Chapter 15 - intro to portfolio approach

Question 1

what does portfolio management focus on?

Answer 1

risk and return

Question 2

what do financial decision revolve around

Answer 2

the risk-return trade-off
- less risk = less return

Question 3

what investments do investors prefer

Answer 3

an investment that generates the greatest return for a given level of risk

Question 4

investors who are very risk averse will own which assets?

Answer 4

safe asset; GIC’s Canada savings bond

Question 5

investors who prefer greater risk will own which assets?

Answer 5

riskier stocks - tesla, apple, google

Question 6

what’s the assets from least to most risk?

Answer 6

1. treasure bills
2. bonds
3. debentures
4. preferred shares
5. common shares
6. derivatives

Question 7

what’s the total return when you own a security?

Answer 7

interest/dividends received when you own it (cash flow yield)
capital gain (price change)

Question 8

what’s the formula to % return

Answer 8

(cash flows + (ending value - beginning value))/beginning value

• cash flow = interest/dividends received
  ending value - beginning value = capital gain

Question 9

define real rate of return

Answer 9

how much an investment has increased in real terms, after adjusting for inflation

Question 10

what’s the real rate of return formula?

Answer 10

nominal rate - inflation rate

Question 11

define inflation risk

Answer 11

inflation erodes the FV of security’s cash flow -> prices fall with an increase in inflation

e.g. increase interest rate to decrease inflation risk

Question 12

define business risk

Answer 12

the risk to that particular business or industry

Question 13

define political risk

Answer 13

the risk of doing business in a particular country
- government regulations, government takeovers,

Question 14

define liquidity risk

Answer 14

how can i monetize my investment quickly and easily

Question 15

define interest rate risk

Answer 15

how sensitive is a security’s return to an increase in interest rates - if interest rates rise, in general a security’s value will fall

Question 16

define foreign exchange risk

Answer 16

how the strength/weakness of the CAD will affect investment returns if investing in foreign securities

Question 17

define default risk

Answer 17

the risk that a company goes bankrupt or defaults on its debt obligations

Question 18

define systematic(market) risk

Answer 18

risk relating to the overall market or economy
- this risk cannot be diversified away - you will always be exposed to general movements in the overall market or economy

Question 19

define non-systematic (non-market) risk

Answer 19

risk relating to a specific firm
- this risk can be diversified away - buying different stocks indifferent industries in different countries

Question 20

how do we measure risk?

Answer 20

variance, standard deviation - helpful in measuring risk

Question 21

define a stock’s beta?

Answer 21

measures the volatility of a security’s return relative to the overall market

Question 22

what does a higher beta mean?

Answer 22

the greater its risk is relative to the overall market

Question 23

how do we determine asset allocations

Answer 23

depends on who is the investor and what are their investment objectives + risk tolerances

Question 24

what’s the expected return of a portfolio

Answer 24

will depend on the expected return of each asset in portfolio and the weighting of each asset

Question 25

why do we diversify our investment

Answer 25

to eliminate the risk specific to one firm

Question 26

what’s the best form of diversity for securities?

Answer 26

securities that move in opposite directions - negative correlation

Question 27

define correlation

Answer 27

measures how the returns of 2 securities are related

Question 28

define the different types of correlation

Answer 28

+1.0 = perfect positive correlation - 2 securities returns are moving perfectly together 100% of the time
-1.0 = perfect negative correlation 0.0 - no correlation

Question 29

why are some company’s beta negative?

Answer 29

inverse relationship to the market

Question 30

why is the overall portfolio risk will be lower than the weighted average risks for all of the securities when the portfolio returns the weighted average of returns for all securities

Answer 30

diversification

Question 31

how to construcut a propert portfolio

Answer 31

determine the objectives

Question 32

what are the primary vs secondary investment objectives

Answer 32

primary:
- safety (can we lose some or all our money)
- income(typically from interest or dividends)
- capital growth(increases in the price of a security)

secondary
- marketability/liquidity (I need my money and I need it fast)
- tax minimization (increasingly important given 50+% taxes in canada)

Question 33

can we minimize safety and maximize income and capital growth

Answer 33

no due to trade-offs made depending on investor investment objectives and risk tolerances