Portfolio Management (7)
Extreme Value Theory
branch of statistics that focuses primarily on extreme outcomes
Risk Analysis
for real-time risk monitoring, data may be aggregated for reporting and used as model input
Leverage
in the context of corporate finance, leverage refers to the use of fixed costs within a company's cost structure. Fixed costs that are operating costs (such as depreciation or rent) create operating leverage. Fixed costs that are financial costs (such as interest expense) create financial leverage
Risk Modification Method
one must weigh benefits and costs in light of the firm's risk tolerance when choosing the method to use
Relative Return Objective
a return objective stated as a return relative to the portfolio benchmark's total return
Conditional VaR
a tail loss measure. The weighted average of all loss outcomes in the statistical distribution that exceed the VaR loss
Blockchain
a type of digital ledger in which information is recorded sequentially and then linked together and secured using cryptographic methods
Risk
exposure to uncertainty. The chance of a loss or adverse outcome as a result of an action, inaction, or external event.
Absolute Risk Objective
expresses a maximum loss in value with an associated probability of loss
Distributed Ledger Technology (DLT)
- DLT has the potential to streamline the existing, often complex and labor intensive post-trade processes in securities markets by providing close to real-time trade verification, reconciliation, and settlement, thereby reducing related complexity, time, and costs - DLT is appropriate for use with tokenization because it has the potential to streamline this rights process by creating a single, digital record of ownership with which to verify ownership title and authenticity, including all historical activity
Sell-Side Firm
- a broker or dealer that sells securities to and provides independent investment research and recommendations to investment management companies
Buyout Fund
- a fund that buys all the shares of a public company so that, in effect, the company becomes private - only a few large investments in private companies with the intent of selling the restructured companies in three to five years
Capital Allocation Line (CAL)
- a graph line that describes the combinations of expected return and standard deviation of return available to an investor from combining the optimal portfolio of risky assets with the risk-free asset - higher risk aversion coefficient, means a lower risk tolerance and a lower expected return on the capital allocation line - investors will have different optimal portfolios depending on their indifference curves. The optimal portfolio for each investor is the one with highest utility; that is, where the CAL is tangent to the individual investor's highest possible indifference curve
Robo-Advisors
- a machine-based analytical tool or service that provides technology-driven investment solutions through online platforms - robo-advisers tend to offer fairly conservative advice, providing a cost-effective and easily accessible form of financial guidance to underserved populations, such as the mass affluent and mass market segments
Informationally Efficient Market
- a market in which asset prices reflect new information quickly and rationally
Beta
- a measure of the volatility, or systematic risk, of an individual stock in comparison to the unsystematic risk of the entire market - a measure of the sensitivity of a given investment or portfolio to movements in the overall market - positive beta indicates that the return of an asset follows the general market trend, whereas a negative beta shows that the return of an asset generally follows a trend that is opposite to that of the market - if an asset's beta is negative, the required return will be less than the risk-free rate in the CAPM. When combined with a positive market return, the asset reduces the risk of the overall portfolio, which makes the asset very valuable. Insurance is an example of a negative beta asset - the lower the beta value, the lower the market risk - risk-free asset's beta is zero because its covariance with other assets is zero - beta of the market is 1 Portfolio Beta = B*Weight in Risk-Free Asset + B*Weight is Risky Asset Ri = (1 - βi)Rf + βi(Rm) + eiDel
Multi-Factor Model
- a model that explains a variable in terms of the values of a set of factors
Closed-End Fund
- a mutual fund in which no new investment money is accepted. New investors invest by buying existing shares, and investors in the fund liquidate by selling their shares to other investors - can trade at a premium or a discount
Open-End Fund
- a mutual fund that accepts new investment money and issues additional shares at a value equal to the net asset value of the fund at the time of investment - this structure makes it easy to grow in size but creates pressure on the portfolio manager to manage the cash inflows and outflows. Redemptions may create the need to liquidate assets that the portfolio manager might not want to sell at the time or to hold cash to meet redemptions - trade at their net asset value per share
Skewness
