Leading indicators & final review
VaR represents the amount a portfolio
may lose over time. It does not have restriction on specific time sets like a year for example. The interval could be a day, 5 months. etc
The delta normal method of calculating VaR assumes a
normal distribution though other methods like Monte Carlo analysis do not
Dividend payout ratio is
percentage of earnings paid out as dividends
When comparing value at risk (VaR) to measures of risk used for performance evaluation, the difference is the
probability or sampling distribution.
An economic indicator is a measure that
provides information about the state of the overall economy.
The CAPM is inspired by Markowitz's MVO model, but is
quite distinct from it
ETNs are similar to bonds in that investors
receive the return of their original invested amount—the principal—at maturity. However, the ETN does not pay periodic interest payments
The ETN pays investors the
return received from the index they track at the maturity date, less any fees or commissions.
Stagflation includes
rising inflation with lower growth rate
The central insight of the Capital Asset-Pricing Model is that in equilibrium the
riskiness of an asset is not measured by the standard deviation of its return but by its beta.
The TRIN statistic is a ______ indicator.
sentiment
Stagflation is a period of
slow economic growth and high unemployment (stagnation) while prices rise (inflation)
Lagging Economic Indicators
Commercial and industrial loans outstanding is a
When prices and values fall due to too much supply
Deflation occurs
Typical scenario: Recession
- Aggregate demand declines - Inventory begins to accumulate - companies slow production - companies cut non essential expenditure - lower GDP
VaR can be calculated using the
Delta normal method, simulations based on sufficient historical data or Monte Carlo simulation
When the inflation rate decreases near market top
Disinflation occurs
Dividend payout ratio formula
Dividend Payout = Annual Dividend / Net Income or Dividends per share / EPS You can also use 1 - retention ratio
Cons of ETP
ETPs have the risk of market losses since their prices fluctuate. Some ETPs behave like debt instruments such as ETNs. ETPs are popular products but have varying trading volumes, which can affect liquidity
Coincident Economic Indicators
Employees on nonfarm payrolls are
Stages of a Business/Economic Cycle
Expansion, peak, contraction and trough
Keynesian Theory of Business Cycles
In the event of lower aggregate demand, lower wages result in lower spending, hence affecting demand further.• Very low interest rates would not stimulate the economy because confidence would be too low.• Government should intervene in a crisis, running a deficit.• Criticisms of this theory: - Government debt could get out of control. - Expansionary policy may cause the economy to grow too fast, resulting in inflation and other ills. - It takes time for fiscal policies to work, so they may be ill timed for a short-term crisis.
to increase the slope of the yield curve
Increasing future expected short rates and increasing liquidity premiums will act
Leading Economic Indicators
Index of Consumer Expectations is a
Coincident Economic Indicators
Industrial Production Index
Leading Economic Indicators
Interest rate spread between 10-year Treasury yields and the federal funds rate is a
Lagging Economic Indicators
Inventory-to-sales ratio is a
The CAPM is a one-period equilibrium model that provides
many important insights to the problem of asset pricing.
Business Cycles are
The transition points across cycles these are called peaks and troughs.
Characteristics of a business cycle:
- They are typical in economies that rely on business enterprises. - There are alternating phases of expansion and contraction. - Phases occur throughout the economy, most often simultaneously. - Phases reoccur but vary in duration and intensity.
Typical scenario: Expansion
- Wages grow and wages decline - Input prices fall - Consumers and companies purchase more - Companies increase capital spending - Increase GDP
CAPM Conclusions
-The market portfolio is on the efficient frontier -Each investor combines the market portfolio with the risk-free asset (long or short) -MVO not needed! -The expected excess return of each security is proportional to its systematic risk with respect to the market portfolio (beta)
PEG ratio formula
= (P/E) / Earnings Growth Rate
has turning points that precede changes in the economy.
A leading economic indicator is a measure that
Cyclical Industries have
Above-average sensitivity to the state of the economy.• Examples include producers of consumer durables (e.g. autos) and capital goods (i.e. goods used by other firms to produce their own products.)• High betas
interests rates are expected to increase in the future
According to the expectations hypothesis and upward sloping yield curve implies that
Coincident Economic Indicators
Aggregate real personal income is a
VaR is the
maximum dollar amount expected to be lost over a given time horizon, at a pre-defined confidence level.
TRIN statistic is also called
Arms Index or trading index created by Richard Arm in 1967
Lagging Economic Indicators
Average bank prime lending rate is a
Lagging Economic Indicators
Average duration of unemployment is a
Leading Economic Indicators
Average weekly initial claims for unemployment insurance are
Leading Economic Indicators
Building permits for new private housing units is a
Lagging Economic Indicators
Change in consumer price index for services or consumer credit is a
Lagging Economic Indicators
Change in unit labor costs is a
There are also disadvantages of Value at Risk (VAR) like
It does not tell you the expected loss if the loss goes beyond the minimum threshold. Even the risk of liquidity is not considered directly, it just focuses on the market risk. It is also difficult to estimate the inputs used for calculating VAR.
Leading Economic Indicators
Manufacturers' new orders for consumer goods and materials are
Leading Economic Indicators
Manufacturers' new orders for nondefense capital goods is a
Coincident Economic Indicators
Manufacturing and trade sales is a
If the forward P/E ratio is lower than the current P/E ratio, this implies that
analysts are expecting earnings to increase.
