Investments Study Guide 1

Investments Study Guide 1 - Top Down vs. Bottom Up...

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Top Down vs. Bottom Up Investment Strategies With a “top-down” investment strategy, you focus on asset allocation or the broad composition of the entire portfolio, which is the major determinant of overall performance. Moreover, top down management is the natural way to establish a portfolio with a level of risk consistent with your risk tolerance. The disadvantage of an exclusive emphasis on top down issues is that you may forfeit the potential high returns that could result from identifying and concentrating in undervalued securities or sectors of the market. With a “bottom-up” investment strategy, you try to benefit from identifying undervalued securities. The disadvantage is that you tend to overlook the overall composition of your portfolio, which may result in a non-diversified portfolio or a portfolio with a risk level inconsistent with your level of risk tolerance. In addition, this technique tends to require more active management, thus generating more transaction costs. Finally, your analysis may be incorrect, in which case you will have fruitlessly expended effort and money attempting to beat a simple buy-and-hold strategy. **Even if an individual shareholder could monitor and improve managers’ performance, and thereby increase the value of the firm, the payoff would be small, since the ownership share in a large corporation would be very small. For example, if you own $10,000 of GM stock and can increase the value of the firm by 5%, a very ambitious goal, you benefit by only: 0.05 × $10,000 = $500. **Ultimately, it is true that real assets do determine the material well being of an economy. Nevertheless, individuals can benefit when financial engineering creates new products that allow them to manage their portfolios of financial assets more efficiently. Because bundling and unbundling creates financial products with new properties and sensitivities to various sources of risk, it allows investors to hedge particular sources of risk more efficiently. The SuperDot system expedites the flow of orders from exchange members to the specialists. It allows members to send computerized orders directly to the floor of the exchange, which allows the nearly simultaneous sale of each stock in a large portfolio. This capability is necessary for program trading. 4 Trends changing the investment environment: 1. Globalization 2. Securitization 3. Financial Engineering 4. Information and Computer Networks Active Management : Attempting to identify mispriced securities or to forecast broad market trends. Arithmetic Average : The sum of returns in each period divided by the number of periods.
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Bank Discount Model : P. 29. Flaws: 1. Based on 360 days 2. Computes the yield as a fraction of par value rather than of the price the investor paid to acquire the bill. Bundling, Unbundling
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Investments Study Guide 1 - Top Down vs. Bottom Up...

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