Unit 20 (7) Flashcards
1
Q
An analyst who recommends allocating to industries based on changes to the business cycle would most likely be said to be
- Sector rotating
- Tactician
- Contrarian
- Laddering
A
Sector rotating is the practice of changing investment emphasis based on patterns to the business cycle. It could be a form of tactical management, but sector rotating is the best choice.
2
Q
Monte Carlo advantages
A
- Clearly display trade offs of risk and return
- Clearer understanding of short term to long term risk
- Better model return over time - starting value of the period plus additions or subtractions to the portfolio
- Ask questions along the timeline “Can I retire earlier?” “Do I need to reduce my withdrawal rate?” Etc.
3
Q
Rebalancing
A
Usually takes place quarterly but never less than annually. If equities are outperforming, the proportion of stocks to bonds would be out of balance, so stock would be sold and bonds purchased to bring back to balance
4
Q
An efficient portfolio is one that offers
A
The most return for a given amount of risk
The least risk for a given amount of return
5
Q
Cash and cash equivalents
A
Passbook savings and checking accounts, money market accounts, money market funds, bank insured cds, t-bills
6
Q
A portfolio that maximizes an investors preferences with respect to return and risk is called
- The efficient frontier
- A diversified portfolio
- An uncorrelated portfolio
- An optimal portfolio
A
- An optimal portfolio. An optimal portfolio lies on the efficient frontier, which is a graph, not a portfolio. The special nature of an optimal portfolio is that it may not always be the most efficient because it takes into consideration the specific preferences of the individual investor, which might create a bias
7
Q
Your portfolio is 60/40 debt to equities. Initial investment is $250k. One year later acct is worth 260k and 90k is stocks. What do you do to bring the it back to 60/40?
A
40 percent of 260k is 104k so you would buy 14k of equity and sell 14k of debt.
8
Q
Efficient frontier
A
Curve that represents the set of portfolios that has the maximum rate of return for every given level of risk. The objective is for the portfolio to lie on the curve. Then, by being on the board efficient frontier the optimal portfolio has been created
9
Q
Optimal portfolio
A
Returns the highest rate of return consistent with the amount of risk an investor is willing to take.
10
Q
Tactical asset allocation
A
tACTical - ACTive
11
Q
Weak EMH
A
Technical analysis is no good.
12
Q
Disadvantages to MCS
A
Simplistic use of historical data
Models simulate return of asset classes but not the assets themselves. Simulating the return of the SNP 500 in a fund with fees could significantly overstate the future value
13
Q
Capital appreciation
A
Moderate to aggressive. Growth stocks, options, futures, special situation stocks (potential takeover or merger candidate), futures, Ipos, and day trading. Must determine the risk appetite of the fund and match to similar clients.
14
Q
Purpose of dollar cost averaging
A
Reduce the investors average cost to acquire a security over the buying period relative to its average price
15
Q
Active management
A
Relies on the managers stock picking and market timing ability to outperform market indices
16
Q
Longer duration has what risk?
A
The longer the duration the greater the interest rate risk.
17
Q
Semi-strong EMH
A
Technical and fundamental analysis is no good.
18
Q
Security market line
A
Allows us to evaluate the individual securities for use in a diversified portfolio. You need:
- Expected rate of return for the asset
- Risk free rate
- Return on market
- Beta of the asset
19
Q
Asset allocation steps
A
- Determine objectives and constraints of asset owner
- Create the Investment Policy Statement
- Determine the asset allocation based on the IPS
- Capital Allocation
- Monitor and evaluate investments
20
Q
Capital asset pricing model
A
How much risk should you assume for an expected rate of return. Solely on the basis of the assets systematic risk.
21
Q
Modern portfolio theory
A
Focuses on relationships between all investments in a portfolio. Specific risk can be diversified away with portfolios with noncorrelated assets. Reduce risk and also increase return. Portfolio with least amount of volatility would do better than one with higher volatility.