Three things when it comes to Value at Risk (VAR)-
Minimum Loss Specified Time Period Probability of exceeding that loss
Leading Economic Indicators
Money supply, real M2 is a
Lagging Economic Indicators
Ratio of consumer installment debt to income is
near a market bottom when rates are historically low
Reflation often occurs
Leading Economic Indicators
S&P 500 Index is a
when prices rise during low growth periods
Stagflation occurs
CAPM Assumptions
Taxes, transaction costs, and other real world considerations can be ignored All investor uses MVO to select portfolios All investors have the same forecasts; i.e., the same capital market assumptions All investors can borrow and lend at the same risk-free rate without limit
Better measurements than Tail Risk?
VaR and Sortino
The normal distribution assumption depends on the method used to calculate VaR that is why
VaR does not required the assumption that returns are normally distribute
Leading Economic Indicators
Vendor performance, slower deliveries diffusion index is a
Leading Economic Indicators
What indicator is a average weekly hours
If the forward P/E is higher than the current P/E ratio, analysts expect
a decrease in earnings.
An expansion occurs after
a low point (the trough) and a contraction occurs after the highest point (the peak).
For example, a 3% VAR of $50 over the next 1 week would mean that
a minimum loss that would occur within the next 1 week is $50 and the probability of this loss is 3%. Just to make the things clearer, we can also restate the above statement as, there is 97% chance that our loss will not exceed $50 within the next 1 week.
A contraction is also referred to as
a recession. - is referred to as a depression if severe and if aggregate activity declines.
While the CAPM formula requires the input of the expected market return, (which is just one factor), the APT formula uses
an asset's expected rate of return and the risk premium of multiple macroeconomic factors.
If an actual loss exceeds the predicted VaR threshold, that event is known as
an exceedance
A business cycle consists of
an expansionary period and a contractionary period. Business Cycle: Graphically
A TRIN value that dips below 0.50 may indicate
an overbought market and that bullish sentiment is overheating.
A TRIN value that exceeds 3.00 indicates
an oversold market and that bearish sentiment is too dramatic. This could mean an upward reversal in prices/index is coming.
short term interest rates will increase
an upward sloping yield curve is base on the expectation that
The APT does not provide insight into the factors to use, so users of the APT model must
analytically determine relevant factors that might affect the asset's returns. On the other hand, the factor used in the CAPM is the difference between the expected market rate of return and the risk-free rate of return.
TRIN statistic is the the ratio of
average volume in declining issues to average volume in advancing issues Ratios above 1.0 are bearish which means more volume went into stocks declining than they went into advancing stocks
like ETFs, also track an underlying index of securities and trade on major exchanges. However, ETNs are
baskets of unsecured debt securities.
The price of ETPs fluctuates from
day-to-day and intraday.
sensitivity and ratio of the percentage change in quantity for a given change in the price of a good
elasticity is the
ETPs trade on
exchanges similar to stocks.
Forward price-to-earnings (forward P/E) is a version of the ratio of price-to-earnings (P/E) that uses
forecasted earnings for the P/E calculation. The earnings used in this formula are just an estimate.
A positive kurtosis may lead to
great VaR
VaR is use to by financial professionals to know
how much capital we need to support the position .
95% VaR metric reflects the maximum amount the portfolio could be expected to lose 95% of the time. It does not indicate
how much would be lost the other 5% of the time when an extremes tail event occurs
Value at Risk (VAR) can also be stated as a percentage of the portfolio i.e. a specific percentage of the portfolio is the VAR of the portfolio. For example,
if its 5% VAR of 2% over the next 1 day and the portfolio value is $10,000, then it is equivalent to 5% VAR of $200 (2% of $10,000) over the next 1 day.
MVO is a normative theory, while the CAPM
is a positive theory
If PEGR = 1 to 2: The firm's stock
is in the normal range of value.
Defensive Industries have
little sensitivity to the business cycle• Examples include food producers and processors, pharmaceutical firms, and public utilities• Low betas
ETPs are usually a
low-cost alternative to mutual funds and actively-managed funds.
A trough occurs at
the bottom of a recession just as the economy enters a recovery.
Mean-variance analysis leads directly to
the capital asset pricing model or CAPM.
Investors who buy ETNs do not own any of the securities in the index they track. As a result,
the likelihood that investors will be paid back the principal and the returns from the underlying index is dependent on the creditworthiness of the issuer.
When assessing tail risk by looking at the 5% worst-case scenario the VaR is
the most optimistic as it takes the highest return (smallest loss) of all cases
If the 95 percent VaR of a portfolio is $100 then we expect
the portfolio will lose $100 or less in 95 percent of the scenarios, and lose $100 or more in 5 percent of the scenarios
PEG ratio
the ratio of a firm's P/E to its expected earnings growth rate per year
The share price of ETPs come from
the underlying investments that they track.
Exchange-traded products (ETP) are types of securities that
track underlying security, index, or financial instrument.
Analysts often combine forward and
trailing P/E estimates to make a better judgment. For example, assume that a company has a current share price of $50 and this year's earnings per share are $5. Analysts estimate that the company's earnings will grow by 10% over the next fiscal year. The company has a current P/E ratio of $50 / 5 = 10x. The forward P/E, on the other hand, would be $50 / (5 x 1.10) = 9.1x. Note that the forward P/E is smaller than the current P/E since the forward P/E accounts for future earnings growth relative to today's share price.
A peak is the
transition from the end of an expansion to the start of a contraction.
A lagging economic indicator has
turning points that are later than changes in the economy.
A coincident economic indicator has
turning points that coincide with the changes in the economy.
If PEGR < 1: The firm's stock is
undervalued.
While both are useful, many investors prefer to use the CAPM, a one-factor model, over the more complicated APT, which requires
users to quantify multiple factors.