Podcast
Questions and Answers
What is required for cash accounts before making a trade?
What is required for cash accounts before making a trade?
- No requirements are needed
- Approval from a financial advisor
- A minimum balance of $1,000
- Funds must be settled in the account (correct)
What does hypothecation allow in margin accounts?
What does hypothecation allow in margin accounts?
- Loaning money without collateral
- Selling shares to increase equity
- Using securities as collateral for loans (correct)
- Using the same security for multiple loans
What is the purpose of Regulation T in trading?
What is the purpose of Regulation T in trading?
- To regulate stock prices
- To encourage higher investments
- To eliminate margin accounts
- To set margin limits for brokers (correct)
When a stock's price declines, which margin requirement must be maintained?
When a stock's price declines, which margin requirement must be maintained?
If your asset is $7,537 and you have a 40% maintenance margin, what minimum equity do you need?
If your asset is $7,537 and you have a 40% maintenance margin, what minimum equity do you need?
What happens to your liability when you sell shares to meet maintenance margin requirements?
What happens to your liability when you sell shares to meet maintenance margin requirements?
What is the risk associated with using a margin account compared to a cash account?
What is the risk associated with using a margin account compared to a cash account?
Which statement correctly describes liquidity in margin trading?
Which statement correctly describes liquidity in margin trading?
What happens to R-squared when a new variable is added to a regression model?
What happens to R-squared when a new variable is added to a regression model?
What is the primary purpose of Adjusted R-squared in regression analysis?
What is the primary purpose of Adjusted R-squared in regression analysis?
What does the Information Ratio measure?
What does the Information Ratio measure?
What risk do we encounter when adding multiple variables to a regression model?
What risk do we encounter when adding multiple variables to a regression model?
What is a common concern regarding Value at Risk (VaR) calculations?
What is a common concern regarding Value at Risk (VaR) calculations?
Why might researchers prefer creating new ratios in finance?
Why might researchers prefer creating new ratios in finance?
What is the purpose of the regularization technique in regression?
What is the purpose of the regularization technique in regression?
In predictive analytics, what does the value Lambda (λ) do?
In predictive analytics, what does the value Lambda (λ) do?
What should be kept in mind when using VaR as a risk measure?
What should be kept in mind when using VaR as a risk measure?
Which statement about risk modeling is true?
Which statement about risk modeling is true?
What do the Fama-French factors include in asset beta calculation?
What do the Fama-French factors include in asset beta calculation?
In the context of market beta, what does 'excess returns' typically refer to?
In the context of market beta, what does 'excess returns' typically refer to?
What is emphasized regarding the use of financial measures?
What is emphasized regarding the use of financial measures?
What should you ensure before including variables in a regression model?
What should you ensure before including variables in a regression model?
What might be a potential flaw in relying solely on a single risk measure?
What might be a potential flaw in relying solely on a single risk measure?
What is the purpose of calculating standard deviations in relation to risk management?
What is the purpose of calculating standard deviations in relation to risk management?
What is the significance of fund managers being ranked against others in the same asset class?
What is the significance of fund managers being ranked against others in the same asset class?
Which of the following is NOT a method of analyzing differences in portfolio performance?
Which of the following is NOT a method of analyzing differences in portfolio performance?
What does Brinson Attribution break down in portfolio performance?
What does Brinson Attribution break down in portfolio performance?
In the context of portfolio management, what factor is considered challenging to conceptualize?
In the context of portfolio management, what factor is considered challenging to conceptualize?
How is the contribution of allocation to portfolio performance calculated?
How is the contribution of allocation to portfolio performance calculated?
What role does investor management play when there is a list of recommended investments?
What role does investor management play when there is a list of recommended investments?
Which component of attribution analysis assesses whether specific securities outperformed their industry?
Which component of attribution analysis assesses whether specific securities outperformed their industry?
Which factor can lead to overestimated portfolio performance due to misjudgment?
Which factor can lead to overestimated portfolio performance due to misjudgment?
What is the result when allocation and selection are considered together in performance analysis?
What is the result when allocation and selection are considered together in performance analysis?
What does a market neutral strategy aim to achieve?
What does a market neutral strategy aim to achieve?
What is the assumption made about alphas in uncorrelated portfolios?
What is the assumption made about alphas in uncorrelated portfolios?
What is implied by the strategy of porting alpha from equity to bond investments?
What is implied by the strategy of porting alpha from equity to bond investments?
