Investment Analysis Midterm

VaR (Value at Risk)

Estimates a loss threshold that should not be exceeded at a chosen confidence level over a specified period.

Shelf registration

Enables firms to sell pre-registered securities quickly without the need for extensive additional documentation

High-frequency trading

A subset of algorithmic trading that relies on computer programs to make extremely rapid decisions

Block trade

A transaction of more than 10,000 shares of stock

Latency

The time it takes to accept, process, and deliver a trading order

Mortgage-backed security

An ownership claim on a pool of mortgages or an obligation that is secured by such a pool

ADRs

Certificates that traded in US markets that represent ownership in shares of a foreign company

Mortgage-backed security

Large pools of mortgages that could be traded like any other financial asset

CDO

A security representing a portfolio of fixed-income assets divided into tranches.

CDS

A contract that provides insurance against the risk of default

ARMs

Loans with low initial or "teaser" interest rates that eventually would reset to current market interest yields

effective annual rate (EAR)

Interest rate annualized using compound rather than simple interest.

annual percentage rate (APR)

Interest rate is annualized using simple rather than compound interest.

dividend yield

The annual dividend payment expressed as a percent of the stock price

nominal interest rate

The interest rate in terms of nominal (not adjusted for purchasing power) dollars.

Sortino ratio

Excess return divided by lower partial standard deviation.

Variant on Sharpe Ratio

scenario analysis

Analysis of investment outcomes across the set of all possible economic scenarios.

capital allocation line (CAL)

A graph showing all feasible risk–return combinations of a risky and risk-free asset.

capital market line (CML)

a line in finance that shows the relationship between the expected return and total risk (standard deviation) of efficient portfolios that combine a risk-free asset with the market portfolio.

indifference curve

a curve that shows different combinations of risk and expected return that give an investor the same level of satisfaction or utility.

Expected Shortfall (ES)

Estimates the average loss in the worst outcomes beyond the VaR threshold.

Sharpe ratio

a financial measure that tells you how much extra return an investment earns for each unit of risk taken.

efficient frontier of risky assets

The portion of the minimum-variance frontier that lies above the global minimum-variance portfolio.

minimum-variance frontier

Graph of the lowest possible portfolio standard deviation corresponding to each value of portfolio expected return.

lowest possible risk for each level of expected return.

minimum-variance portfolio

The portfolio of risky assets with lowest possible variance.

information ratio

Ratio of alpha to the standard deviation of diversifiable risk

how much extra return a fund earns for each unit of risk taken relative to its benchmark.

security characteristic line (SCL)

A plot of the excess return on a security (over the risk-free rate) as a function of the excess return on the market.

shows the relationship between a security’s return and the market’s return. It is used in the Capital Asset Pricing Model (CAPM) to measure how sensitive a stock is to market movements.

single-factor model

A model that explains a security’s return using one common factor, such as market movements or interest-rate changes, along with a company-specific component. It helps investors understand how one common influence affects a security’s return.

single-index model

A model that explains a security’s return using the return of a market index, such as the S&P 500, along with a company-specific component. It simplifies portfolio analysis by estimating each stock’s sensitivity to the market and its contribution to portfolio risk.

market portfolio

The portfolio encompassing all assets in which each asset is held in proportion to its market value.

mutual fund theorem

A result associated with the CAPM, asserting that investors will choose to invest their entire risky portfolio in a market-index mutual fund.

Mutual funds

Are the common name for open end investment companies

Bootstrapping

Resamples historical returns to estimate risk while retaining observed non-normal features, including fat tails.

Risk pooling

Combines risks across many people or assets

Risk sharing

Divides a loss or financial exposure among parties

Time diversification

Uses a longer investment horizon to manage short-term fluctuations

Global minimum-variance portfolio

The risky portfolio with the lowest possible variance among all feasible portfolios of risky assets

Capital allocation

top-level choice determining how wealth is divided between safe risk-free assets and the broad risky portfolio.

Asset allocation

involves distributing risky funds across broad classes such as equities, fixed income, and commodities.

Insurance Principle

Risk reduction by spreading exposure across many independent risk sources

Efficient frontier

contains portfolios that offer the highest expected return for each given level of risk (or lowest risk for a given expected return).

Naive diversification strategy

aims to include different securities in the portfolio to reduce exposure to firm-specific risks.

By spreading investments across multiple securities, the impact of any single firm's performance on the overall portfolio is minimized

single-index model

A model of stock returns that decomposes influences on returns into a systematic factor, as measured by the return on a broad market index, and firm-specific factors.

