Topic 1 - Investment and Portfolio Management Process Flashcards
What are ‘Real Assets’?
- Used to produce goods and services
- Eg. Land, buildings, machines, intellectual properties etc.
What are ‘Financial Assets’?
- Claims to the income generated by Real Assets or claims on income from the government
- Do not directly contribute to the productive capacity of the economy
- Eg. Stocks, bonds etc.
What are three main types of Financial Assets?
- Fixed-Income / Debt Securities - Promises a fixed stream of income or stream of income determined by a specified formula (Corporate Bonds)
- Equity - Represent ownership in a firm (shares)
- Derivatives - Payoff depends on the value of other financial variables such as stock prices, interest rates or exchange rates.
What are 2 other types of markets for Financial Assets?
- Currency / FX - $2 Trillion of currency traded each day in London alone
- Commodities - Eg. corn, wheat, natural gas, electricity
What are some mechanisms that can be used to mitigate ‘Agency’ problems?
- Compensation plans to tie manager income to success of the firm
- Monitoring from Board of Directors
- Monitoring by large investors and security analysts
- Threat of takeover for poor performers
What is the difference between a “Top-down” and a “Bottom-up” investment approach?
- Top-down = Asset allocation followed by determination of particular securities to be held in each asset class
- Bottom-up = Investment based on attractively priced securities without as much concern for asset allocation
What does the ‘risk-return trade off’ state?
The potential return rises with an increase in risk
What does the ‘efficient market hypothesis’ suggest?
- The prices of securities fully reflect available information
- If this were true, there would exist neither underpriced nor overpriced securities
In portfolio management, what is the different between ‘Passive Management’ and ‘Active Management’?
Passive management
- Highly diversified portfolio
No attempt to improve investment performance by identifying mispriced securities
Active management
- Focus on improving performance by finding mispriced securities or by timing the performance of broad asset classes
Who are the main “Players” in markets?
(Who needs capital, who supplies it, other roles inc. IB, VC, PE)
- Firms: Net demanders of capital. Raise capital now to pay for investments in plant and equipment.
- Households: Typically net suppliers of capital. Purchase securities issued by firms that need to raise funds.
- Governments: Can function as borrowers or lenders, depending on the relationship between tax revenue and government expenditures.
- Financial Intermediaries: Bring the suppliers of capital (investors) together with the demanders of capital (primarily corporations and the federal government). Eg. Investment companies, Banks, Insurance companies, Credit unions.
- Investment bankers: Specialize in the sale of new securities to the public, typically by underwriting the issue
- Venture capital (VC): Money invested to finance a new, not yet publicly traded firm
- Private equity: Investments in companies whose shares are not publicly traded in a stock market
What are the three elements of the investment process? (According to the CFA institute)
- Planning: Establishing inputs necessary for decision making
- Execution: Details of optimal asset allocation and security selection
- Feedback: Process of adapting to changes in expectations and objectives, as well as to changes in portfolio composition that result from changes in market prices
What are some important things to consider when making investment decisions? (Risk tolerance questionnaire)
Are liquidity, Investment horizon (planned length of an investment), Regulations, Tax and personal considerations all relevant investment constraints?
Yes
What does an Investment Policy Statement (IPS) encompass?
- Scope and purpose
- Governance
- Investment, return, and risk objectives
- Risk management
What is Asset allocation?
Deciding how much of the portfolio to invest in each major asset category
