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Financial Risk Management 212 > The investment setting > Flashcards

The investment setting Flashcards

1
Q

Goal of investment management

A

To find investments that satisfy the investor’s required rate of return

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2
Q

Wealth

A
  • Can be seen as an individual’s total assets minus their liabilities (Net Worth)
  • Or as the present value of their future income minus the present value of their expenses
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3
Q

Investments

A
  • Defined as the current commitment of an individual’s money, based on fundamental research, to real and/or financial assets for a given period in order to accumulate wealth over the long term
  • Can be seen as an individual’s actual portfolio
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4
Q

Speculation

A
  • Investments that involve high risks and high returns

- Usually associated with a certain view taken on the market in order to make a profit

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5
Q

Gambling

A
  • Taking an almost certain small loss for the probability of making a large profit
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6
Q

Most important decision in creating wealth

A

Asset allocation

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7
Q

Most important decision in creating wealth

A

Asset allocation

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8
Q

Required rate of return

A

The minimum return an investor should accept from an investment to compensate him for deferring consumption

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9
Q

Three components/categories of required rate of return

A
  • The time value of money during the period of the investment (excluding inflation)
  • The expected rate of inflation during the period
  • The risks involved
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10
Q

Real Risk Free Rate

A
  • Price charged for the exchange between current consumption and future consumption
  • Starting point in determining the investor’s required rate of return
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11
Q

Risk Free Investment

A

An investment which provides the investor with certainty regarding the amount and timing of the expected returns

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12
Q

Capital markets

A

Bring together investors (who want to invest their savings) and demanders of funds

Monetary and fiscal policy determine the conditions in the capital market

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13
Q

Monetary policy

A

Refers to the policy of the central bank (SARB in SA) on the control of interest rates based on its expectations about growth in the economy, the inflation rate and the exchange rate of the local currency

If the economy grows / inflation increases, the the interest rates increase (FACT CHECK!!!)

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14
Q

Fiscal Policy

A
  • Fiscal policy is determined by the extent to which a government finances its expenditure by mean of taxes and debt
  • The greater the deficit (the part of the budget that cannot be financed by taxes), the more money the government has to borrow in the capital market
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15
Q

Different types of risk premiums

A
  • Political Risks
  • Business Risks
  • Financial Risks
  • Liquidity Risks
  • Currency Risk
  • Market Risk
  • Callability Risk
  • Convertibility Risk
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16
Q

Political Risks

A

Broadly refers to the risks associated with a certain country’s political system

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17
Q

Business Risk

A

Refers to the extent of certainty about a firm’s cash flows as a result of the nature of its business

Eg monopolies and products with an inelastic demand have greater certainty about their income and cashflows

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18
Q

Financial Risk

A

Relates to the financial leverage (gearing) employed by a firm

Credit Rating and how firms is financed

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19
Q

Liquidity Risk

A

Relates to obtaining the right price in the right time for a certain investment

Liquidity Risk thus refers to the effort and certainty of trading a specific investment instrument in the secondary financial markets

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20
Q

Currency Risk

A

Relates to the fluctuation of the exchange rate

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21
Q

Market Risk

A

Refers to adverse movements in the value of equities, currencies, interest rates and commodities

22
Q

Callability Risk

A

Refers to the variability of return that derives from the possibility that bonds or preference shares may be called by the issuing firm

23
Q

Convertibility Risk

A

Refers to the possibility that the investment may be converted into the issuer’s ordinary shares at times or under terms which prevent the investor from achieving his required rate of return

24
Q

Total Risk

A

Non-Systematic Risk + Systematic Risk

25
Q

Non-Systematic Risk

A
  • Risk that can be diversified away

- Relates to events that affect individual companies

26
Q

Systematic Risk

A
  • Risk that cannot be diversifies away

- Relates to general economic conditions and monetary and fiscal policy that affect all firms

27
Q

Time value of money

A

Refers to the phenomenon that an amount of money can increase in value because of interest earned from an investment over time

28
Q

Risk

A
  • The uncertainty about whether an investment will earn its expected rate of return
  • Uncertainty about future outcomes or the probability of an adverse outcome
29
Q

Non-financial / Pure Risk

A
  • Exposure to uncertainty that has a non-monetary outcome or implication
  • No financial benefit from an increases exposure to the risk
  • Best outcome is no loss
30
Q

Financial Risk

A

-Associated with a distribution of possible outcomes, including both positive and negative scenarios