- a quantitative measure of skew (lack of symmetry); a synonym of skew - negative skew - distribution is concentrated to the right - positive skew - distribution is concentrated to the left
Market Model
- a regression equation that specifies a linear relationship between the return on a security (or portfolio) and the return on a broad market index Ri = αi + βiRm + ei - where the intercept, αi, and slope coefficient, βi, are estimated using historical security and market returns - βi, is an estimate of the asset's systematic or market risk - these parameter estimates then are used to predict firm-specific returns that a security may earn in a future period
Jensen's Alpha
- alpha indicates whether or not the portfolio has outperformed the market. If alpha is positive, the portfolio has outperformed the market; if alpha is negative, the portfolio has underperformed the market - like Treynor ratio, based on systematic risk - equal to the difference between the actual portfolio return and the calculated risk-adjusted return - vertical distance from the SML measuring the excess return for the same risk as that of the market. - commonly used for evaluating most institutional managers, pension funds, and mutual funds. - maximum amount you should be willing to pay the manager to manage your money - managers who are maximizing risk-adjusted returns will seek to invest more in securities with higher values of Jensen's alpha αp = Rp - [Rf + βp(Rm - Rf)]
Money Market Fund
- although money market funds have been a substitute for bank savings accounts since the early 1980s, they are not insured in the same way as bank deposits - two types of money market funds: taxable and tax-free - taxable money market funds invest in high-quality, short-term corporate debt and federal government debt - tax-free money market funds invest in short-term state and local government debt - maturity is as short as overnight and rarely longer than 90 days
Risk Tolerance
- amount of risk an investor is willing and able to bear to achieve an investment goal - an organization's risk tolerance should reflect its competitive position
Cryptocurrency
- an algorithmic process to encrypt data, making the data unusable if received by unauthorized parties - an electronic medium of exchange that lacks physical form
Buy-Side Firm
- an investment management company or other investor that uses the services of brokers or dealers (ex: the client of the sell side firms)
Separately Managed Accounts (SMA)
- an investment portfolio managed exclusively for the benefit of an individual or institution - unlike a mutual fund the assets are owned directly by the individual in an SMA
Historical Risk and Correlation
- as with risk, correlations are quite stable among assets of the same country. - inter-country correlations, however, have been on the rise in the last few decades as a result of globalization and the liberalization of many economies - correlations below 0.30 are considered attractive for portfolio diversification
Exchange Traded Funds (ETFs)
- combine features of closed-end and open-end mutual funds - ETFs trade like closed-end mutual funds; however, like open-end funds, ETFs' prices track net asset value due to an innovative redemption procedure - ETFs are created by fund sponsors who determine which securities will be included in the basket of securities - do not have capital gain distributions
Machine Learning (ML)
- diverse approaches by which computers are programmed to improve performance in specified tasks with experience - "over-fitting/over-training" is when training data can be learned too precisely, resulting in inaccurate predictions when used with different datasets
Avenues for DIversification
- diversify with asset classes - domestic large caps, domestic small caps, growth stocks, value stocks, domestic corporate bonds, long-term domestic government bonds, domestic Treasury bills (cash), emerging market stocks, emerging market bonds, developed market stocks - diversify with index funds - diversification among countries - diversify by not owning your employer's stock - evaluate each asset before adding to a portfolio using Sharpe ratio - buy insurance for risky portfolios
Venture Capital Fund
- fund for private equity investors that provides financing for development-stage companies
Sharpe Ratio
- if the Sharpe ratio of the new asset is greater than the Sharpe ratio of the current portfolio times the correlation coefficient, it is beneficial to add the new asset - is simply the slope of the capital allocation line; the greater the slope, the better the asset - portfolio with the highest Sharpe ratio has the best performance, and the one with the lowest Sharpe ratio has the worst performance, provided that the numerator is positive for all comparison portfolios - a limitation is that it uses total risk of the portfolio, not just systematic risk although only systematic risk is priced - for it to be useful, it has to be ranked against the Sharpe ratios of other portfolios (Rp−Rf) / σp
Value at Risk (VaR)
- indicates the probability of a loss of at least a certain level in a time period - ex: one-day 5% Value at Risk of $1 million, means 5% of the time the firm is expected to lose at least $1 million in one day
