Investment & Portfolio Management Review

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Questions and Answers

What is the primary goal of investment and portfolio management?

  • To maximize returns without considering risk.
  • To minimize investment costs regardless of financial goals.
  • To make strategic decisions about asset allocation to achieve specific financial goals while managing risk. (correct)
  • To outperform market benchmarks in every investment period.

What fundamental trade-off is central to the concept of risk and return in investing?

  • Risk and return are inversely proportional.
  • Higher potential returns are usually associated with lower risks.
  • Higher potential returns are usually associated with higher risks. (correct)
  • Lower potential returns are usually associated with higher risks.

How does diversification primarily reduce risk in an investment portfolio?

  • By investing in a single asset with high growth potential.
  • By reducing the overall return on investment.
  • By focusing solely on investments within the same industry.
  • By investing in a variety of assets across different sectors. (correct)

Which aspect does Modern Portfolio Theory (MPT) emphasize for optimizing a portfolio?

<p>The importance of diversification in optimizing a portfolio's risk-return profile. (A)</p> Signup and view all the answers

According to the Capital Asset Pricing Model (CAPM), what is the significance of beta?

<p>It measures the volatility of an asset relative to the overall market. (B)</p> Signup and view all the answers

What does the Sharpe Ratio measure in the context of portfolio performance?

<p>Risk-adjusted returns by comparing portfolio returns to a risk-free rate. (A)</p> Signup and view all the answers

What does a positive alpha indicate regarding a portfolio's performance?

<p>The portfolio has outperformed market-adjusted expectations. (D)</p> Signup and view all the answers

What is the primary function of financial products, such as stocks and bonds, in an investment portfolio?

<p>To generate returns for investors. (D)</p> Signup and view all the answers

What distinguishes preferred stocks from common stocks?

<p>Preferred stocks provide fixed dividends with priority over common stocks. (C)</p> Signup and view all the answers

Which of the following is a characteristic of debt instruments like bonds?

<p>Provide fixed-income with less volatile interest. (D)</p> Signup and view all the answers

How do options contracts differ from futures contracts?

<p>Options contracts grant the right, but not the obligation, to buy or sell an asset, while futures contracts obligate the holder. (A)</p> Signup and view all the answers

What is the primary purpose of real estate investments as an alternative investment?

<p>To provide rental income or appreciation. (B)</p> Signup and view all the answers

What is the main function of Mutual Funds?

<p>To engage fund managers to manage portfolio. (C)</p> Signup and view all the answers

Apart from risk reduction, what additional benefit does portfolio diversification offer?

<p>Enhancing potential returns by capitalizing on varied market opportunities. (D)</p> Signup and view all the answers

In the context of calculating beta, what does covariance measure?

<p>The relationship between investment and market. (C)</p> Signup and view all the answers

According to Jensen's alpha, what conclusion can be drawn when the result is positive?

<p>The portfolio has performed effectively. (B)</p> Signup and view all the answers

What is the primary goal of financial analysis?

<p>To understand an organization's financial health and make informed business decisions. (B)</p> Signup and view all the answers

What key information does a balance sheet provide?

<p>Provides a snapshot of an organization's financial position at a specific point in time. (A)</p> Signup and view all the answers

What is the use of income statement?

<p>Reflects revenue, expenses, and net income or loss. (D)</p> Signup and view all the answers

What are the three classifications found in the cash flow statement?

<p>Categorized into operating, investing, and financing activities. (A)</p> Signup and view all the answers

Why is computing of financial ratios important?

<p>To evaluate liquidity, profitability and risk. (B)</p> Signup and view all the answers

What is the use of trend analysis?

<p>To identify patterns or trends over time, useful for forecasting future performance. (A)</p> Signup and view all the answers

Common size analysis reveals

<p>Comparison across companies or periods. (B)</p> Signup and view all the answers

What are accounting principles and standards?

<p>Guidelines and rules that govern financial accounting and reporting. (C)</p> Signup and view all the answers

What ensures consistency, transparency, and comparability of financial information?

<p>Accounting principles and standards. (A)</p> Signup and view all the answers

What are IFRS?

<p>Global Accounting Standards. (B)</p> Signup and view all the answers

What is the PFRS primarily adapted from?

