Alternative and Traditional Investments Quiz
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Questions and Answers

Which of the following is classified as a traditional investment?

  • Gold
  • Stocks (correct)
  • Hedge funds
  • Private equity

What distinguishes alternative investments from traditional investments?

  • They often use unconventional investment vehicles. (correct)
  • They include government bonds.
  • They offer a higher correlation with traditional investments.
  • They utilize conventional strategies.

Which asset class is considered one of the most liquid in alternative investments?

  • Fine art
  • Gems and stones
  • Private equity
  • Currencies (correct)

Which of the following alternative investments is typically considered illiquid?

<p>Fine art (C)</p> Signup and view all the answers

What common characteristic is shared by all alternative investments?

<p>Low correlation with traditional investments (D)</p> Signup and view all the answers

In the context of investment liquidity, which statement is true?

<p>Currencies are highly liquid. (B)</p> Signup and view all the answers

What is an example of a managed futures investment?

<p>Trend-following strategies (D)</p> Signup and view all the answers

Which type of investment is NOT considered a component of classical investments?

<p>Commodities (A)</p> Signup and view all the answers

What is the effect of active management on the efficient frontier?

<p>Active management shifts the efficient frontier upwards. (C)</p> Signup and view all the answers

How does a fund manager's ability impact the efficient frontier?

<p>A fund manager’s poor stock picking can shift the frontier downwards. (D)</p> Signup and view all the answers

What characteristics does the Fama-French model incorporate?

<p>It includes factors like SMB and HML related to underlying asset characteristics. (C)</p> Signup and view all the answers

What type of model are macroeconomic based models typically categorized as?

<p>They incorporate macroeconomic risk factors. (C)</p> Signup and view all the answers

Which of the following statements regarding the Capital Asset Pricing Model (CAPM) is true?

<p>CAPM is a market-oriented and objective approach. (C)</p> Signup and view all the answers

In the context of multi-factor models, what does the term 'special interest factor' refer to?

<p>Factors that are chosen based on specific queries like exchange rate effects. (B)</p> Signup and view all the answers

Which is NOT a standard factor model mentioned in the provided content?

<p>Constant Growth Model (D)</p> Signup and view all the answers

What does the term 'equilibrium market' refer to in the context of CAPM?

<p>A market where supply for securities equals demand. (C)</p> Signup and view all the answers

What does the index model equation estimate for stock i on day t?

<p>The expected return of the stock (D)</p> Signup and view all the answers

Why is it important to estimate the index model for a period that does not include the event window?

<p>To accurately reflect 'normal' returns (C)</p> Signup and view all the answers

What formula represents the calculation of abnormal return ARi,t?

<p>ARi,t = Ri,t – (αi + βi.Rm,t) (B)</p> Signup and view all the answers

What does the variance of the sample abnormal return consist of?

<p>Variance of the error term plus a sampling error component (A)</p> Signup and view all the answers

Which of the following best describes cumulative abnormal return (CAR)?

<p>The sum of all abnormal returns over a specified period (B)</p> Signup and view all the answers

What distribution does the cumulative abnormal return CARi,t,τ follow?

<p>N(0, var(CARi,t,τ)) (A)</p> Signup and view all the answers

What is the relationship between ARi,t and CARi,t,τ?

<p>CARi,t,τ is the sum of all ARi,t over a specified period (D)</p> Signup and view all the answers

What happens if the data used to estimate expected returns is contaminated?

<p>It leads to an unreliable estimation of normal returns (D)</p> Signup and view all the answers

What does a beta greater than 1 indicate about a security?

<p>The security has higher fluctuations compared to the market. (C)</p> Signup and view all the answers

What is the market beta for the market portfolio itself?

<p>1 (D)</p> Signup and view all the answers

How is beta calculated in relation to the covariance with the market?

<p>Beta is the ratio of the covariance of the asset’s return with the market return to the market's variance. (C)</p> Signup and view all the answers

What characterizes a defensive security in terms of beta?

<p>β &lt; 1 (C)</p> Signup and view all the answers

What is the purpose of the security market line (SML)?

<p>To provide the expected return for a security based on its specific beta. (C)</p> Signup and view all the answers

What is indicated by a negative correlation with the market portfolio?