Defined Contribution Pension Plans
- individual accounts to which an employee and typically the employer makes contributions, generally on a tax-advantaged basis. The amounts of contributions are defined at the outset, but the future value of the benefit is unknown. The employee bears the investment risk of the plan assets
Bond Mutual Fund
- investment fund consisting of a portfolio of individual bonds and, occasionally, preferred shares. The net asset value of the fund is the sum of the value of each bond in the portfolio divided by the number of shares - maturities as short as one year and as long as 30 years
Index Fund vs. ETF
- investor investing in an index mutual fund buys the fund shares directly from the fund and all investments are settled at the net asset value. An ETF, however, investors buy the shares from other investors just as if they were buying or selling shares of stock. This setup includes the opportunity to short the shares or even purchase the shares on margin - expenses are lower for ETFs but, unlike mutual funds, investors do incur brokerage costs - all purchases and redemptions in a mutual fund take place at the same price at the close of business. ETFs are constantly traded throughout the business day, and as such each purchase or sale takes place at the prevailing market price at that time - the minimum required investment in an ETF is usually smaller
Practical Limitations of the CAPM
- market portfolio: The true market portfolio according to the CAPM includes all assets, financial and non-financial, which means that it also includes many assets that are not investable, essentially true market portfolio is unobservable - proxy for a market portfolio: in the absence of a true market portfolio, market participants generally use proxies - estimation of beta risk: a long history of returns (3-5 years) is required to estimate beta risk. Generally, the CAPM is an ex ante model, yet it is usually applied using ex post data - CAPM is a poor predictor of returns - homogeneity in investor expectations
M-Squared
- measure of what a portfolio would have returned if it had taken on the same total risk as the market index - incorporates the standard deviation of the market and portfolio, which are measures of total risk - is good as a performance measure for an investor who is not fully diversified wp = (σm) / (σp)
Return-Generating Model
- model that can provide an estimate of the expected return of a security given certain parameters and estimates of the values of the independent variables in the model
Correlation Coefficient
- number between −1 and +1 that measures the consistency or tendency for two investments to act in a similar way. It is used to determine the effect on portfolio risk when two assets are combined - investor may achieve diversification by combining two assets that are not perfectly correlated. This diversification increases as the correlation decreases - the lower the correlation (even into the negatives), the lower the portfolio risk (standard deviation), all else being equal - if two securities are completely uncorrelated, the correlation coefficient is 0
Individual's Ability to Take Risk
- objective factors such as time horizon and expected income
Defined Benefits Pension Plan
- plans in which the company promises to pay a certain annual amount (defined benefit) to the employee after retirement. The company bears the investment risk of the plan assets - tend to have high risk tolerance and low liquidity because the time horizon is long similar to endowments and funds
Security Characteristic Line (SCL)
- plot of the excess return of a security on the excess return of the market - Jensen's alpha is the intercept and the beta is the slope Ri - Rf = αi + βi(Rm - Rf)
Risk-Free Asset & Risky Asset Portfolio Optimization
- portfolio of the risk-free asset and a risky asset or a portfolio of risky assets can result in a better risk-return tradeoff than an investment in only one type of an asset, because the risk-free asset has zero correlation with the risky asset
Portfolio Diversification
- portfolios reduce risk more than they increase returns - helps investors avoid disastrous investment outcomes
Hedge Funds
- private investment vehicles that typically use leverage, derivatives, and long and short investment strategies - vast majority of hedge funds are exempt from many of the reporting requirements for the typical public investment company (mutual fund) - some general hedge fund strategies include: a) convertible arbitrage—buying such securities as convertible bonds that can be converted into shares at a fixed price and simultaneously selling the stock short. b) dedicated short bias c) emerging markets d) equity market neutral—Attempting to eliminate the overall market movement by going short overvalued securities and going long a nearly equal value of undervalued securities. e) event driven f)fixed-income arbitrage - trying to profit from arbitrage opportunities in interest rate securities g) global macro - using derivatives on currencies or interest rates. h) long/short—buying long equities that are expected to increase in value and selling short equities that are expected to decrease in value - minimum investment from $250,000 to $1,000,000 - limited withdrawals - management fees are a fixed percentage of the funds under management; managers also collect fees based on performance
