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Economics In Action > Wk 7 - Measuring Returns > Flashcards

Wk 7 - Measuring Returns Flashcards

1
Q

what are Fixed income (debt) securities

A

They pay a specified cash flow over a specific period

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2
Q

What is Equity

A

An ownership share in a corporation

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3
Q

What are derivative securities

A

Securities providing payoffs that depend on the value of assets

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4
Q

What is the informational role of financial markets

A

Investors decide whether a company lives or dies.

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5
Q

What is Consumption timing

A
  • Some earn > consume (buy shares),
  • Others consume > earn (sell shares)
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6
Q

What is The separation of ownership and management

A

Agency problem (conflict of interest)

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7
Q

What is Holding Period Return

A

(HPR) - Total return on an investment / asset over a period of time, (Usually as %)

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8
Q

What is the calculation for HPR

A

HPR = Capital gain yield + dividend yield (cash dividend / share price)

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9
Q

What is the formula for HPR

A

HPR = (P1 - P0 + D1)/P0
HPR = (Ending price - Beginning Price + Dividend) / Beginning Price

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10
Q

What is Arithmetic Average (AAR)

A

The sum of returns in each period / no. periods

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11
Q

What is the formula for AAR

A

AAR = (r1 + r2 + r3 … +rn) / n

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12
Q

What is Geometric Average

A

GAR - The single per-period return that gives the same cumulative performance as the sequence of actual returns
(Time-weighted returns)

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13
Q

How Do you calculate GAR

A

Compound the actual period returns and then finding the equivalent single per-period return

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14
Q

What is the formula for GAR

A

GAR = {[(1+ra)(1+rb)…(1+rn)]}*^1/n - 1

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15
Q

When should you use AAR

A

If you are NOT reinvesting any cashflows received before the end of the period

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16
Q

When should you use GAR

A

If you ARE reinvesting any cash flows received before the end of the period

17
Q

What is Effective Annual Rates

A

EAR
The actual return on a savings account or other interest-bearing investments when the effects of compounding are considered

18
Q

What is the formula for EAR

A

(1+ rate for period)^n periods per year -1

19
Q

What is the relation between APR & EAR

A

1+EAR = (1+Rate per period)^n = (1+APR/n)^n
Rearranged:
APR = [(1+EAR)^1/n -1]*n

20
Q

What are the risks involved in investments

A

Macroeconomic fluctuations
Shifts in industry
Unexpected asset-specific developments

21
Q

What is Probability Distribution of HPRs

A

The list of possible outcomes (HPRs) with associated probabilities

22
Q

What is Scenario Analysis

A

Process of devising a list of possible economic scenarios and specifying the likelihood of each one, as well as the HPR that will be realised in each case

23
Q

What is expected return

A

The mean value of the distribution of HPR

24
Q

What is required to implement scenario analysis and the probability distributions

A

Mean Return:
- The mean of the distribution/most likely value

Variance:
- The expected value of the squared deviation from the mean
or
- The expected value of the squared “Surprise” across scenarios

Standard Deviation:
- The square root of the variance

25
Q

How do you measure Expected Return, E(r)

A

E(r) = The sum of the probabilities of each scenario * the return of each scenario

E(r) = (probability A * return A) + (probability B * return B) … + (probability N * return N)

26
Q

What is Variance

A

The expected value of the squared deviation from the mean
(The expected value of the squared “surprise” across scenarios)
The deviation is squared to deal with negative values

27
Q

What is the calculation for the Variance

A

VAR = deviation^2

= sum of [ probability of scenario * (return of scenario - Expected return of scenario)^2 ]

= Sum of p(s) * [ r(s) - E(r) ]^2

28
Q

What is Standard Deviation

A

The square root of the variance

29
Q

How do you calculate Standard Deviation

A

SD(r) = Square root VAR(r)
SD(r) = VAR(r)^1/2

30
Q

Key Points for Normal Distribution

A

Probabilities are highest for outcomes near the mean
e.g. return of 15% not important if SD = 20%, but v unusual if SD = 5%

31
Q

What are the 2 critical theoretical and practical realisations of investment management

What do they imply

A

1) The return of a portfolio of 2+ assets whoes returns are normally distributed will also be normally distributed
2) The normal distribution is fully described by its mean and SD

Implies that SD is an appropriate measure of risk for a portfolio comprised of assets with normally distributed returns

32
Q

What is the difference between Equity and Fixed-Income (debt) security

A

Equity = lower-priority claim. Represents an ownership share in a corporation
Fixed-income (debt) security = higher-priority claim but has no ownership interest.

Fixed-income (debt) security pays a specified cash flow at pre-contracted intervals until the last payment on the maturity date. Equity has an indefinite life.

33
Q

What are the features of Equity Securities

A

Ownership:
- Represents ownership shares in a corporation

Claim Priority:
- Lower priority (after creditors)

Payments:
- Dividends not guaranteed, depends on
profits and reinvestment

Life Span:
- Indefinite

Risk and Returns:
Higher risk, returns depend on
company performance and market
conditions

34
Q

What are the features of Fixed-Income Securities

A

Ownership:
- Does not confer ownership interest

Claim Priority:
- Higher priority (before equity holders)

Payments:
- Fixed cash flows paid at contracted
intervals until maturity

Life Span:
- Fixed term, principal repaid at maturity

Risk and Returns:
- Lower risk, more stable returns based
on interest rates and issuer’s credit
status

35
Q

What are the differences between real and financial assets?

A

Real assets are assets used to produce goods and services. Financial assets are claims on real assets
or the income generated by them

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