CFA III SS 11&12 Equity.txt

  1. 1. Price weighted
    2. Value weighted
    3. Equal weighted
    • 1. weighted by price per share; a divisor adjustment removes the effect of dividends and splits; overrepresentation of firms with large share price
    • 2. weighted by market cap; float adjusted, so computed on investable rather than outstanding shares; overrepresentation of large market cap firms
    • 3. reflects average return of each stock; mainly used for academic purposes
  2. Passive index strategies
    • index - mutual fund or etf
    • cash plus long equity futures
    • cash plus total return equity
  3. index: mutual fund vs etf
    etfs generally lower cost (no individual shareholder recordsand have structural advantages, such as trade continuously, can be shorted, and shares are not redeemed for cash
  4. Equity Futures pros and cons
    • Pros: low transaction costs; very liquid
    • Cons: short term contracts are the most liquid but must be rolled over
  5. equity swap definition
    swap portfolio return for different, desired return; ex. rf of a market neutral with S&P 500
  6. index methods, pros and cons:
    1. replication
    2. stratified sampling
    3. optimization
    • 1. all stocks are purchased; pros - low tracking risk, less rebalancing cost (only when composition of index changes); cons - costly, and only plausible for small index (less than 1000 stocks)
    • 2. match index on one or two dimensions; pros - low cost; cons - higher tracking risk
    • 3. use factor model to match factor exposures of the index; pros - accounts for CoV b/w risk factors, lower tracking risk than stratified; cons - models are sensitive, freq rebalancing
  7. Three equity investing styles
    • value
    • growth
    • market oriented
  8. Two ways to determine investing style
    • returns based: regress manager returns with multiple known portfolios (large value, large growth, small value, small growth) and examine correlations and R2 over. Can be used over time to judge manager drift. 
    • adv - quick and easy; easy to compare portfolios
    • disadv - over time, so may not reflect current portfolio; inappropriate comp indices could lead to inaccurate results
    • holdings-based style: examine and classify portfolio holdings, usually based on P/E level, EPS growth rate and variability, and industry sector
    • adv - current, based on actual holdings
    • disadv - subjective, data intensive, may not reflect how manager selects securities (ex. if they move from growth to value while held)
  9. socially responsible investing and biases it creates
    • screens securities based on social, ethical, or religious concerns; screens can be negative - won't purchase, or positive - seek certain stocks
    • bias toward small cap growth
  10. long-only vs long-short strategy
    • long-only: can only purchase or not purchase stocks, so maximum underweighting is the index weight (ex. 0% in P vs 2% in index)
    • long-short: buy undervalued and short overvalued stocks; can leverage portfolio by using short funds to purchase more long positions; can earn equitize by adding a long position in equity futures or ETFs
  11. pairs trade or pairs arbitrage
    • manager matches long and short positions with similar stocks (usu same industry)
    • market neutral strategy
  12. fundamental law of active management
    • IR = IC * sqrt(IB)
    • IR = information ratio
    • IC = information coefficient; depth of knowledge
    • IB = investor breadth; number of independent investment decisions (ex if buy all stocks in one sector as a single decision to buy sector, only counts as 1)
  13. core-satellite vs completeness
    • both have market exposure plus alpha
    • core-sat: majority of portfolio is indexed or semi-active, then choose satellite managers to vary with certain funds, adding alpha and tracking risk
    • completeness: start with value add managers then add market portfolio; market portfolio considers value add managers holdings
  14. alpha and beta separation
    • some funds invested in index
    • some funds invested in long-short market neutral
    • this separates alpha and beta
    • creates portable alpha bc its not related to market portfolio
  15. calculate value add and true value add
    value add = active return / active risk

    • true value add = true act return / true act risk
    • true act return = manager's return - manager's normal benchmark
    • total act risk = sqrt(true act risk^2 + misfit act risk^2); solve this eq to get true act risk

    • total act return = manager's return - investor's benchmark
    • misfit return = manager's normal benchmark - investor's benchmark
  16. breadth vs investability
    • mostly applies to international indices
    • breadth is the number of securities covered by index
    • investability is the liquidity of the securities in the index
    • these are inversely related
  17. reconstitution
    • stocks added to index increase in price, and removed stocks decrease in price, so adding/removing from an indexed portfolio is disadvantageous (buy high, sell low)
    • effect is more prominent in judgmental indices (vs objective and transparent) bc investors don't know when a stock will be added or removed
  18. 1. friedman doctrine
    2. utilitarianism
    3. kantian ethics
    4. rights theories
    5. justice theories
    • 1. only social responsibility of business is to increase profits
    • 2. morality is determined by consequences - cost/benefit analysis; leads to seeking greatest good for greatest number of people; hard to calculate and may lead to exploiting small groups
    • 3. people should be treated with dignity and respect, they are not machines; incomplete philosophy bc does not address sympathy or caring
    • 4. fundamental rights trump collective good; managers must have a moral compass
    • 5. fair and equitable distribution of goods and services is just; argues rules are fair if all would agree to distribution under "veil of ignorance," meaning don't know which one they will receive.
Card Set
CFA III SS 11&12 Equity.txt