Asset Allocation
- process of determining how investment funds should be distributed among asset classes - fixed income has lower risk compared to equity, and alternative assets is the most volatile
Geometric Mean Return
- provides a more accurate representation of the growth in portfolio value over a given time period than does an arithmetic mean return Geometric Mean Return = [(1+R1) x (1+R2) x ... (1+Rt)]^(1/t) - 1
Risk Acceptance
- risk response strategy whereby the project team decides to acknowledge the risk and not take any action unless the risk occurs - they may establish a reserve fund to cover losses
Liquidity Risk
- risk that a financial instrument cannot be purchased or sold without a significant concession in price due to the size of the market - also called transaction cost risk. When the bid-ask spread widens, purchase and sale transactions become increasingly costly
Systematic Risk
- risk that affects the entire market or economy; it cannot be avoided and is inherent in the overall market. - also known as non-diversifiable or market risk - only systematic risk is priced
Optimal Portfolio
- risk-seeking investors, which are those who are willing to take higher risks for a higher expected return, will invest more than 100% in the optimal risky portfolio by borrowing at the risk-free rate. This portfolio lies to the right point of the optimal risky portfolio on the CAL - each individual investor's optimal mix of the risk-free asset and the optimal risky asset is determined by the investor's risk preference
Theoretical Limitations of the CAPM
- single-factor model: only systematic risk or beta risk is priced in the CAPM. Thus, the CAPM states that no other investment characteristics should be considered in estimating returns, very restrictive - single-period model: the CAPM is a single-period model that does not consider multi-period implications or investment objectives of future periods, which can lead to myopic and suboptimal investment decisions
Individual's Willingness to Take Risk
- subjective factors such as personality type, safety of principal, luck, independent thinking - because risk attitude is a subjective factor and measuring risk attitude is difficult. Oftentimes, investment managers use psychometric questionnaires
Fintech
- technological innovation in the design and delivery of financial services and products in the financial industry
Liquidity
- the ability to purchase or sell an asset quickly and easily at a price close to fair market value. The ability to meet short-term obligations using assets that are the most readily converted into cash - liquidity impacts the bid-ask spread and can impact the stock price
Modern Portfolio Theory (MPT)
- the analysis of rational portfolio choices based on the efficient use of risk
Risk Averse
- the assumption that an investor will choose the least risky alternative - the most risk-averse investor has the indifference curve with the greatest slope
Many Risky Assets
- the contribution of each individual asset's variance (or standard deviation) to the portfolio's volatility decreases as the number of assets in the equally weighted portfolio increases - contribution of the co-movement measures between the assets increases (ex: covariance and correlation) as the number of assets in the equally weighted portfolio increases
Risk Aversion
- the degree of an investor's inability and unwillingness to take risk - evidence of risk aversion is best illustrated by a risk-return relationship that is positive
Internal Rate of Return (IRR)
- the discount rate that makes net present value equal 0; the discount rate that makes the present value of an investment's costs (outflows) equal to the present value of the investment's benefits (inflows)
Risk Budgeting
- the establishment of objectives for individuals, groups, or divisions of an organization that takes into account the allocation of an acceptable level of risk - adding a risk budgeting process causes the organization to consider how its total risk tolerance will be allocated across its subsidiaries and forces risk tradeoffs across the organization
Variance
- the expected value (the probability-weighted average) of squared deviations from a random variable's expected value - to calculate portfolio variance only the assets' weights, standard deviations (or variances), and covariances (or correlations) are used - risk-free asset has a variance of zero
Security Market Line (SML)
- the graph of the capital asset pricing model - a graphical representation of the capital asset pricing model with beta, reflecting systematic risk, on the x-axis and expected return on the y-axis - SML intersects the y-axis at the risk-free rate of return, and the slope of this line is the market risk premium, Rm-Rf - the security market line applies to any security, efficient or not. The CAL and the CML use the total risk of the asset (or portfolio of assets) rather than its systematic risk, which is the only risk that is priced