Arbitrage

The exploitation of security mispricing in such a way that risk-free profits can be earned

Zero investment portfolio

portfolio with no net value, established by buying and shorting component securities, usually in the context of an arbitrage strategy

Weak form EMH

Asserts that stock prices already reflect all information contained in the history of past prices

Semi strong form EMH

Asserts that stock prices already reflect all publicly available information

Strong form EMH

Asserts that stock prices reflect all relevant information, including insider information

Is rare

Fundamental analysis

Uses earnings and dividend prospects of the firm, expectations of future interest rates, and risk evaluation of the firm to determine the present value of all the payments a stockholder will receive from a share of stock

Event study

A technique used to assess the impact of a particular event on a firm’s stock price

Abnormal return due to an event

The difference between the stock’s actual return and a proxy for the stock’s return in the absence of the event

Efficient Market Hypothesis

All info we need in order to invest

Magnitude issue

Only managers of large portfolios earn enough trading profits to make exploiting minor mispricing worth the effort

Selection Bias issue

Only unsuccessful (or partially successful) investment schemes are made public; good schemes remain private

Lucky event issue

For every big winner, there may be many big losers, but we never hear of these managers

Reversal effect

The tendency of poorly performing stocks and well-performing stocks in one period to experience reversals in following periods

P/E Effect

Portfolios of low P/E ratio stocks have provided higher returns than high P/E portfolios

Neglected-firm effect

Investments in stock of less well-known firms have generated abnormal returns

Liquidity effect

Illiquid stocks have a strong tendency to exhibit abnormally high returns

Single factor model

A model of security returns that acknowledges only on source of systematic risk

Security Market Line (SML)

The graphical representation of the relationship between the beta of a security and its excess return

The Law of One Price

States that if two assists are equivalent in all economically relevant respects, then they should have the same price

Anomalies

Patterns of return that seem to contradict the efficient market hypothesis

Arbitrage pricing theory (APT)

Predicts a security market line linking expected returns to risk

Random Walk

Price changes should be random and unpredictable

Technical analysis

The search for recurrent and predictable patterns in stock prices

The key to successful technical analysis

Sluggish response of stock prices to fundamental and supply-and-demand factors

Relative strength approach

Compared stock performance over a recent period to the performance of the market or other stock of the same industry

Example of technical analysis

Resistance level (support levels)

Component of technical analysis.

its said to be price levels above which it is difficult for stock prices to rise or below which it is unlikely for them to fall

Example of resistance level

Stock X is traded for $72 and it fell to $65. If price begin to increase, then $72 will be the resistance level cause investors are eager to sell when they break even

Abnormal return

The difference between the actual return and this benchmark

Cumulative abnormal return (CAR)

The sum of all abnormal returns over the time period of interest

Serial Correctional

Refers to the tendency for stock returns to be related to past returns

weak form of EMH

Momentum effect

The tendency of poorly performing stocks and well-performing stocks in one period to continue that abnormal performance in following periods

Returns of long-horizon returns

Found suggestions of pronounced negative long-term serial correlation in the performance of the aggregate market

Multifactor model

Model of security returns positing that returns respond to several systematic risk factors as well as firm-specific influences

Factor beta

Sensitivity of security returns to the realization of a systematic factor

Tracking portfolios

are constructed to isolate exposure to a single macroeconomic risk driver while maintaining zero sensitivity to others.

Small minus big (SMB)

captures the excess return of a portfolio of small-cap stocks over a portfolio of large-cap stocks.

High Minus Low (HML)

representing the excess return of high book-to-market stocks over low book-to-market stocks.

Operating Profitability (RMW)

Accounts for the return premium associated with firms generating robust operating profits relative to those with weak profitability.

Investment (CMA)

Incorporates the variation in returns between firms that invest conservatively versus those that invest aggressively.

Smart-beta ETFs

alter traditional market-cap index weights to target systematic risk drivers like value, size, or momentum.

What is a key difference between the CAPM market portfolio and APT factor benchmarks?

CAPM requires a market portfolio containing all risky assets, which cannot be fully observed or measured, whereas APT factors can be constructed from observable indices.

risk arbitrage

involves identifying mispriced assets and taking positions to profit as pricing corrections occur.

mean-variance criterion

a method used to compare investments based on two things:

Mean (expected return) And Variance (risk)

The general idea is that investors prefer higher returns and lower risk.

Derivative security

A security who’s payoff depends on the value of other financial variables such as stock prices or bond

ESG investing

Accounting for environmental, social, and governance characteristics of firms when making investment decisions

Commercial paper

Short-term unsecured debt issued by large corporations

Capital gains

The amount by which the sale price of a security exceeds the purchases price

Exercise price

Price set for calling (buying) an asset or putting (selling) an asset

Municipal bonds

Tax exempt bonds issued by the state and local governments.

Repurchase agreements (repo)

Short-term, often overnight, sales of securities with an agreement to repurchase them at a slightly higher price

Reverse repurchase agreement (repo)

A purchase with an agreement to resell at a specified price on future date

Dark pools

Electronic trading networks where participants can anonymously buy or sell large blocks of securities

Private placement

Primary offering in which shares are sold directly to small group of institutional or wealthy investors

Underwriters

Investment bankers who help companies issue their securities to the public