<p>The asset can lower the overall portfolio risk. (C)</p> Signup and view all the answers

In the capital asset pricing model (CAPM), what do we mean by risk-free asset's beta?

<p>It has a beta equal to 0. (D)</p> Signup and view all the answers

If a portfolio predominantly contains stocks with a beta of less than 1, what type of portfolio is it considered?

<p>Defensive market portfolio (A)</p> Signup and view all the answers

What characterizes a left-skewed return distribution?

<p>Frequent small gains and few extreme losses. (A)</p> Signup and view all the answers

Which of the following best describes positively skewed return distributions?

<p>They provide large gains which occur infrequently. (B)</p> Signup and view all the answers

What is the implication of having a leptokurtic distribution?

<p>It implies a higher peak around the mean and fat tails. (C)</p> Signup and view all the answers

Why can leptokurtic distributions be considered dangerous for investors?

<p>They increase the occurrence of extreme losses. (B)</p> Signup and view all the answers

What happens to the kurtosis of financial returns as the temporal aggregation increases?

<p>It decreases. (B)</p> Signup and view all the answers

How does a normal distribution's kurtosis compare to a leptokurtic distribution?

<p>Normal distribution has a kurtosis of 0, while leptokurtic has positive kurtosis. (B)</p> Signup and view all the answers

What are the 'fat tails' in a leptokurtic distribution indicative of?

<p>Infrequent but extreme market events. (D)</p> Signup and view all the answers

What does the skewness of financial returns typically indicate?

<p>Typically no systematic difference from zero. (B)</p> Signup and view all the answers

What is the unconditional variance in the context of the ARCH model?

<p>$σ_t^2 = 1 - ∑ β_i$ (D)</p> Signup and view all the answers

What characteristic defines the GARCH model compared to the original ARCH model?

<p>It incorporates past conditional variances. (C)</p> Signup and view all the answers

In practical applications, what is typically sufficient to model financial time series using GARCH?

<p>A GARCH(1,1) model (B)</p> Signup and view all the answers

What does $σ_{t-1}^2$ represent in the GARCH model?

<p>The previous period's volatility (A)</p> Signup and view all the answers

Which of the following components is NOT part of the GARCH(1,1) model formulation?

<p>c (A)</p> Signup and view all the answers

Why is the lowest order GARCH model often sufficient?

<p>It includes historical adjustments to volatility. (D)</p> Signup and view all the answers

What does the sum $∑ a_i.ε_{t-i}$ in the GARCH model signify?

<p>The weighted influence of past disturbances (A)</p> Signup and view all the answers

In the context of GARCH modeling, what does 'ω' typically represent?

<p>The constant term in the variance equation (D)</p> Signup and view all the answers

Flashcards

Traditional Investments

Investing in assets like stocks, bonds, and cash, with the goal of increasing value over time.

Alternative Investments

Investing in assets like hedge funds, commodities, and private equity, often using unconventional strategies.

Liquidity

The ease with which an asset can be bought or sold without affecting its price.

Heterogeneity

The degree to which assets in a market are similar or different.

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Low Correlation

The tendency of assets to move in different directions.

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Managed Futures

A type of alternative investment where money managers invest in derivatives, often reacting to market trends.

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Commodities

A type of alternative investment that includes investing in gold, oil, and other natural resources.

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Private Equity

A type of alternative investment that involves investing in unlisted companies, usually in a private or early stage.

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Left-Skewed Return Distribution

A distribution with infrequent extreme losses and frequent small gains. The rare large losses can significantly impact an investor's wealth.

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Right-Skewed Return Distribution

A distribution with infrequent large gains and frequent small losses. The potential for large gains attracts investors.

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Kurtosis

A measure of the 'peakedness' of a distribution. It describes how likely extreme values are compared to values near the mean.

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Leptokurtic Distribution

A distribution with a higher peak around the mean and fatter tails than a normal distribution. This is characteristic of financial market returns.

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Platykurtic Distribution

A distribution with a lower and wider peak compared to a normal distribution.

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Tail Risk

The likelihood of extreme events, such as market crashes or sudden price spikes, occurring in financial markets.

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Stylized Fact 1: Leptokurtosis

The observation that financial market returns tend to have a higher kurtosis than a normal distribution.

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Stylized Fact 2: Kurtosis and Temporal Aggregation

The observation that the kurtosis of financial market returns decreases as the time horizon for analysis increases.