Markowitz Efficient Frontier
- the graph of the set of portfolios offering the maximum expected return for their level of risk (standard deviation of return) - does not account for risk free rate - the increase in return with every unit increase in risk keeps decreasing as one moves from left to right because the slope of the efficient frontier continues to decrease. Thus, investors obtain decreasing increases in returns as they assume more risk - Markowitz efficient frontier is the set of portfolios above the global minimum-variance portfolio that dominates the portfolios below the global minimum-variance portfolio
Risk Management Framework
- the infrastructure, process, and analytics needed to support effective risk management in an organization - all framework should address the following factors: a) risk governance b) risk identification and measurement c) risk infrastructure d) defined policies and processes e) risk monitoring, mitigation, and management f) communications g) strategic analysis or integration
Money-Weighed Return
- the internal rate of return on a portfolio, taking account of all cash flows
Capital Market Line (CML)
- the line with an intercept point equal to the risk-free rate that is tangent to the efficient frontier of risky assets; represents the efficient frontier when a risk-free asset is available for investment - while the CAL includes all possible combinations of the risk-free asset and any risky portfolio, the CML is a special case of the capital allocation line, which uses the market portfolio as the optimal risky portfolio - theoretically, any point above the CML is not achievable and any point below the CML is inferior - a portfolio lying to the right of the market portfolio on the CML is formed by borrowing funds at the risk-free rate and investing all available funds in the market portfolio - as one moves further to the right of point M on the capital market line, an increasing amount of borrowed money is being invested in the market portfolio. This means that there is negative investment in the risk-free asset, which is referred to as a leveraged position in the risky portfolio - the combinations of the risk-free asset and the market portfolio on the CML where returns are less than the returns on the market portfolio are termed 'lending' portfolios
Treynor Ratio
- the numerators must be positive for the Treynor ratio to give meaningful results - measures the return premium of a portfolio versus the risk-free asset relative to the portfolio's beta, which is a measure of systematic risk
Global Minimum-Variance Portfolio
- the portfolio on the minimum-variance frontier with the smallest variance of return; smallest standard deviation - the global minimum-variance portfolio is the left-most point on the minimum-variance frontier among all portfolios of risky assets - although the portfolio is attainable, when the risk-free asset is considered, the global minimum-variance portfolio is not the optimal risky portfolio
Risk Management
- the process of identifying the level of risk an entity wants, measuring the level of risk the entity currently has, taking actions that bring the actual level of risk to the desired level of risk, and monitoring the new actual level of risk so that it continues to be aligned with the desired level of risk - maximizing utility while taking risk consistent with individual's level of risk tolerance - adjusts its risk to a predetermined level
Financial Risks
- the risk that environmental, social, or governance risk factors will result in significant costs or other losses to a company and its shareholders; the risk arising from a company's obligation to meet required payments under its financing agreements - risks originating within the financial market, internal risks - ex: solvency risk, operational risk
Strategic Asset Allocation
- the set of exposures to IPS-permissible asset classes that is expected to achieve the client's long-term objectives given the client's investment constraints - assets within a specific asset class have high paired correlations and low correlations with other asset classes - lower correlations indicate a greater degree of separation between asset classes 1) Principle 1: portfolio's systematic risk accounts for most of its change in value over the long run 2) Principle 2: the returns to groups of like assets... predictably reflect exposures to certain sets of systematic factors
Two-Fund Separation Theorem
- the theory that all investors regardless of taste, risk preferences, and initial wealth will hold a combination of two portfolios or funds: a risk-free asset and an optimal portfolio of risky assets - the dominant capital allocation line is the combination of the risk-free asset and the optimal risky portfolio - the capital allocation line (CAL) dominates the efficient frontier at all points except for the optimal risky portfolio. The ability of the investor to purchase additional amounts of the optimal risky portfolio by borrowing (i.e., buying on margin) at the risk-free rate makes higher rates of return for levels of risk greater than the optimal risky asset possible
Risk Governance
