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maxkelly
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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
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Passive index strategies
- index - mutual fund or etf
- cash plus long equity futures
- cash plus total return equity
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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
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Equity Futures pros and cons
- Pros: low transaction costs; very liquid
- Cons: short term contracts are the most liquid but must be rolled over
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equity swap definition
swap portfolio return for different, desired return; ex. rf of a market neutral with S&P 500
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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
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Three equity investing styles
- value
- growth
- market oriented
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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)
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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
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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
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pairs trade or pairs arbitrage
- manager matches long and short positions with similar stocks (usu same industry)
- market neutral strategy
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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)
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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
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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
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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
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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
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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
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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.
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