31
Q

Return

A

Refers to the sum of cash dividends, interest and any capital appreciation or loss resulting from an investment

32
Q

Standard deviation assumptions

A
  • The scale of measurement for standard deviation is the same as for the original data and expected value. Probability distributions are assumed relatively normal
  • Can be used for a non-diversified portfolio, but not the most-appropriate measure for a diversified portfolio
33
Q

Doen nog normality vs skewness vs kurtosis

A
34
Q

Diversification

A

Refers to a method of reducing the unsystematic risk of a portfolio by investing in various classes

35
Q

Asset classes

A 
Real Assets
Financial Assets
- Money market
- Bonds
- Preference shares
- Equity
- Ordinary shares
- Warrants
- Unit trusts
- Investment trusts
- Hedge funds
- Participation bond schemes
36
Q

Real Assets

A

Involve some kind of tangible asset, such as real estate, commodities, art and collectable items

37
Q

Financial Assets

A

Represent legal claims to some future benefit and are also called financial instruments or securities

38
Q

Fixed Income Securities

A
  • Debt-like instruments
  • An investor would place an upfront investment and receive periodic payments, called coupons
  • The nominal amount is returned after a set term

Such as:

  • Certificate of deposit
  • Money market funds
  • Eurodollar deposit
  • Treasury bill
  • Banker’s acceptance
39
Q

Bonds

A

Different bonds based on:

  • Collateralisation
  • seniority
  • Covenants
  • Interest type (zero, fixed, floating, CPI-linked, etc.)
  • Convertibility
  • Callability

Different types p 12:

  • Secured
  • Mortgage
  • Collateral
  • Equipment trust certificates
  • Debentures
  • Senior/Subordinate
  • Income
  • Convertible
  • Treasury
  • Zero-coupon
40
Q

Preference shares

A
  • Regarded as fixed income securities because most preference share dividends are fixed
  • Receive dividends before ordinary shareholders and are usually cumulative
  • Can be callable and/or redeemable
41
Q

Equity

A
  • Ordinary shares

- Warrants

42
Q

Ordinary shares

A
  • Gives the investor all the privileges and rights of ownership in the firm, but with a limited extent of liability, which is measured by the amount invested in the firm
  • Shareholder has the right to vote, and the right to refuse new share offerings
  • The ordinary shareholder would also be entitled to any dividends declared to ordinary shareholders

NOG???????

43
Q

Warrants

A

Derivative securities that give the holder the right, but not the obligation, to buy a stated number of the ordinary shares of the issuing company at a specified price, called the exercise price, during the life of the warrant

Warrants are issued by the same company of the underlying equity

44
Q

Unit trusts

A

Unit trust companies receive investor’s money, issue sub-shares(units) to investors, pool the money and invest it on behalf of unit holders in diversified portfolios consisting of various securities

45
Q

Investment trusts

A

Investment trusts receive investors’ money after selling ordinary shares of the company to them. The investors’ money is pooled and invested on their behalf in various securities. The investors are called participants

46
Q

Exchange Traded Funds (ETFs)

A

Listed investment products that track the performance of a group or basket of shares, bonds or commodities

47
Q

Hedge funds

A

May be describes as a pool of private capital structured as a limited partnership with the objective of consistently achieving returns under all market conditions by investing in any asset class and by using any investment strategy

48
Q

Participation bond schemes

A

Pools funds received from investors and lends them out by means of first mortgage bonds over commercial or industrial properties

49
Q

Benefits of international diversification

A
  • Risk is reduced

- The risk-adjusted return of the portfolio is improved

50
Q

Constraints of international diversification

A
  • Unfamiliarity with foreign markets
  • Regulations
  • Market Efficiency (Liquidity risks)
  • Risk Perception (Currency risks)
51
Q

Costs of international diversification

A
  • Transaction costs
  • Custodian costs
  • Taxes
  • Management fees
52
Q

Investment management process

A
  • Establish investment objectives and constraints
  • Create investment policy statement (a written statement which guides and controls investment decision making because it represents the long term objectives and constraints of the investor)
  • Select a portfolio strategy (active [uses information and forecasting techniques to seek a better performance than with a diversified portfolio] or passive [minimum expectational input and relies on diversification to match performance of some market index])
  • Select the assets
  • Measure and evaluate portfolio performance
  • Repeat from step 1

Financial Risk Management 212 (3 decks)

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