- the top-down process and guidance that directs risk management activities to align with and support the overall enterprise - the role of the board of directors, risk governance is where goals and responsibilities are defined and top-level decisions (such as determining the company's risk tolerance) are made - provide guidance on the size of the largest acceptable loss for the organization - defines risk tolerance, provides risk oversight and guidance to align risk with enterprise goals - not about specifying methods to mitigate risk at the business line level. Rather, it is about establishing an appropriate level of risk for the entire enterprise - takes care of 1) risk tolerance, then 2) risk budgeting, and then 3) risk exposures
Text Analytics
- the use of computer programs to analyze and derive meaning from typically large, unstructured text- or voice-based datasets - models using natural language processing (NLP) analysis may incorporate non-traditional information to evaluate what people are saying—via their preferences, opinions, likes, or dislikes—in the attempt to identify trends and short-term indicators about a company, a stock, or an economic event that might have a bearing on future performance - appropriate application for economic trend analysis
Big Data
- the vast amount of data being generated by industry, governments, individuals, and electronic devices that arises from both traditional and non-traditional data sources - refers to datasets having the following characteristics: a) volume b) velocity - speed with which the data are communicated c) variety - involves formats with diverse types of structures (ex: PDF, HTML)
Leverage Buyout
- transaction whereby the target company management team converts the target to a privately held company by using heavy borrowing to finance the purchase of the target company's outstanding shares
Stock Mutual Funds
- two types of stock mutual funds: 1) actively managed fund - in which the portfolio manager seeks outstanding performance through the selection of the appropriate stocks to be included in the portfolio 2) passive management - is followed by index funds that are very different from actively managed funds. Their goal is to match or track the performance of different indexes
Nonsystematic Risk
- unique risk that is local or limited to a particular asset or industry that need not affect assets outside of that asset class - investors are capable of avoiding nonsystematic risk by forming a portfolio of assets that are not highly correlated with one another, thereby reducing total risk and being exposed only to systematic risk Total Variance = Systematic Variance + Nonsystematic Variance
Bottom-Up Analysis
- with reference to investment selection processes, an approach that involves selection from all securities within a specified investment universe, ex: without prior narrowing of the universe on the basis of macroeconomic or overall market considerations
Top-Down Analysis
- with reference to investment selection processes, an approach that starts with macro selection (ex: identifying attractive geographic segments and/or industry segments) and then addresses selection of the most attractive investments within those segments
Self-Investment Limits
- with respect to investment limitations applying to pension plans, restrictions on the percentage of assets that can be invested in securities issued by the pension plan sponsor
Investment Policy Statement (IPS)
- written planning document that describes a client's investment objectives and risk tolerance over a relevant time horizon, along with constraints that apply to the client's portfolio - written IPS, to be successful, must incorporate a full understanding of the client's situation and requirements
Portfolio Management Process
1) The Planning Step - understanding the client's needs - preparation of an investment policy statement (IPS) 2) The Execution Step - asset allocation - security analysis - portfolio construction 3) The Feedback Step - portfolio monitoring and rebalancing - performance measurement and reporting
Types of Investors
1) individual - varying risk and liquidity 2) institutional - defined benefit pensions plans, university endowments, charitable foundations, banks, insurance companies, investment companies, and sovereign wealth funds (SWFs) 3) banks - low risk, high liquidity for withdrawals 4) insurance companies - need to be relatively conservative and liquid, given the necessity of paying claims when due 5) investment companies- varying risk, high liquidity
Assumptions of the CAPM
1) investors are risk-averse, utility-maximizing, rational individuals 2) markets are frictionless, including no transaction costs and no taxes. 3) investors plan for the same single holding period 4) investors have homogeneous expectations or beliefs - all investors have the same economic expectation of future cash flows and thus should invest in the same optimal risky portfolio, implying the existence of only one optimal portfolio (ex: the market portfolio) 5) all investments are infinitely divisible - investor can invest as much as he or she desires in any asset 6) investors are price takers
Benefits of Good Risk Management