22
Q
Equities
A
Preferred and common stocks of all kinds, income appreciation, and stock mutual funds.
23
Q
Three forms of efficient market hypothesis
A
Weak
Semi-strong
Strong
24
Q
Barbell
A
Bonds maturing in one or two years, equal amount maturing in 10+ years. Nothing in between. Active strategy. Cash from shorter term bonds can be reinvested at higher rates.
25
Three major asset classes
Stock, bonds cash
26
Capital market line
Provides an expected return based on the level of risk. Equation uses:
1. Expected return of the portfolio
2. Risk free rate
3. Return on the market
4. Standard deviation of market and standard deviation of portfolio
27
How do large portfolio managers like pension funds use options to hedge?
If the portfolio consisted of large cap stocks, you could buy puts on an index that mirrors the portfolio
28
The capital asset pricing model is used to assess the expected return of a security. If the risk free rate is 2%, the current return on the market is 10%, and the stock’s beta is 1.5 with a standard deviation of 3.2, the expected return would be?
Take the market return and subtract the risk free = 8 then multiply that by the beta of 1.5 to get 12 and add back the risk free rate. The answer is 14%. The standard deviation is not relevant
29
Ladder
Bonds all bought at the same time but mature at different times like steps in a ladder. As shorter maturities come due they are reinvested. Common strategy for buying CDs
30
Hard assets
Real estate, collectibles, precious metals, stones
31
Followers of EMH believe that
An efficient market is one that produces random results
32
Optimal or efficient portfolio
Under modern portfolio theory, the optimal or efficient portfolio is the one that has the most return for a given amount of risk.
33
Strong EMH
Even insider information is known - the market is totally efficient.
34
Asset allocation
Diversifies into different asset classes and reduced unsystematic risk
35
Are REITS considered an asset class?
Yes. REITs are a proxy for actual real estate
36
Weak form EMH
Current stock prices have already incorporated all historical market data and that historical price trends are therefore, of no value in predicting future price. Technical analysis is no good
37
Portfolio insurance
Using an option to limit downside
38
Major asset classes
```
Equity
Debt
Cash
Real Estate
Commodities
```
39
Tactical asset allocation
Short term portfolio adjustments that adjust the portfolio mix between asset classes in consideration of current market conditions and investor sentiment.
40
Efficient set/efficient frontier
Collection of efficient portfolios
41
Value
Stocks that are cheaper and trading at lower p/e and price to book multiples. Focus on financial statement. Higher dividend yields found here.
42
The optimal portfolio is one that
Lies on the efficient frontier. Portfolios on the line provide the highest rate of return for a given amount of risk. Below the frontier is inefficient and a portfolio cannot be above the line.
43
Dollar cost averaging allows
You to buy fewer shares when the price is high and more shares when the price is low
44
Market Cap
Outstanding shares * Market Price = Market Cap
45
What are the two active bond strategies?
Barbell and ladder have bonds maturing at regular intervals so it requires an active role in reinvesting the principal
46
Bullet
Pick a target. Purchase bonds to hit that target. 2 years from now buy shorter maturity bonds to hit same target. Allows you to capture current rates as they change rather than the whole investment at the same rate.
47
Portfolio diversification
Reduces unsystematic risk, such as business risk, and enhances returns. Enhanced by adding foreign securities to the portfolio.
48
Semi-strong EMH
Current prices reflect all historical price data and fundamental data. Only insider info may produce above market returns. Technical and fundamental are no good.
49
Contrarian
Manager thinks majority is wrong do they do the opposite
50
Strategic asset allocation
The proportion of various types of investments composing a long term investment portfolio
51
Contrarian
Takes opposite position of other managers. You buy when everyone else is selling and vice versa.
52
What is rebalancing?
It is done periodically to bring a portfolio back to target allocation percentages. It is a passive strategy
53
Constant dollar plan
Maintain a constant dollar amount in stocks, moving money in and out of a money market account when necessary. You want 70k in stocks and stock value goes up to 90k, you sell 20k and that goes into a money market account. If the value drops to 75k, you take 15k from the money market fund and buy stocks.
