The investment environment and asset classes Flashcards
What is a financial instrument?
A financial security or financial asset that represents a legal contract conferring the right to receive future benefits.
Where are financial instruments traded?
They are usually traded in organized markets but may also be over-the-counter (OTC).
What are the two main classifications of financial instruments?
- Cash securities
- Derivative securities
What are the three types of financial instruments?
- Debt
- Equity
- Hybrid
How are debt securities classified?
By issuer and maturity.
How are equity securities classified?
By sector, size, and country.
What is portfolio management?
The process of setting investment objectives, constructing a portfolio, evaluating its performance, and adjusting it as necessary.
What are the key steps in portfolio management?
- Setting investment policy
- Constructing a portfolio
- Capital allocation between risk-free and risky assets
- Asset allocation among various asset classes
- Security allocation within each asset class
- Buying or selling securities following an investment strategy
- Evaluating and adjusting the portfolio as necessary
What is asset allocation?
Determining how much of an investor’s wealth should be invested in different asset classes.
What are the main asset classes in asset allocation?
Cash, bonds, equities, property, commodities, and derivative securities.
What is passive management?
An investment strategy that does not react to changes in capital market expectations. Examples include Buy and Hold and Indexing.
What is active management?
An investment strategy that aims to outperform a portfolio’s benchmark through security analysis.
What is managed returns strategy?
A strategy using derivatives to generate a particular return profile while limiting downside risk.
What are the types of investment companies?
- Unit Investment Trusts (UIT)
- Closed-End Funds
- Mutual Funds
- Exchange-Traded Funds (ETFs)
- Other Investment Organizations
How can investors invest?
Either directly or indirectly via an investment company.
What is Net Asset Value (NAV)?
The value of each share in an investment company.
Why is NAV important?
Investors use NAV to assess the value of an investment fund.
What are key characteristics of UITs?
- Generally passive investment
- Shares are redeemable at NAV
- Market share has declined over time
What are key characteristics of closed-end funds?
- Actively managed
- Unredeemable (shares outstanding remain constant)
- Investors cash out by selling to new investors
- Priced at a premium or discount to NAV
What are key characteristics of mutual funds?
- Dominant investment vehicle (~90% based on NAV value)
- Actively managed
- Redeemable (traded once a day, after market close)
- Heavily regulated
What are different mutual fund investment policies?
- Money market, equity, bond
- Sector-specific (industry-focused)
- International (regional, emerging markets)
- Balanced (entire portfolio)
- Fund of Funds (investing in other mutual funds)
- Index funds (track market index)
What are the key fees associated with mutual funds?
- Operating expenses
- Front-end load (initial investment charge)
- Back-end load (charge when selling shares)
- 12b-1 charge (annual marketing/distribution fee)
What are key characteristics of ETFs?
- Investment companies that track an index
- Shares trade on exchanges like stocks
- Prices fluctuate throughout the day
What are the different types of ETFs?
- Equity ETF – invests in stocks
- Bond ETF – invests in government, corporate, and municipal bonds
- Commodity ETF – invests in commodities like gold
- Currency ETF – invests in foreign currencies
- Inverse ETF – profits from market decline
What are the advantages of ETFs?
- Lower expense ratios and Lower broker commissions than mutual funds
What are Real Estate Investment Trusts (REITs)?
Investment organizations focusing on real estate or loans secured by real estate.
What are hedge funds?
Lightly regulated investment vehicles pursuing complex trading strategies.
How do institutional investors contribute to the market?
- Market efficiency and stability – Better at processing information and have a longer investment horizon.
- Corporate governance and social responsibility – Monitor and discipline companies.
- Economic growth and development – Provide capital for large projects and efficient resource allocation.
What are the two key measures of return distribution?
Expected return – The average outcome.
Variance – The dispersion of outcomes around the average (risk).
What is standard deviation?
The positive root of variance, representing risk.
What is covariance?
The expected value of the product of deviations of two returns from their expected values.
What does a positive correlation coefficient indicate?
The assets move together on average.
What does a negative correlation coefficient indicate?
The assets move in opposite directions.
What does a zero correlation coefficient indicate?
The assets are independent (no linear correlation).
What is excess return?
The return over the risk-free rate.
What is skewness in return distribution?
A measure of asymmetry in returns.
What is kurtosis in return distribution?
A measure of the degree of fat tails in returns (likelihood of extreme outcomes).