1) less frequent surprises and a better notion of what the damage would be in the event of a surprise 2) more decision discipline leading to better consideration of trade-offs and better risk−return relationships 3) better response and risk mitigation stemming from more awareness and active monitoring, which should trim some of the worst losses 4) better efficiency and fewer operational errors from policies and procedures, transparency, and risk awareness 5) better relations, with more trust, between the governing body and management, which generally results in more effective delegation 6) a better image or reputation because analysts and investors perceive a company as prudent and value-focused
Capital Asset Pricing Model (CAPM)
E(Ri) = Rf + βi[E(Rm) - Rf] - shows that the primary determinant of expected return for an individual asset is its beta, or how well the asset correlates with the market - market risk premium is the difference between the return on the market and the risk-free rate, which is the same as the return in excess of the market return
Utility Function
U = E(r) − (1/2Aσ^2) - negative utility function indicates that the individual is a risk seeker - for a risk averse individual, their measure of risk aversion(A) is 0. Thus, utility for risk averse individuals is just expected return - all individuals still choose highest utility value
Normal Distribution
a continuous, symmetric probability distribution that is completely described by its mean and its variance
Indifference Curves
a curve representing all the combinations of two goods or attributes such that the consumer is entirely indifferent among them
High-Fequency Trading
a form of algorithmic trading that makes use of vast quantities of data to execute trades on ultra-high-speed networks in fractions of a second
Asset Class
a group of assets that have similar characteristics, attributes, and risk/return relationships
Unsupervised Learning
a machine learning approach that does not make use of labeled training data
Supervised Learning
a machine learning approach that makes use of labeled training data
Market
a means of bringing buyers and sellers together to exchange goods and services
Covariance
a measure of the co-movement (linear association) between two random variable
Vega
a measure of the sensitivity of an option's price to changes in the underlying's volatility
No-Load Fund
a mutual fund in which there is no fee for investing in the fund or for redeeming fund shares, although there is an annual fee based on a percentage of the fund's net asset value
Load Fund
a mutual fund in which, in addition to the annual fee, a percentage fee is charged to invest in the fund and/or for redemptions from the fund
Gamma
a numerical measure of how sensitive an option's delta (the sensitivity of the derivative's price) is to a large change in the value of the underlying
Risk Management Committee
a part of the risk governance structure at the operational level
Mutual Fund
a professionally managed investment pool in which investors in the fund typically each have a pro-rata claim on the income and value of the fund
Major Components of an IPS
a) Introduction: this section describes the client. Statement of Purpose. This section states the purpose of the IPS. b) Statement of Duties and Responsibilities: this section details the duties and responsibilities of the client, the custodian of the client's assets, and the investment managers. c) Procedures: this section explains the steps to take to keep the IPS current and the procedures to follow to respond to various contingencies. d) Investment Objectives: this section explains the client's objectives in investing. e) Investment Constraints: this section presents the factors that constrain the client in seeking to achieve the investment objectives. f) Investment Guidelines: this section provides information about how policy should be executed (e.g., on the permissible use of leverage and derivatives) and on specific types of assets excluded from investment, if any. g) Evaluation and Review: this section provides guidance on obtaining feedback on investment results. h) Appendices: ex: Strategic Asset Allocation and Rebalancing Policy
Risk Shifting
actions to change the distribution of risk outcomes
Risk Transfer
actions to pass on a risk to another party, often, but not always, in the form of an insurance policy
Tail Risk
although it involves unlikely but substantial losses, typically results from using inappropriate modelling assumptions such as assuming that returns are normally distributed
Data Science
an interdisciplinary field that brings computer science, statistics, and other disciplines together to analyze and produce insights from Big Data
Capital Market Expectations
an investor's expectations concerning the risk and return prospects of asset classes
Enterprise Risk Management
an overall assessment of a company's risk position. A centralized approach to risk management sometimes called firm-wide risk management
Initial Coin Offering (ICO)
an unregulated process whereby companies raise capital by selling crypto tokens to investors in exchange for fiat money or another agreed-upon cryptocurrency
