SEM1 Flashcards
Efficient Portfolio
Means there is no way to reduce the volatility of the portfolio without lowering expected return
efficient portfolio has the highest sharpe ratio
inefficient Portfolio
Means it is possible to find another portfolio that is better in terms of both expected return and volatility
How does change in YTM effect current bond prices
as YTM’s go down, Current Bond market prices increase
As Maturity date increaes what happens to YTM
Usually investors demand more yield in return for investing their money for longer term, so YTM is higher.
Leading to an upwards sloping yield curve
- What does a sharply increasing yield curve suggest
- What does a decreasing yield curve suggest
sharply increasing indicates that short term interest rates are expected to rise in the future
an inverted yield curve signals expected decline in future interest rates.
How does coupon rate effect a bonds sensitivity to YTM/interest rate changes
higher coupon rate bonds are less sensitive to YTM/Interest rate changes
Enterprise Value defintion
The present value of the Free Cash Flows of a whole company.
this is the value of the firm to all who have financed it minus any cash in the company bank accounts
What is required return
is the expected return that is necessary to compensate for the risk investment i will contribute to the portfolio
State the 3 CAPM assumptions
- investors can buy and sell at competitive market price with no transaction costs, and can borrow/lend at the risk free rate
- investors are regional agents, they only hold efficient portfolios of traded securities
- investors have homogeneous expectations regarding the volatilities , correlations, and expected returns of securities
What is a securities beta
securities exposure to systematic risk ( the market risk present in the securities return) Beta of market portfolio = 1
Beta of risk free asset = 0
Why would an investor hold stocks with a negative beta
negative beta shows an inverse correlation with the market
they are purchased as recession insurance, held for diversification purposes
What is Capital Budgeting
process used to analyse alternate investments and decide which to accept
What is a constant annuity
stream of N equal cash flows paid at regular intervals
what is cannibalisation in finance
when a new investment project decreases some of the sales of an existing business
What are the problems with using IRR
- investment project may have multiple IRR’s
- investment project may have no IRR’s
- delayed investment fallacy
how are bond yields/interest rates linked to bond prices
Bond prices are inversely related to bond yields
How does a bond duration affect sensitvity to YTM/ interest rate changes
Duration is a measure of sensitivity not time
high duration = high sensitivity
What does ESG stand for with examples
Environmental - climate / sustainability
Social - Human rights/ Diversity
Governance - Corporate structure
What is the size effect
when the market portfolio is not efficient we expect that stocks with low market caps will have positive alphas
As positive alpha implies a stock has a relatively higher expected return > lower price >lower market value
What is the momentum strategy ( past returns)
it is found that the best performing stocks had positive alphas for the next 3-12 months.
strategy is to buy stocks with high past returns and short poorly performing stocks
SMB portfolio
small minus big
short the big stocks , financing,
longing the small stocks
HML
High minus low
buying big stocks ( above 70th percentile)
financing this by shorting small stocks
this portfolio is equally weighted
PR1YR
prior one year momentum portfolio
each year ranking stocks by their return over the last 1 year, buying the stop 30% shorting the bottom 30%
CML vs SML
cml looks at total volatility whereas sml only considers systematic risk (beta)
cml applies to portfolios combining risk free investments and market efficient portfolio, where the sml applies to any individual stocks or portfolios
cml cannot deduct a clear relation between individual stock risk and expected returns as opposed to sml which shows the required return for each security as a function of its beta with the market
