Unit 4 - Session 16 - Portfolio Mang., Styles, Strategies, & Techniques

Question 1

Classes of Asset Allocation

Answer 1

1. ) Stock - with subclasses based on market capitalization, value versus growth, and foreign versus equity
2. ) Bonds - with subclasses on maturity (intermediate versus long-term and issuer (Treasury v corporate v non-treasuries)
3. ) cash - focusing mainly on the standard risk-free investment, 90-day treasury bill, also includes short-term money markets
4. ) Tangible Assets - Real estate, precious metals, commodities, collectables (fine art)
5. ) Alternative Investments - Hedge Funds, Private Equity, Venture Capital

Question 2

Standard Asset Allocation Model

Answer 2

Suggests subtracting a person’s age from 100 to determine the percent of the portfolio to be invested in stocks.

Question 3

Rebalancing

Answer 3

Brings the asset mix back to the target allocation. If the stock market performs better than expected, the client’s proportion of stocks to bonds would out of balance. Allows the sale of stocks to be sold in a rising market and buying bonds in a falling market.

Question 4

Constant Ratio Plan

Answer 4

maintains a constant ratio of asset classes (i.e. 70% equities 30% debt)

Question 5

Constant Dollar Plan

Answer 5

maintain a constant dollar amount in stocks and moving money in and out of money market fund - when stocks go up, sell stock and add to money market. when the value of stocks falls take money from the money market and buy stock

Question 6

Tactical Asset Allocation

Answer 6

Refers to short-term portfolio adjustments that adjust the portfolio mix between asset classes in consideration of current market conditions

Question 7

Active Management

Answer 7

Uses a stock selection approach of buying and selling stocks - relies on a manager’s stock picking and market timing ability to outperform indexes

Question 8

Passive Management

Answer 8

Believes that no particular management style will consistently outperform market averages and therefore constructs a portfolio that mirrors a market index. Seeks low cost means of generating consistent, long-term returns with minimal turnover

Question 9

Buy and Hold

Answer 9

Manager that rarely trades the portfolio, which results in lower transaction costs and long-term capital gains taxes. This often may be reflected in a mutual fund approach. Passive strategy that is easy to implement. Selling usually occurs when their is a change in the objective, funds are needed, earnings have dropped, P/E rations are too high, age change.

Question 10

Indexing

Answer 10

Investment portfolios constructed to mirror the components of a particular stock index such as the S&P 500. Costs are relatively low such as indexed mutual funds. Popular passive strategy.

Question 11

Growth Style

Answer 11

Focus on stocks of companies whose earnings are growing faster than most other stocks and are expected to continue to do so. Rapid earnings are usually price into the stock, growth investment management are likely to buy stocks that are at the high end of the 52-week price, so they may be buying the stocks at an overvalued price. Managers are looking for “earnings momentum”. Expect to see high P/E ratios, high price-to-book, and little to no dividend

Question 12

Value Style

Answer 12

Management concentrates on undervalued or out-of-flavor securities whose price is low relative to the company’s earnings or book value and whose earnings prospects are believed to be unattractive by investor and analysts. Primary source of information is the company’s financial statements. More likely to buy stocks at the 52-week bottom price range. Expect to see low P/E ratios, low price-to-book, and dividends offering a reasonable yield, and sometimes large cash surpluses

Question 13

Market Capitalization

Answer 13

Using market cap to influence securities selection. Micro-cap is less than $300MM, small-cap is $300MM-$2B; mid-cap is $2B-$10B; and large cap is $10B+. In a strong economy small, fast-moving companies with concentrated product line in a fast-growing sector can dramatically outperform larger, more bureaucratic companies

Question 14

Contrarian

Answer 14

Investment managers who take positions opposite of that of other managers and general market beliefs who are buying when others are selling and vice versa.

Question 15

Income Style

Answer 15

Generating portfolio income. When dividends on common stock offer better income opportunities than interest on debt securities the portfolio will be overweight in that direction. income usually relies heavily on debt securities

Question 16

Barbells

Answer 16

Investor purchases the bonds maturing one or two years and an equal amount maturing in 10 (or more) years with no bonds in between. Assuming a normal yield curve, the long-term end of the barbell contains bonds offering the higher long-term interest rates, while the short-term end provides you with soon to be realized cash (as they mature) that may be reinvested at higher rates if that is the direction the market takes This is an active strategy you will be buying new bonds as the old ones get closer to maturity

Question 17

Bullets

Answer 17

Hitting a target date such as college or retirement planning and buying bonds at different times during the investment period that all mature at the same time (i.e yr 10, 5, 2, etc.). Allows the investor to capture current interest rates as they change rather than having the entire portfolio locked into one rate

Question 18

Ladders

Answer 18

Bonds are bought at the same time but mature at different times (like steps on a ladder). As the shorter maturities come due, they are reinvested and now become long-term ones. This has also been a very common strategy who those purchasing CDs at their local bank.