<p>International Financial Reporting Standards (IFRS) (D)</p> Signup and view all the answers

Flashcards

Investment & Portfolio Management

Managing investments strategically to meet specific financial goals while controlling risk.

Risk and Return

The fundamental trade-off where higher potential returns usually involve higher risks.

Diversification

Spreading investments across various assets to reduce the impact of any single asset's performance on the overall portfolio.

Asset Allocation

Distributing investments among different asset classes based on risk tolerance, goals and investment timeline.

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Modern Portfolio Theory (MPT)

Emphasizes diversification to optimize a portfolio's risk-return profile.

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Capital Asset Pricing Model (CAPM)

Explains the link between systematic risk and expected return, mainly for stocks.

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Portfolio Performance

Evaluating the returns of a portfolio relative to its risk and benchmarks.

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Return on Investment(ROI)

Measures investment profitability as a percentage of the initial investment.

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Sharpe Ratio

Assesses risk-adjusted returns by comparing portfolio returns to a risk-free rate.

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Alpha

Indicates the excess return of the portfolio over its benchmark.

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Beta

Measures the portfolio's volatility relative to the overall market.

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Tracking Error

Reflects how closely a portfolio follows its benchmark index.

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Investment Instruments

Financial tools investors use to generate returns.

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Common Stocks

Ownership shares in a company with voting rights.

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Preferred Stocks

Stocks that provide fixed dividends with priority over common stocks.

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Bonds

Fixed-income securities issued by corporations, municipalities or governments.

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Treasury Bills

Short term government securities.

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Certificates of Deposit(CDs)

Time deposits with fixed interest rates

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Options

Contracts granting the right, but not the obligation, to buy/sell an asset at a specified price.

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Futures

Agreements to buy/sell an asset at a future ate at a predetermined price.

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Swaps

Contracts to exchange cash flows or financial instruments.

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Real Estate

Property investments for rental income or appreciation,

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Commodities

Physical goods like gold, oil, or agricultural products.

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Hedge Funds

Pooled funds employing diverse strategies to generate returns.

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Mutual Funds

Pooled investments managed by professionals.

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Exchange-Traded Funds (ETFs)

Funds traded on stock exchanges, tracking specific indices.

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Portfolio Diversification

It reduces risk because it spreads investments across different asset classes.

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Beta

A measure of a stock's volatility, relative to the overall market.

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Positive Alpha(>0)

The portfolio has outperformed the market-adjusted expectations.

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Zero Alpha(=0)

The portfolio has performed in line with market expectations.

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Study Notes

  • Today's review will help recall important concepts and theories, figure out excam strategies, and pass the exam.
  • It's important to be ready to take the comprehensive examination.

Comprehensive Examination Reviewer

  • The Comprehensive Examination Reviewer includes: financial management, banking & financial institutions, financial analysis & reporting, capital market, investment & portfolio management, and monetary policy and central banking.

Investment & Portfolio Management

  • Investment and portfolio management involves making strategic decisions about asset allocation to achieve specific financial goals while managing risk.

Key Concepts

  • Risk and Return are the fundamental trade-off in investing; higher potential returns usually come with higher risks.
  • Diversification is the reduction of risk by investing in a variety of assets, such as stocks, bonds, real estate, and other securities.
  • Asset Allocation involves distributing investments among different asset classes based on risk tolerance, goals, and investment horizon of the investor.

Portfolio Theories

  • Modern Portfolio Theory (MPT), developed by Harry Markowitz, emphasizes the importance of diversification in optimizing a portfolio's risk-return profile.

Capital Asset Pricing Model (CAPM)

  • The Capital Asset Pricing Model (CAPM) explains the relationship between systematic risk and expected return for assets, particularly stocks.
  • The CAPM formula is: E(Ri) = Rf + βi(E(Rm) – Rf)
  • E(R₁) is the expected return on the investment
  • Rf is the risk-free rate
  • B₁ is the beta of the investment
  • E(Rm) is the expected market return

Portfolio Performance

  • Portfolio Performance refers to the process of evaluating returns generated by an investment portfolio relative to its risk and benchmarks.