54
Jones and Smith enter retirement with 1mil. Both withdraw 50k per year and both get 10%. Yearly results are the same but come in diff order. Jones has 15 up years followed by 5 down years. Smith has 5 down years followed by 15 up years. Who is better off?
Jones is better off. Smith will deplete her portfolio in the early years and wont benefit fully from the positive returns down the line
55
Micro cap
Market cap < 300mil
56
What type of strategy is rebalancing?
Passive
57
Calculating the security market line
Start by comparing the markets return to the risk free rate. Then multiply that difference by the stocks beta and add that number to the risk free rate.
58
Dollar cost averaging
Investing a fixed dollar amount on a regular basis and purchasing at different prices
59
Expected return on the mkt is 20% and the risk free is 4%. Stock with beta of .8 would have a expected return under capm of?
(Market rate - risk free) * beta
20-4 = 16 * .8 = 12.8
Take .128 and add the risk free
.128 + .04 = .168 or 16.8%
60
Fixed income investments
Corporate bonds, muni bonds, treasuries, bond funds, mortgage backed securities
61
Cash asset class
Focus mainly on the standard risk free investment, the 91 day (13 week) treasury bill, but also including other short term money market instruments
62
Random walk
Throwing darts is as good a method as any for selecting stocks
63
Bonds are a hedge against what and equities are a hedge against what?
Bonds are a hedge against deflation, equities are a hedge against inflation
64
What do you need to know to compute the capital market line?
Standard deviation. You don’t need to know the alpha or beta.
65
Passive portfolio manager
Believes no particular management style will consistently outperform market averages. Constructs a portfolio that mirrors a market index.
66
Active management is tactical
Passive management is strategic
67
Bond asset class
Subclasses based on maturity (intermediate vs long term) and issuer (treasury vs Corp vs non-US issuers)
68
Covered call writer
Limits potential gain in exchange for partial protection
69
An individual is a participant in a 403b plan with his employer. He invests $200 per month into one of the growth sub accounts. What is he doing?
Dollar cost averaging. Dollar cost averaging is investing the same amount at regular intervals.
70
Buy and hold
Lower transaction costs. Gains taxed at lower long term rate. Common reason for selling is changing objectives.
71
Growth
Focus on stocks of companies whose earnings are growing faster than most other stocks and are expected to continue to do so. Growth investment managers are likely to buy at the high end of the 52 week price range. Might seem like they are buying overvalued stocks. Looking for earnings momentum.
72
Stochastic
Forecast how returns on different asset classes vary over time. “To aim or guess”. Uses simulations to produce probability distributions for various outcomes.
73
Best way to protect a loss on a short sale?
Buy a call option
74
Rainy day fund
Stocks with a large cash value. Sign of value stock.
75
Constant ratio plan
Maintains a ratio in a portfolio of stocks to bonds or other assets. The account is periodically rebalanced to get back to the desired ratio
76
Is there semi-weak EMH?
No. There is only weak, semi-strong, and strong
77
Probable return
An estimate of all probable returns an investment is expected to yield
78
Which of the following is the simplest portfolio management style for individual stocks?
1. Indexing
2. Buy and hold
3. Moving averages
4. Core
Buy and hold. The key to answering this question is recognizing that it’s asking about individual stocks. If the question dealt with managing a portfolio, then indexing would be the simplest style.
79
What is not used in the CML?
Alpha and beta. It uses standard deviation
80
Asset allocation
Spreading of portfolio funds among diff asset classes with diff risk/return characteristics, based on the investment policy statement IPS
81
Efficient market hypothesis
Security prices adjust rapidly to new information. Security prices fully reflect all available information. I.E. markets are efficiently priced as a a result.
82
Which bond strategy is least active?
