7.4 Investment Analysis

Arbitrage(2)

- a strategy that generates a guaranteed profit from a transaction - common strategy: simultaneous purchase and sale of the same security in different markets at different prices to lock in a profit

3 Advantages of Eurodollar Bonds to Investors

- because they are US-dollar denominated, they bear no currency risk to US investors - they are rated by US rating agencies so the risk is clear - they may offer higher yields than domestic bonds from the same issuer

Sharpe Ratio

- measure of a portfolio's (or individual security's) risk in comparison to its expected return - calculated as the portfolio's average return that is in excess of the risk-free rate divided by the standard deviation of the portfolio - higher the Sharpe Ration the more attractive an investment becomes

Beta

- measure of a stock's volatility in relation to the overall market - "1" if in line with the market - more volatile than market if beta > 1, less if beta < 1

3 Disadvantages of Eurodollar Bonds to Investors (As With Foreign Bonds In General)

- since they are not registered with the SEC, there may be a lack of transparency - they have political and social risk (taken into consideration by the rating agencies) - they have less liquidity than domestic issues

Systematic Risk (Market Risk)

- the risk in the return of an investment that is associated with the macroeconomic factors that affect all risky assets - Total Risk = Systematic Risk + Unsystematic Risk

R-Squared (R^2)(5)

- used to reference what percentage of a portfolio's performance can be tied to a standard benchmark - ranges from a low of 0 to a high of 100 - 100 = moves right in line with the index - once below 50, there is not much in common with the index - low R^2 means you should ignore the beta

Unsystematic Risk

-specific risk associated with an investment (not related to macroeconomic factors

Eurobond

a bond denominated in a currency other than the currency of the country in which it is issued

Completely Diversified Portfolio

a portfolio in which the specific risk of each asset in the portfolio has been diversified away

Technical Analysts

attempt to predict the direction of prices on the basis of historic price and trading volume patterns

Efficient Market Theory

believes that the prices of securities rapidly reflect simultaneous access to all information

Fundamental Analysts

evaluate broad-based economic trends, current business conditions within an industry, and the quality of a particular corporation's business, finances, and management

Risk-Free Rate

generally refers to the interest rate of 90-day US Treasury bills

Benchmark Portfolio

model portfolio of a large number of assets, such as the S&P 500, against which the performance of a fund or portfolio is measured

Optimal Portfolio

portfolio that provides the highest expected returns for a given level of risk

Capital Asset Pricing Model

securities market investment theory that attempts to derive the expected return on an asset on the basis of the asset's systematic risk

Monte Carlo Simulation

statistical method to determine the return profile of a security or portfolio that recreates potential outcomes by generating random values on the basis of the risk and return characteristics of the securities themselves

Alpha

the extent to which an asset's or portfolio's actual return exceeds or falls short of its expected returns, positive is desirable over negative

Earnings Multiplier/Price to Earning (PE) Ratio

the price of the stock divided by its earnings per share