Key Metrics

  • Return on Investment (ROI) measures profitability as a percentage of the initial investment.
  • Sharpe Ratio assesses risk-adjusted returns by comparing portfolio returns to a risk-free rate.
  • Alpha indicates the excess return of the portfolio over its benchmark.
  • Beta measures the portfolio's volatility relative to the overall market.
  • Tracking Error reflects how closely a portfolio follows its benchmark index.

Investment Instruments

  • Financial products are used by investors to generate returns.

Categories of Equity Instruments

  • Common Stocks are ownership shares in a company with voting rights.
  • Preferred Stocks provide fixed dividends with priority over common stocks.

Categories of Debt Instruments

  • Bonds are fixed-income securities issued by corporations, municipalities, or governments.
  • Treasury Bills are short-term government debt securities.
  • Certificates of Deposit (CDs) are time deposits with fixed interest rates.

Categories of Derivatives

  • Options are contracts granting the right, but not the obligation, to buy/sell an asset at a specified price.
  • Futures are agreements to buy/sell an asset at a future date at a predetermined price.
  • Swaps are contracts to exchange cash flows or financial instruments.

Categories of Alternative Investments

  • Real Estate are Property investments for rental income or appreciation.
  • Commodities are physical goods like gold, oil, or agricultural products.
  • Hedge Funds are pooled funds employing diverse strategies to generate returns.

Categories of Mutual Funds and ETFs

  • Mutual Funds are pooled investments managed by professionals.
  • Exchange-Traded Funds (ETFs) are Funds traded on stock exchanges, tracking specific indices.

Importance of Portfolio Diversification

  • Reduces risk by spreading investments across different asset classes.
  • Enhances potential returns by capitalizing on varied market opportunities.
  • Balances performance fluctuations across assets.

Definition and Calculation of Beta

  • Beta measures a stock's volatility relative to the overall market; it indicates how much the stock's price is expected to change in response to market movements.
  • The formula for Beta is: β = Covariance (Stock, Market) / Variance (Market)
  • Beta = 1: Stock moves with the market.
  • Beta > 1: Stock is more volatile than the market.
  • Beta < 1: Stock is less volatile than the market.

Concept of Jensen's Alpha

  • Jensen's Alpha is a risk-adjusted performance measure that represents the average return on a portfolio or investment above or below the expected return predicted by the Capital Asset Pricing Model (CAPM).
  • Formula: α = Rp - [Rf + β(Rm - Rf)]
  • Rp = Portfolio return
  • Rf = Risk-free rate
  • β = Portfolio beta
  • Rm = Market return
  • Positive Alpha (>0): The portfolio has outperformed the market-adjusted expectations, indicating superior performance by the portfolio manager.
  • Zero Alpha (=0): The portfolio has performed in line with market expectations.
  • Negative Alpha (<0): The portfolio has underperformed relative to market-adjusted expectations, suggesting poor performance.

Financial Analysis & Reporting

  • Financial analysis involves evaluating financial statements to understand an organization's financial health and make informed business decisions.

Key Financial Statements

  • Balance Sheet provides a snapshot of an organization's financial position at a specific point in time and lists assets, liabilities, and equity.
  • Income Statement reflects the company's performance over a period, showing revenue, expenses, and net income or loss.
  • Cash Flow Statement tracks the flow of cash in and out of the business, categorized into operating, investing, and financing activities.

Analysis Techniques

  • Ratio Analysis involves calculating financial ratios to evaluate liquidity (current ratio, quick ratio), profitability (net profit margin, return on assets), and leverage (debt-to-equity ratio).
  • Trend Analysis examines historical data to identify patterns or trends over time, useful for forecasting future performance.
  • Common Size Analysis expresses each item in the financial statements as a percentage of a base figure (e.g., total assets or net sales) to facilitate comparison across companies or periods.
  • Accounting principles and standards are guidelines and rules that govern financial accounting and reporting, ensuring consistency, transparency, and comparability of financial information.

Accounting Standards

  • International Financial Reporting Standards (IFRS): Global accounting standards ensuring transparency and comparability.
  • Generally Accepted Accounting Principles (GAAP): U.S.-based standards focusing on consistency and reliability.
  • Philippine Financial Reporting Standards (PFRS): Adapted from IFRS, applicable in the Philippines.

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