Investment Planning

Conservative Allocation

3-5 years, 50% fixed income 30% cash, 15% large-cap, 5% international

Moderately Conservative Allocation

5 years, 50% fixed income, 25% large cap, 10% international, 10% cash, 5% small cap

Moderate Allocation

10 years; 35% large cap, 35% fixed income, 15% international, 10% small cap, 5% cash

Moderately Aggressive

>10 years; 45% large cap, 20% international; 15% fixed income; 15% small cap; 5% cash

Aggressive

15+ years; 50% large cap, 25% small cap, 20% international, 5% cash

St Dev Buckets

68% +- 1 st Dev, 95% 2, 99% 3

Skewed right, positively skewed

Most values to left, outliers to right

Kurtosis

How prone data is to producing outliers

Mesokurtic

Normal Distribution

Leptokurtic

Slender; more extreme values because most crowded around average

Platykurtic

Broad; less extreme values

EMT efficient market theory forms

Strong, semi-strong, Weak

Do anomalies disprove the EMT

No

Sharpe Ratio

Measures risk adjusted performance in terms of st dev.

Sharpe ratio formula

(Rport - Rrf) / St Dev

Ratio when R² < 0.7

Sharpe Ratio (correlation with stock market less so can’t use Beta)

Traynor Ratio

Sharpe but with Beta instead of St Dev

CAPM pricing model

Quantify expected return given market return and beta; quantify investors required rate of return; plot the Security Market Line (SML)

CAPM formula

Ri = Rf + (Rm - Rf)*Beta

Market risk premium

Rm - Rf

Stock Premium

(Rm - Rf) * Beta

Jensen’s performance Index (alpha)

Evaluate benefit of portfolio manager

jensen’s portfolio index (alpha) formula

Alpha = Rportfolio - CAPM formula

When/how to use Alpha

R² is 0.7 or higher; it is a plot above or below SML line

Money markets

Exchange of short-term debt instruments

Capital Markets

Long-term debt and equity instruments

Primary Market

IPOs, issuing firm receives proceeds, Securities act of 1933

Secondary Market

Organized exchange (NYSE), OTC market, Securities act of 1934

Holding period return

Ending price - Beg Price + Dividends / Beg price

Time-weighted-return

Geometric. 1.02 × 0.98 ^ (1/2). TVM use initial price purchased, then average price sold for, solve for I

Dollar-weighted-return

For specific client cash flows. IRR of cash flows

Systematic Risk

CANNOT be eliminated through diversification

PRIME for systematic risk

Purchasing power risk

Reinvestment Risk

Interest Rate risk

Market Risk

Exchange Rate Risk

Unsystematic risk / firm-specific

Business Risk, financial risk, default risk, regulation risk, sovereignty risk