the book-to-market value of a security
how is smart beta investing delivered?
in the form of an exchange traded fund
what are issues with traditional passive investing
should be buying the cheap and selling the expensive whereas trackers choose of market cap which means buying the expensive companies
