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12 Cards in this Set
- Front
- Back
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As a student, are you a borrower or a saver? Why? |
-Low income. -They have madeinvestments in their education today for what they hope will be a return in thefuture, by way of a higher salary. This cost is not necessarily financial (particularlyfor Scottish students who have their fees paid for by the taxpayer). -There isan opportunity cost to education i.e. giving up paid work to make time forUniversity. -Could also pointother things about student finance such as finding it hard to borrow money frombanks due to a lack of collateral. |
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You are the following information on two securitiesA and B. A B Expectedreturn 15 8 Standarddeviation 10 6 Calculatethe expected return and standard deviation of a portfolio which invests 60% inA and 40% in B if the correlation between the returns of A and B is 0.6. |
E(Rp) = WA x E(RA) WB x E(RB)
σ_p^2 = W_A^2 σ_A^2+W_B^2 σ_B^2+2W_A W_B Cov(A,B)= given in exam |
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SML (security market line) is a linear line thatshows risk-return combinations of securities. U-U-L-H-L-S |
-From least riskyto most risky we have: -US governmentbonds (an argument could be made for UK government bonds – more stablepolitical system e.g. think US government shut down and some rating agenciesgive UK debt a higher credit rating). But for simplicity put US governmentbonds and comment on size of market making them very liquid-UK governmentbonds-Low-gradecorporate bonds-High-yield corporatebonds-Large-cap stocks-Small-cap stocks |
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Explain the relationship between correlation and therisk of a two-asset portfolio. |
The smaller thecorrelation between the securities, the more portfolio risk can be reduced –negative returns in one asset can be ironed out by positive returns in anotherasset. |
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An investor is considering an investment where all the securities have an equal variance of 15 and an equal covariance of 10. Calculate the portfolio variance of an equalweighted portfolio when (a)N=1; (b)N=10; (c)N=40; (d)N=100. |
(1/N)(average variance)+((N^2-N)/N^2 )(averagecovariance) |
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Consideran equally weighted 3 asset portfolio which has the following return series Calculatethe mean and median return of each asset. Do you notice any significantdifference? If so, why? |
σp^2=WA^2 σA^2+WB^2 σB^2+WC^2 σC^2+2WA WBρ(A,B) σA σB+2WA WC ρ(A,C) σA σC+2WB WC ρ(B,C), σB ,σC |
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Explain what is meant by the mean-variance efficientfrontier.
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The efficientfrontier shows the set of portfolios that provide the highest rate of returnfor a given level of risk (variance / standard deviation). |
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-Whatis meant by short selling? |
- Short selling is when an investor sells an assetthey do not own - - Encouragesspeculators to go for short-term gains at the expense of long-term investors.· -Can lead toattacks on stocks with weak sentiment (as was the case with banking stocks in2008). -If short sellingleads to falling share prices and higher market volatility it could lead toincreased frequency of fat-tail events. · Ethics ofprofiting from others’ misery. |
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In your view, is it a risky activity? |
-maximum gain of 100% and an unlimited losspotential - hedge against a long position in a portfolio. -it gives investors more options as they are notforced into holding a portfolio that is overly concentrated in long positions. |
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In October 2008,the US, UK, and Australian regulators temporarily imposeda ban on short selling activity. Reasons |
-Encouragesspeculators to go for short-term gains at the expense of long-term investors. -Can lead toattacks on stocks with weak sentiment (as was the case with banking stocks in2008). -If short sellingleads to falling share prices and higher market volatility it could lead toincreased frequency of fat-tail events. -Ethics ofprofiting from others’ misery. |
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Were they justified in this action? Explain |
Legitimateinvestment the same as going long. If investors don’t want to hold a stock,they will sell and this will lead to falling prices anyway. Leads to more efficient price discovery asencourages discipline (e.g. many only went short in Enron because of itsirregular accounting gains, many only went short in banking stocks in 2011/2012because of bad debt sitting on banks’ balance sheets). Investors do notsystematically pick on stocks to short sell – they short stocks that areperforming badly. Knowing this, it is up to companies to manage their affairsso as to encourage investors to buy their stock. -No empiricalevidence suggesting short selling leads to falling share prices (relative towhat would have happened if investors sold shares) or higher market volatility.In fact, the opposite is true. -Ethics is verydebatable. Is it ethical to let a company engage in bad practice and gounpunished? Markets can impose efficiency which serves an important economicpurpose. Short selling is simply part of that. |
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Outline some ‘stylized facts’ of financial markets.Are there any investment implications? |
-Stocks performbetter than bonds over the long term. -Value stocksoutperform growth stocks in the long-run.· -Small-capsoutperform large-caps in the long-run. -‘Sin’ stockstend to beat the market. -Fat-tails.Examples are Britain’s withdrawal from the ERM, the collapse of Long TermCapital Management and the Russian default in 1998, the bursting of the techbubble, the financial crisis of 2007 – 2009 which saw Lehman Brothers’bankruptcy and RBS’ bailout. More recently one could discuss the Eurozonecrisis and the Greek debt restructuring. -Better relativeperformance of UK vs Scottish stocks – this is mainly due to betterdiversification of the UK stock market and Scotland’s concentration in financialservices stocks. |
