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Risk In Financial Services > Chapter 6: Investment risk > Flashcards

Chapter 6: Investment risk Flashcards

1
Q

Define inflation

A

An overall upward price movement of goods and services in a economy

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2
Q

What is the ‘nominal’ return

A

The return an investment gives without adjusting for inflation

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3
Q

What is the ‘real’ return

A

The return from an investment after considering inflation

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4
Q

Formula for real rate of return

A

1 + RROT = (1 + Nominal Rate)/(1 + Inflation Rate)

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5
Q

What is total return

A

The returns on an investment both from its income production, and any other capital gains (or losses) that it generates

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6
Q

What is holding period returns

A

The total return on an asset or portfolio over the period during which it was held.

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7
Q

How do you calculate holding period returns

A

The sum of income over a particular period, divided by the initial period value

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8
Q

formula for compound interest

A

s= x(1 + r)^n

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9
Q

what is present value

A

the amount of money which must e invested now for n years at r% interest to earn a given future sum of money

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10
Q

What is currency risk

A

The risk arrising from fluctuations in the value of currencies against one another

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11
Q

what is interest rate risk

A

The risk that interest rates move against the investor

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12
Q

What is issuer risk

A

The risk that the bond issuer, whether government or corporate, gets into financial trouble and cannot keep up with interest payments, or defaults on the final payment

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13
Q

What types of risk contribute to equity risk

A

Liquidity risk, growth risk, volatility risk, strategic risk

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14
Q

What is growth risk

A

the risk that, if investing for growth, the company may not grow as expected

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15
Q

What is volatility risk

A

The risk that the performance of an investment can change quickly, in either direction over a short period of time.

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16
Q

What is commodity risk

A

The risk of an adverse price movement in the value of the commodity

17
Q

What is property risk

A

Location of the property
the effect of the use of the property on its value
the credit quality of the tenants
the length of the lease

18
Q

What is Liquidity risk

A

Liquidity risk refers to the likelihood of being unable to transform assets into cash

19
Q

Examples of an investments fund benchmark

A

Performance of peer group funds
relevant market index

20
Q

What is the beta factor

A

Measures the volatility on an investment relative to the market or benchmark

Beta factor of 1 moves in line with the market
Beta factor > 1 varies more widely than the market
Beta factor < 1 varies less than the market

21
Q

Over what time period are beta factors calculated

A

36 months

22
Q

What is alpha factor

A

Used when assessing the performance of a fund or portfolio, and refers to the extent of any outperformance against the benchmark

23
Q

What is a disadvantage of alpha

A

Does not distinguish between underperformance caused by incompetence and underperformance caused by fees

24
Q

What is the Sharpe ratio

A

Uses a concept called ‘risk free return’. This risk free return rate is the rate that it is assumed can be obtained by investing in financial instruments with no default risk.
The Sharpe ratio measures the excess return of a portfolio over the risk-free interest rate, for each unit of risk assumed by the portfolio

25
Q

Sharpe ratio formula

A

((Return on the portfolio) - (Risk free return))/Standard deviation of portfolio

26
Q

What does a high Sharpe ratio mean

A

The higher the Sharpe ratio, the better risk adjusted performance of the portfolio, and the greater implied level of active management skill

27
Q

What is the information ratio

A

Compares the excess return achieved by a fund over its benchmark, to the funds tracking error (Tracking error is its standard deviated compared to benchmark)

28
Q

Information ratio formula

A

Mean of excess returns/Standard deviated of excess return from benchmark

29
Q

What is private equity

A

An illiquid asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange

30
Q

Advantages of private equity

A

Potential for higher returns and lack of correlation to ‘standard’ investment

31
Q

What is venture capital

A

A type of private equity, typically provided to early-stage, high-potential, growth companies in the hope of generating a return through an eventual sale of the company once it has become successful

32
Q

Advantages of venture capital

A

Tax advantages - typically tax relief is given on the investment
Potential for higher returns then can be achieved by mature companies
Lack of correlation with more standard investment

33
Q

What is responsible investment

A

RI began as a niche investment area, serving the needs of those who wished to invest ethically. In recent years it has become much more popular

34
Q

What is asset allocation

A

The macro equivalent of diversifying a portfolio to reduce risk

35
Q

What is tracking error

A

A measure of how closely a portfolio follows the index to which it is benchmarked, and it can be calculated either as a historical or a predicative indicator. Tracking error is ‘realised’ or ‘ex post’ while predictive tracking error is ‘ex ante’

36
Q

What is an investment mandate

A

It is set out by the investment manager’s company and determines the fund’s aims, the limits within which it is supposed to invest, and the investment policy it should follow

37
Q

What is optimisation

A

Often referred to as mean-variance optimisation, it is the construction of techniques to obtain the best expected returns from the riht mix of correlations and variances

38
Q

What is hedging

A

Hedging is a means of reducing the risk of adverse price movements by taking an offsetting position in a related product. It is a means of insuring against market risk

39
Q

What are the four main areas where a portfolio will benefit from monitoring, management and reporting

A

Peer review with other internal fund managers
Risk review with internal independent fund manager s
Monitoring for mandate compliance
Performance attribution reporting

Risk In Financial Services (7 decks)

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