What is a key challenge in portfolio construction and execution?
What is a key challenge in portfolio construction and execution?
How should one view the ability to time the markets according to managerial strategies?
How should one view the ability to time the markets according to managerial strategies?
Which of the following describes isolation of alpha in portfolio management?
Which of the following describes isolation of alpha in portfolio management?
What is a potential outcome of combining strategies that are not correlated with each other?
What is a potential outcome of combining strategies that are not correlated with each other?
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Study Notes
Brokerage Accounts
- Cash Accounts: Require settled funds for trading
- Margin Accounts (Reg T): Use securities as collateral for loans, offer higher risk and strict regulations.
- Hypothecation: The practice of using securities as collateral.
Margin Requirements
- Regulation T: Sets margin limits for brokers.
- Initial Margin: Minimum equity percentage required to open a margin position.
- Maintenance Margin: Minimum equity percentage required to maintain a margin position.
- Portfolio Margin: Advanced margin calculation for sophisticated investors often resulting in looser requirements.
Margin Example
- Scenario: Buying 100 shares of NKE without full funds.
- Margin Use: 50% initial margin (50% equity, 50% borrowed from broker).
- Maintenance Margin: Usually 25% but may be higher depending on the broker and security.
- Margin Call: Required when equity dips below maintenance margin, restoring to initial margin or maintenance margin (depending on broker policy).
Overfitting
- Overfitting: Including irrelevant variables in a regression model, leading to higher R-squared but inaccurate results.
- Adjusted R-squared: Adjusts R-squared to account for chance and penalizes for variable size.
- Regularization: Constrains model complexity and prevents overfitting by applying a penalty to coefficients.
- Lambda (λ): Value used in regression to regulate the model's complexity.
Fama-French Model
- Multi-factor model: Expands on traditional beta by adding value and size factors to explain asset returns.
- Value and Size Factors: Variables believed to impact asset returns beyond market beta.
Information Ratio
- Information Ratio: Measures a portfolio's performance relative to a benchmark, considering tracking error.
- Formula: (Portfolio - Index) / Tracking Error
- Potential Issues: May not account for all relevant risk factors or market conditions.
Value at Risk (VaR)
- Risk Management Tool: Estimates potential losses for a portfolio at a given confidence level.
- Standard Deviation and Percentile: Typically calculated using standard deviations and a specific percentile (e.g., 2nd percentile).
- Application: Used by banks and portfolio managers to manage risk and allocate resources.
- VaR Calculation: Utilizes standard deviation of portfolio returns and a chosen percentile (e.g., 2nd percentile).
- VaR Expressing: Often expressed in dollars, representing potential losses at the chosen percentile.
VaR Limitations
- Assumptions: Assumes normal distribution of returns, consistent strategy, and sufficient historical data.
- Market Volatility: May not accurately reflect changes in market volatility or regimes.
- Single Measure: Should not be used in isolation; multiple measures and analysis are crucial.
Performance Attribution
- FP&A (Financial Planning & Analysis): Similar to portfolio attribution, used to analyze performance deviations from forecasts.
- Attribution Analysis: Identifies factors contributing to performance differences.
- Brinson Attribution: Breaks down performance attribution into selection, allocation, and interaction.
- Selection: Outperformance of specific securities within a portfolio.
- Allocation: Outperformance due to overweighting certain industries or asset classes.
- Interaction: The combined effect of selection and allocation.
Hedging and Portfolio Strategies
- Risk-Adjusted Returns: Objective for portfolio managers, seeking to maximize returns while controlling risk.
- Market Timing: Attempting to predict market movements, generally considered unreliable.
- Market Neutral: Strategies aiming for zero market beta, isolating alpha through factor models or shorting the index.
- Factor Investing: Using identified factors (e.g., size, value) to construct market-neutral portfolios with alpha.
Portfolio Construction and Execution
- Theses and Execution: Maintaining strong investment ideas and effectively executing them is critical.
- Investment Horizon: Time required to execute an investment strategy, potentially impacting its effectiveness.
- Alpha Porting: Translating alpha from one asset class to another (e.g., stock alpha to bond portfolio).
Portfolio Construction, Execution, Personal Portfolios
- Portfolio Construction: The art and science of building portfolios designed for specific goals, risk tolerance, and time horizons.
- Portfolio Execution: The act of putting a portfolio plan into action by choosing and investing in specific securities.
- Personal Portfolios: Portfolios created and managed for one's own financial needs, not for clients.
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