Bullet. Bullet involves investing in bonds that all mature at or around the same time. Once the portfolio is established you sit and wait for the bonds to mature.
83
Monte Carlo simulation
Stochastic modeling. Uses random number generator to provide an output with specific probabilities of outcomes. Provides best case and worst case scenarios.
84
Security market line
Determines the expected rate of return for a security on the basis of its beta and the expectations about the market and the risk free rate.
85
Investment strategy where a higher price is paid based on expected returns?
Growth investing. Growth investors buys shares that have exhibited faster than average gains in earnings over the past few years that is likely to continue to show high levels of margin.
86
Mid cap
2-10bil
87
What does the CML use as a measure of risk?
Like markowitz’s efficient frontier, it uses standard deviation
88
Form of portfolio management that rotates between sectors based on changes to the business cycle?
Segment rotation. Even though this uses the word “cycle” use that as your clue that cycle is NOT part of the answer
89
Who invented the capital asset pricing model
William Sharpe. Basic premise is every asset has systematic and nonsystematic risk. Systematic cannot be diversified away. Nonsystematic can
90
Three techniques for minimizing interest rate risk
Barbell
Bullet
Laddering
91
Value
Undervalued or out of favor stocks. Price low relatively to earnings or book value. Sometimes cos operating at a loss. Buy undervalued cos before they report positive earnings. Study balance sheet. Buys stocks at low end of 52 week range.
92
Large cap
Greater than 10bil
93
Strong EMH
The market is totally efficient. Even insider information is known. Full reflects all information from both public and private sources.
94
Stock asset class
Subclasses based on market cap, value vs growth, and foreign equity
95
Small cap
300mil - 2bil
96
The beta of ABC co is 1.2 and the market return is expected to be 13% with a risk free return of 3%. Then the expected return of ABC is 15%
Diff between risk free and market (13-3)=10
Multiply the expected return in excess of the risk free rate by the beta 10 * 1.2 = 12
Add 12 to risk free of 3 = 15
97
Investors wishing to employ a passive strategy for their bond portfolios would most likely elect which of the following?
1. Barbell
2. Bullet
3. Laddering
4. Buy and hold
Buy and hold is the most passive strategy no matter what you’re investing in. The other three options involve some level of activity.
98
Tangible assets
Placed in a portfolio to reduce inflation risk
99
Income
Generate portfolio income. If dividends on common are better, skew that way. Sometimes foreign securities and/or high yield bonds. For the most part relies heavily on debt.
100
When asking about limited partnerships vs general, look for something indicating how they want to share control
If the control is limited, it will be an LP. If the control is general and has no qualifiers, use GP
101
Growth
Stocks that trade at higher price to earnings and price to book ratios than value stocks. Earnings momentum is important. Growth is more volatile and requires higher risk tolerance
102
Indexing
Portfolios constructed to mirror the components of a particular index. Not actively managed so costs are relatively low. Less frequent portfolio turnover.
103
A well diversified investor following a rebalancing portfolio strategy in a rising market will most likely what?
Sell part of the stock in the portfolio. Rebalancing seeks to maintain a constant ratio of a portfolios original investment allocation. If stock increases in value, some of it will be sold to maintain the proportion of stock in the portfolio
104
Computing alpha with risk free given
(Actual return - risk free) - (beta x (market return - risk free))
105
Computing alpha with no risk free rate
Actual return - (beta x market return)
106
Sharpe ratio
Actual return - risk free / standard deviation
107
Average market price
Share price total / number of investments
108
The CAPM is an investment theory that serves as a model for
Pricing securities based on their systematic risk only
109
In a Monte Carlo simulation, a small change in the projected rate of return will result in?
Large differences in the outcome
110
The term feasible set has to do with what?
The efficient frontier
111
What is not a type of diversification achieved by investing in international equities?
1. Asset class
2. Currency
3. Geographic
4. Style
Style is not achieved by diversifying internationally. Style is something like value or growth or buy and hold
