Leading indicators & final review

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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.


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