Lesson 2

VaR or value at risk

VaR(value at risk) - is a way to quantify the risk of potential losses for a firm or an investment.

• Invented after crash of 1987

• units of $ for a given probability or time horizon

• 1% one-year VaR of $10 million - 1% that a portfolio wil loose $10 million in a year

Stress Test

Stress Testing - method used to test resilienace of institutons and companies to possible financial crisis (banks)

• used to determine portfolio risks

• helps to asses the adequacy of assets

• can use hypothetical scenarios

• response to 2008 crisis, 2010 Dodd-Frank Act

• as a firm you can demand info from other firms

S&P 500

Market Capitalization (or cap) - the total market value of a company’s outsanding shares of stock

Market Cap = Current Share Price * Total Number of Shares Outstanding

S&P 500 - market-capitalization-weighted index of 500 leading publicly traded companies in the US

• Companies are from the US

• at least 20$ billion dollars cap

• public float of at leat 50 % shares

• positive earnings

• has been publicy traded for 12 months

Limitations of S&P 500 - when stocks in the index become overvalued the stock inflates the overall value or price of the index if it has heavy weighting

The larger the market weight of a compnay the more imact each 1% of change in a stcok’s price will have on the index

\frac{\text{market cap of one company}}{\text{total SnP cap}} *100

Apple compared to S&P 500

Beta

Is a measure of a stock’s volatility in relation to the overall market

Volatility - statistical measure of the dispersion of returns for a given security or market index over a specific period of time. The higher the riskier the security is

HOW GREATLY AN ASSET’S PRICE SWINGS AROUND THE MEAN PRICE

Volatility = σ\sqrt{T}

where:

• σ = standard deviation of returns

• T = number of periods in the time horizon

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1.0 - a stock that swings more than a market

= 1.0 - a market itself < 1.0 - a stock that swings less than a market

like elasticity