Investment Management Study Guide

Topics: Investment, Active management, Efficient-market hypothesis Pages: 8 (2036 words) Published: February 5, 2014
FINA 4112 – Fall 2013
Learning Objectives

Asset Classes and Historical Returns

Why should we invest in international stocks or bonds?
Global assets have greater share of world assets
Higher rates of return available
**where a company’s headquarters are located is not much of a factor anymore** Why should we invest in real estate?
Adds diversification to the portfolio (part of investment universe) Low correlation with other assets
Very high return per unit of risk
Hedge against inflation
Good income producer
Why should we invest in Treasury Inflation Protected Securities? Maintains purchasing power in deflation times’
Extremely low-risk investment since backed by U.S. government Par value rises with inflation and interest rate remains fixed Describe the major attributes of TIPS.
Available in 5, 10, and 30 year maturities
Exempt from state and local income taxes
Correlate more highly with commodities
Interest rate and price are inversely related
As principle goes up, interest goes up
Describe the historical correlation of international stocks, TIPS and real estate with traditional asset classes like common stocks and LT bonds. US TIPs correlation with other classes:

Modern Portfolio Theory in Practice and Pitfalls

What are some of the problems with portfolio optimization?
Assumes that asset classes act in a linear fashion and have bell curve return distributions In reality, most asset classes have tails that are fatter than the normal distribution and have negative skews Difference between theory and practice

Pitfalls of asset class selection (which ones, performance measurable/predictable, investable, liquidity) By limiting the asset class, you are immediately creating an inefficient model Hedge funds are difficult to invest in because of selective self-reporting Property transactions occur too infrequently so correlation appears to be low Private equity and venture capital are illiquid and might only estimate valuations and returns quarterly How do you address some of the pitfalls and limitations of certain asset classes? Is the asset class accessible? (Ex. Can only invest Class b shares in Shanghai index) Are there gates, lock ups, funding requirements?

Is the asset liquid or will it tie up your money for a long period of time? Exit fee? Can you achieve a portfolio on the efficient frontier?
No such thing as efficient frontier; think of it as a range
Problems of assuming asset returns are normally distributed and practical implications Insufficient number of variables needed to be estimated for an optimized model Sensitivity of the variables to be estimated upon ending market weights Problem of historical data (YOU DO NOT GET HISTORICAL AVERAGES) If you use historical averages then you will be skipping Step #2 of the investment management process Why is there a momentum bias to MPT?

MPT over weighs asset classes that have recently performed well and high valuations Trendy investing in an illiquid asset classes can create positive momentum (Ex. Yale model) Understand instability of standard deviations and correlations

Efficient Market Hypothesis

Describe the Efficient Market Hypothesis and its assumptions or conditions. Securities prices adjust rapidly to the infusion of new information Current security prices reflect all available information

Should receive a rate of return consistent with risk of the security Assumptions:
Large number of profit-maximizing participants analyzing securities New information reaches the market in a random order
Price adjustments aren’t perfect
Profit-maximizing investors adjust security prices rapidly due to influx of new information Describe the Weak-form EMH and 2 tests that affirm or disaffirm. Current prices reflect all security market information and assumes past historical market data should have no relationship with future returns 2 tests to affirm or disaffirm:

Autocorrelation: measures independence of data over time...
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