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Macroeconomic Multifactor Model

A financial model that uses risk factors based on economic conditions like output growth, inflation, and interest rates.

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Market Equilibrium

The situation where the price of a security is at a level where the supply and demand for that security are balanced.

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Capital Asset Pricing Model (CAPM)

A financial model that aims to predict the expected return for a security based on the assumption that the market is in equilibrium.

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Risk-Free Rate

The risk-free rate is the return you can expect from a risk-free investment like a government bond.

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Risk Premium

The difference in return between a risky asset and a risk-free asset.

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Beta

A measure of how much the return of a security is affected by changes in the overall market.

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Expected Return

The return expected from an investment based on its risk level compared to the overall market.

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Fama-French Three Factor Model

A financial model that extends the CAPM by adding additional factors like company size and value.

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ARCH Model (Autoregressive Conditional Heteroskedasticity)

A statistical model that captures the volatility of financial time series by expressing the conditional variance of the returns as a function of past squared errors.

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GARCH Model (Generalized Autoregressive Conditional Heteroskedasticity)

The generalized ARCH model, which allows for the conditional variance to depend on both past squared errors and past conditional variances.

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GARCH(1,1)

The lowest order GARCH model used to capture the volatility of financial time series. It considers only the previous period's squared error and conditional variance.

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Conditional Variance in GARCH

The conditional variance captures the expected volatility for the next period, based on the information available at the current time.

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Volatility Modelling

A statistical method used to model the volatility of a time series, based on the assumption that past volatility influences current and future volatility.

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Volatility Clustering

The process where a financial asset's price changes in unexpected ways, often characterized by periods of high and low volatility that cluster together.

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Persistence of Volatility

The effect of previous price changes on the current and future volatility. The more volatile the past, the more likely the current and future periods will also be volatile.

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GARCH Model Parameter Estimation

The process of determining the optimal parameters (ω, a, and b) for a GARCH model to best fit the observed data of a financial time series.

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Covariance and Portfolio Risk

The contribution of an asset to the total risk of a portfolio is determined by its covariance with the market portfolio.

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Beta (β)

A measure of how much an asset's return fluctuates with the market's return.

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Market Beta (βm)

The beta of the market portfolio, representing the average market risk.

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Beta for Risk-Free Asset (βf)

Beta for a risk-free asset. It has no systematic risk.

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Aggressive Securities (β > 1)

Securities with a beta greater than 1, indicating higher volatility than the market.

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Neutral Securities (β = 1)

Securities with a beta of 1, moving in sync with the market.

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Defensive Securities (β < 1)

Securities with a beta less than 1, displaying lower volatility than the market.

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Security Characteristics Line (SCL)

The relationship between the expected return of an asset (Ri) and the market return (Rm), with beta as the slope coefficient.

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Expected Return (Ri,t)

The expected return of a stock on a given day, calculated using the index model, which considers the stock's sensitivity to the market (beta) and the expected market return.

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Abnormal Return (ARi,t)

The difference between the actual return of a stock and the expected return calculated using the index model. It represents the impact of specific events or factors affecting the stock.

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Index Model

A statistical method that models the relationship between a stock's return and the overall market return. It helps estimate the expected return of a stock.

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Estimating the Index Model

The process of estimating the parameters of the index model, such as beta and alpha, using historical data.

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Event Window

The period of time during which a significant event is happening and the stock's return is likely to be influenced by the event.

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Cumulative Abnormal Return (CAR)

The cumulative abnormal return (CAR) is the sum of all abnormal returns over a specific period, typically related to an event. It measures the overall impact of an event on a stock's return.

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Variance of the Sample Abnormal Return

The variance of the abnormal return is calculated as the sum of the variance of the error term and the sampling error in estimating alpha and beta. It quantifies the uncertainty associated with the abnormal return.

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Distribution of Abnormal Return

The distribution of the abnormal return is normally distributed with a mean of zero and a variance equal to the variance of the error term plus the sampling error. This means that the abnormal return is expected to fluctuate around zero with a certain level of uncertainty.

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Study Notes

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Description

Test your knowledge on the differences between traditional and alternative investments. This quiz covers key concepts such as liquidity, asset classes, and investment models. Perfect for finance students and professionals looking to enhance their understanding of investment strategies.

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