Portfolio Development and Analysis

Question 1

Fundamental Analysis

Answer 1

• believe that there is an intrinsic value for the overall market and individual securities and that these values depend on underlying company and economic factors.
• the fundamental analyst seeks to determine the intrinsic value by examining the variables that determine value (earnings, cash flows, etc)

Question 2

Top-Down Analysis

Answer 2

• begins with researching the overall economy and current conditions within the secondary market,
• proceed by selecting the industry or industry sector that they believe will generate superior performance over the upcoming time frame.
• finally, they then screen a database of securities to determine within the selected industry to recommend acceptable individual companies and their stock.

Question 3

Bottom-Up Analysis

Answer 3

• beings with the analysis of the company fundamentals
• then they review the industry
• lastly, the economy as a whole

Question 4

Liquidity Ratios

Answer 4

• measure how “liquid” assets are or the speed in which the company can convert its current assets into cash.
• Current Ratio = current assets/current liabilities
• Quick Ratio = current assets-inventory/current liabilities

Question 5

Activity Ratios

Answer 5

• measure how efficient the company is in using its assets to generate sales
• inventory turnover ratio = annual sales/average inventory
• average collection period = annual receivables/sales per day
• fixed asset turnover = annual sales/fixed assets

Question 6

Profitability Ratios

Answer 6

• measure how profitable the company is and, particularly, its monetary return to its owners, the shareholders of the company.
• Operating Profit Margin = EBIT/annual sales
• Net Profit Margin = earnings after taxes/annual sales
• ROA = Earnings after taxes/total assets
• ROE = Earnings after taxes/stockholder equity

Question 7

Technical Analysis

Answer 7

• an attempt by the security analyst to determine the demand for a particular stock or security and, therefore, to predict the direction of its future price.
• based on a belief that studying the history of security trades and security markets will lead to buying opportunities.

Question 8

Technical Analysis Tools

Answer 8

• Charts
• Sentiment Indicators
• Flow of Funds Indicators
• Market Structure Indicators

Question 9

Investment Policy Statement

Answer 9

• summarizes in a written document the investor’s goals, risk tolerance, preferences, time horizon, and other investment constraints
• clarifies the risk/return trade off to investors and documents that this important concept has been discussed in connection with the investor’s expectation of return on the investment portfolio
• creates a structure for making investment decisions and managing the investor’s portfolio
• established a standard of agreed-upon goals and other criteria upon which investment performance can be measured.

Question 10

Proper Performance Technique for evaluating performance

Answer 10

-A time weighted return measurement (such as geometric average) should be used to fairly evaluate the performance of the portfolio manager.

Question 11

Monte Carlo Simulation

Answer 11

• evaluates the chance of an actual return given the occurrence of certain independent conditions or factors.
• it marries probability distributions with scenario analysis, but on a much larger scale

Question 12

Sharpe Ratio

Answer 12

• measures the risk premium of a portfolio per unit of total risk as measured by the portfolio’s standard deviation
• since it uses standard deviation, it implies that the portfolio is not widely diversified
• most appropriately used when evaluating the performance of a smaller, “thinly diversified” or non-diversified portfolio.
• using the standard deviation removes market influence from the analysis, therefore allowing comparisons of non-diversified portfolios and those tracking different benchmarks.

Question 13

Sharpe Ratio Analysis

Answer 13

• a ratio of 1.0 represents “good” compensation per unit of total risk
• a ratio of 2.0 represents “very good” rating
• a ratio of 3.0 or better is “outstanding compensation”
• if the portfolio is fully diversified then it should yield similar results as the treynor index.

Question 14

Treynor Ratio

Answer 14

• a measure of portfolio performance that measures the risk premium of a portfolio per unit of nondiversifiable (systemic) risk, which is measured by the portfolio’s beta
• used with diversified portfolios
• like the sharpe ratio the higher the ratio the better.

Question 15

Jensen Performance Index (alpha)

Answer 15

• an absolute measure of performance and measures how well the managed portfolio performed relative to an unmanaged portfolio of equal risk.
• determines how much the actual or realized return of the portfolio differs from its required return, as specified by the CAPM.
• only takes systemic risk into account, therefore beta is used. This also implies that the portfolio is diversified.

Question 16

Information Ratio

Answer 16

• the ratio of expected return to risk as measured by standard deviation.
• the objective of the ratio is to quantify the amount of incremental risk undertaken by a portfolio manager to achieve an excess return.
• should only be used when alpha is positive or when the portfolio manager has added excess value on a risk-adjusted basis
• the higher the better