Investment Portfolio

These flashcards cover essential investment concepts, theories, and terms relevant to finance and portfolio management.

Prospect Theory

A theory that suggests investors are risk-averse and seek higher rewards for taking risks.

Alpha (α)

Excess return above a benchmark, with zero alpha indicating a portfolio matches the benchmark's risk-adjusted return.

Modern Portfolio Theory

Theory proposing that the best return for a given risk can be achieved through diversification.

Systematic Risk

Market risk that affects all companies, including inflation and interest rates.

Idiosyncratic Risk

Firm-specific risk such as lawsuits or leadership issues that affect only one company.

Real Assets

Tangible assets that generate cash flows, like property and gold.

Financial Assets

Intangible claims to cash flows, including stocks and bonds.

Minimum-Variance Portfolio

The portfolio with the lowest possible volatility for a given return.

Efficient Frontier

A set of optimal portfolios that offer the best possible expected return for a given level of risk.

Sharpe Ratio

A measure of risk-adjusted performance calculated as (Portfolio return – risk-free rate) / standard deviation.

Information Ratio

The ratio of excess return relative to a benchmark per unit of tracking error.

CAPM (Capital Asset Pricing Model)

A model that describes the relationship between systematic risk and expected return.

Beta (β)

A measure of an asset's volatility in relation to the market.

Fama-French Model

An extension of CAPM that incorporates size and value factors.

Random Walk Theory

The theory that stock price changes are unpredictable and only respond to new information.

Efficient Market Hypothesis (EMH)

The theory that asset prices fully reflect all available information.

Initial Public Offering (IPO)

The first time a private company offers its shares to the public.

Electronic Communication Networks (ECNs)

Automated systems that match buyers and sellers in the financial markets.

Margin Trading

Borrowing money from a broker to trade securities, raising potential gains as well as losses.

Disposition Effect

The tendency to sell winning investments too early and hold losing ones too long.

Cash Flow

The total amount of money being transferred in and out of a business.

Utility Function

A mathematical representation of an investor's preferences regarding different levels of wealth.

Fair Game

A betting scenario featuring 50/50 odds where there is an equal chance of winning, but the outcomes are unequal.

Alpha (α)

The excess return of an investment above that of a benchmark index.

Systematic (Market) Risk

Risks that affect the entire market, including factors like inflation, interest rates, unemployment, and tariffs.

Idiosyncratic (Firm-Specific) Risk

Risks that are unique to specific firms; examples include lawsuits, accounting fraud, and leadership issues.

Mortgage-Backed Securities (MBS)

Financial instruments that offer proportional ownership in a pool of mortgages.

Money Market Securities

Short-term securities that mature in less than one year and include Treasury bills, commercial paper, and certificates of deposit.

Indifference Curves

Graphical representations showing combinations of risk and return that provide the same level of utility to an investor.

Minimum-Variance Portfolio

The portfolio which exhibits the lowest level of volatility for a given return.

Optimal Portfolio

This portfolio delivers the highest expected return per unit of risk, also known as maximizing the Sharpe ratio.

Separation Theory

A theory describing the two steps of portfolio selection: 1. Identify the optimal risky portfolio. 2. Combine it with a risk-free asset based on individual investor preferences.

Diversification

Investments made across various asset classes to eliminate idiosyncratic risk.

CAPM (Capital Asset Pricing Model)

A model that calculates the expected return of an asset: ext{Expected return} = ext{risk-free rate} + eta imes ( ext{market return} - ext{risk-free rate})

Security Market Line (SML)

A graphical representation depicting the relationship between beta and expected return.

Roll Critique

States that the true market portfolio cannot be fully identified as it is unobservable.

Beta (β)

A measure of an asset's volatility in relation to the overall market.

Sharpe Ratio

A metric to assess risk-adjusted performance of an investment: ext{Sharpe Ratio} = rac{ ext{Portfolio return - risk-free rate}}{ ext{Standard deviation}}

Information Ratio

A metric reflecting excess return relative to the benchmark per unit of tracking error.

APT (Arbitrage Pricing Theory)

Suggests that returns can be explained by multiple macroeconomic factors, focusing solely on systematic risk.

Fama-French Model

An extension of CAPM that incorporates size and value factors, suggesting 'growth' stocks have higher risks and 'value' stocks preserve value.

Barra Model

A multifactor risk model that dissects exposure to various macroeconomic and industry factors.

Momentum Factor

The claim that 'winners keep winning, losers keep losing,' indicating persistent trends in asset prices.

Efficient Market Hypothesis (EMH)

A theory proposing that asset prices reflect all available information, with forms classified as weak, semi-strong, and strong.

Random Walk Theory

Suggests that future price changes cannot be predicted based on past movements and that prices only respond to new information.

Anomalies

Observations or patterns that contradict the EMH, such as investor overreactions or momentum effects.

Prospect Theory

States that individuals experience losses more acutely than equivalent gains, leading to hyperbolic discounting and risk aversion.

Behavioral Finance

This field studies the psychological factors behind investor biases, irrational behaviors, and emotional influences in trading.

ETF (Exchange-Traded Fund)

Investment funds that hold a collection of securities and trade on stock exchanges like individual stocks, known for being low-cost and tax-efficient.

Mutual Funds

Actively managed by professionals, mutual funds do not trade throughout the day. Investors are taxed on dividends, capital gains, and redemptions.

Stop-Loss Order

An order to sell a stock when it reaches a certain price to limit potential losses.

Margin Call

A demand for additional funds or liquidations that a broker may issue when a margin account's equity drops below a mandated level.

Short Selling

Involves borrowing shares, selling them at the current market price, then repurchasing them at a lower price, returning the shares to the lender, and capturing the profit.

Electronic Communication Networks (ECNs)

Automated systems that facilitate trading by matching buyers and sellers directly.

Algorithmic Trading

Trading carried out by computers based on pre-programmed algorithms and predictive models to enhance efficiency and profitability.

Market Indexes

Benchmarks used to track overall market performance (e.g., S&P 500, Dow Jones Industrial Average).

Speculation vs. Gambling

Speculation involves informed risk decisions based on analysis, while gambling is based on chance without informed decisions.

Utility Function

A mathematical representation of an investor's satisfaction or happiness derived from various investment outcomes.

Real vs. Nominal Interest Rates

Real interest rates are adjusted for inflation, while nominal rates are not.

Expected Return / Expected Risk

Expected return is the anticipated return on an investment, while expected risk refers to the volatility of that investment.

Optimization

The process of adjusting the weights of assets in a portfolio to achieve the maximum Sharpe ratio.

Equity Risk Premium

The expected return on stocks minus the risk-free rate, reflecting the additional compensation investors require to take on the inherent risk of equities.