Question 19

Capital Appreciation

Answer 19

Takes several forms from moderate to aggressive. Involves the search for appreciation through different sources such as options, futures, IPOs, day trading etc. It is critical to determine the risk scale from lower to moderate to speculative and the manager’s philosophy.

Question 20

Capital Asset Pricing Model

Answer 20

Securities market investment theory that attempts to derive the expected return on an asset on the basis of the asset’s systematic risk. The basic premise is that every investment carries tow distinct risks: systematic (which cannot be diversified away) and unsystematic (which can be mitigated through appropriate diversification). Under this theory, the investor should be rewarded for the risks taken. Used to provide an expected return on a security or portfolio based on the level of risk.

Question 21

Modern Portfolio Theory

Answer 21

An approach that attempts to quantify and control portfolio risk. It emphasizes determining the relationship between risk and reward in the total portfolio rather than analyzing specific securities. Focuses on the relationships among all the investments in a portfolio. Holds that certain risk can be diversified away by building a portfolio of assets whose returns are not correlated. Reduce risk by increasing returns. Diversification reduces risk only when assets whose prices move inversely, or at different times, in relation to each other are combined. Harry Markowitz

Question 22

Optimal Portfolio

Answer 22

One that returns the highest rate of return consistent with the amount of risk an investor is willing to take

Question 23

Efficient Portfolio

Answer 23

The goal of modern portfolio theory. An efficient portfolio is one that offers:

1. ) most returns for a given amount of risk or;
2. ) lease risk for a given amount of returns

This is called an efficient set. This is to be set on a curve, and any portfolio that is below the curve is not efficient and is said to be taking too much risk for too little return

Question 24

Capital Market Line

Answer 24

Provides an expected return based on the level of risk; provides and expected return for a portfolio based no the expected return of the market, the risk free rate of return, standard deviation of the portfolio in relation to standard deviation of the market. This uses the standard deviation, not alpha or beta

Question 25

Security Market Line

Answer 25

Derived from the CML, uses beta of the asset v standard deviation to determine the expected return of a security

Question 26

Monte Carlo Simulations

Answer 26

Risk analysis techniques in which probable future events are simulated on a computer, generating estimated rates of return. Can be used to randomly generate the behaviors of various asset classes to obtain the range of possible outcomes for a portfolio

Best Used for:

1. ) situations where no real-world data exist
2. ) problems with unknown variables
3. ) problems for which no analytical solution exist

Question 27

Efficient Market Hypothesis

Answer 27

Maintains that security prices adjust rapidly to new information with security prices fully reflecting all available information,

Question 28

Random Walk Theory

Answer 28

Suggest that throwing darts at the stock listings is as good a method as any for selecting stocks for investment

Question 29

Weak-Form Market Efficiency

Answer 29

States that current security prices fully reflect all currently available security market data. Thus, past price volume information will have no predictive power about the future direction of security prices because price changes will be independent from one period to the next. Cannot use technical analyst in this circustmance

Question 30

Semi-Strong Form Market Efficiency

Answer 30

Holds that security prices rapidly adjust without bias to the arrival of all new public information. Current security prices fully reflect all publicly available information. This form says security prices include all past security market information and nonmarket information available to the public. Cannot use fundamental analyst in this circumstance b/c all info is in the hands of investors

Question 31

Strong-Form Market Efficiency

Answer 31

State that security prices fully reflect all information from both public and private sources. Includes all types of information: past security market, public, private information. This means that no group has monopolistic access to information relevant to the formation of prices and none should be able to consistently achieve positive, abnormal returns. If this is the case, there is no use of using any analytical tools

Question 32

Portfolio Diversification

Answer 32

Committing to an array of separate investments reduces unsystematic risk, such as business risk, enhances returns. The selected securities are chosen b/c they do no move up and down in relation to each other. This kind of diversification is enhanced by the addition of foreign securities to a portfolio b/c they are usually not highly correlated with domestic equity.

Question 33

Name the general asset classes

Answer 33

1. ) Cash and Cash Equivalents
2. ) Fixed-Income
3. ) Equities
4. ) Hard Assets

Question 34

Sector Rotating

Answer 34

Different sectors of the economy are stronger at different points in the economic cycle. Each industry sector follows it cycle as dictated by the state of economy. Portfolio managers attempt to buy into the next sector that is about to experience a move up.

Question 35

What is the purpose of dollar cost averaging?

Answer 35

to reduce the investor’s average cost to acquire a security over the buying period relative to its average price

Question 36

Dividend Reinvestment Plans (DRIPs)

Answer 36

When the shareholder is entitled to purchase the additional shares directly from the issuer paying little or no commissions and often at a discount to market price.