Scenario Analysis
analysis that shows the changes in key financial quantities that result from given (economic) events, such as the loss of customers, the loss of a supply source, or a catastrophic event; a risk management technique involving examination of the performance of a portfolio under specified situations. Closely related to stress testing
Volatility
as used in option pricing, the standard deviation of the continuously compounded returns on the underlying asset
Smart Contracts
computer program that is designed to self-execute on the basis of pre-specified terms and conditions agreed to by parties to a contract
Neural Networks
computer programs based on how our own brains learn and process information
Natural Computer Processing
computer programs developed to analyze and interpret human language
Artificial Intelligence (AI)
computer systems that exhibit cognitive and decision-making ability comparable (or superior) to that of human
Core-Satellite Approach
investing the majority of the portfolio on a passive or low active risk basis while a minority of the assets is managed aggressively in smaller portfolios
Deep Learning
machine learning using neural networks with many hidden layers
Alternative Data
non-traditional data types generated by the use of electronic devices, social media, satellite and sensor networks, and company exhaust - there are three main sources: 1) data generated by individuals, 2) data generated by business processes, and 3) data generated by sensors
Duration
measure of the approximate sensitivity of a security to a change in interest rates (ex: a measure of interest rate risk)
Hybrid/Balanced Funds
mutual funds that invest in both bonds and shares
Internet of Things
network arrangement of structures and devices whereby the objects on the network are able to interact and share information
Permissioned Networks
networks that are fully open only to select participants on a DLT network
Permissionless Networks
networks that are fully open to any user on a DLT network
Diversification Ratio
ratio of the standard deviation of an equally weighted portfolio to the standard deviation of a randomly selected security
Model Risk
risk of using the wrong model to analyze an investment or the risk of using the right model for the analysis but using it incorrectly
Solvency Risk
risk that an entity does not survive or succeed because it runs out of cash, even though it might otherwise be solvent
Market Risk
risk that arises from movements in interest rates, stock prices, exchange rates, and commodity prices
Non-Financial Risks
risks that arise from sources other than changes in the external financial markets, such as changes in accounting rules, legal environment, or tax rates - ex: operational risk, settlement risk
Statistical Factor Models
use historical and cross-sectional return data to identify factors that explain the variance or covariance in the observed returns of securities
Homogeneity of Expectations
the assumption that all investors have the same economic expectations and thus have the same expectations of prices, cash flows, and other investment characteristics
Tactical Asset Allocation
the decision to deliberately deviate from the strategic asset allocation in an attempt to add value based on forecasts of the near-term relative performance of asset classes
Performance Evaluation
the measurement and assessment of the outcomes of investment management decisions
Minimum-Variance Portfolio
the portfolio with the minimum variance for each given level of expected return
Portfolio Planning
the process of creating a plan for building a portfolio that is expected to satisfy a client's investment objectives
Tokenization
the process of representing ownership rights to physical assets on a blockchain or distributed ledger
Security Selection
the process of selecting individual securities; typically, security selection has the objective of generating superior risk-adjusted returns relative to a portfolio's benchmark
Holding Period Return
the return that an investor earns during a specified holding period; a synonym for total return Return = Capital Gain + Dividend Yield
Credit Risk
the risk of loss caused by a counterparty's or debtor's failure to make a promised payment. Also called default risk
Delta
the sensitivity of the derivative price to a small change in the value of the underlying asset
Rho
the sensitivity of the option price to the risk-free rate
Rebalancing Policy
the set of rules that guide the process of restoring a portfolio's asset class weights to those specified in the strategic asset allocation
Risk Exposure
the state of being exposed or vulnerable to a risk. The extent to which an entity is sensitive to underlying risks
Kurtosis
the statistical measure that indicates the combined weight of the tails of a distribution relative to the rest of the distribution
Algorithmic Trading
the widespread adoption of algorithmic trading is increased
Distributed Ledger
type of database that may be shared among entities in a network
Macroeconomic Factor Models
use economic factors that are correlated with security returns, such as economic growth, the interest rate, the inflation rate, productivity, etc