International Capital Markets at TU München | Flashcards & Summaries

Lernmaterialien für International Capital Markets an der TU München

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TESTE DEIN WISSEN

Explain the core problem of international asset pricing: 

Lösung anzeigen
TESTE DEIN WISSEN

Heterogeneous Investors:

  • Deviations from absolute and relative PPP at all times
    • different composition of consumption baskets
    • relative prices of goods

--> Investors from different countries have different purchasing power

  • Investment opportunities are different across countries, because:
    • regulations and restrictions
    • capital control

--> Investors face different investment opportunity sets


Consequence:

  • different setting for portfolio optimisation
  • investors value return from international assets differently
  • investors evaluate cross section of internationally traded assets differently 


Lösung ausblenden
TESTE DEIN WISSEN

Comment on critical assumptions and the practicability of the base-line ICAPM: 

Lösung anzeigen
TESTE DEIN WISSEN

Critical assumption:

  • inflation rate changes do not systematically affect the cross-section of asset returns


Practicability:

  • If covariance between inflation rate changes and asset return is small --> formula can be used as approximation

--> strong and unrealistic assumption


Model does not adequately fit reality because:

  • investors in different countries dont have same preferences
  • Transportation costs, taxes, tariffs, etc. cause difference in structure of relative prices across countries
  • prices change differently over time across countries 

--> no reason for PPP to hold

Lösung ausblenden
TESTE DEIN WISSEN

Explain the priced sources of risk in the Adler-Dumas model and the determinants of expected returns in equilibrium 

Lösung anzeigen
TESTE DEIN WISSEN

Priced sources of risk:

  • World market risk and inflations risk


Determinants of expected returns in equilibrium:

  • Asset hedging potential in each country
  • Investors willingness to pay for hedging in each country


Lösung ausblenden
TESTE DEIN WISSEN

Explain the three forms of market efficiency

Lösung anzeigen
TESTE DEIN WISSEN
  1. Weak form efficiency:
    • security prices fully reflect all information in past prices
    • increase returns through fundamental analysis (not technical)
    • no prediction of future prices by using past ones
  2. Semi-Strong form efficiency:
    • security prices fully reflect all publicly available information
    • increase returns through use of insider information
    • markets are at least semi-strong
  3. Strong form efficiency
    • security prices fully reflect all publicly available information and insider information
    • impossible to achieve higher returns (--> Passive investments way to go)
Lösung ausblenden
TESTE DEIN WISSEN

Name three major fields for harvesting risk premiums?

Lösung anzeigen
TESTE DEIN WISSEN
  1. Asset premiums (currencies, FI, Equity)
  2. Style premiums (momentum, value, size, high-yield spreads, TERM spread, credit spreads)
  3. strategy premiums (momentum, value, carry trading, merger arbitrage, convertible arbitrage)
Lösung ausblenden
TESTE DEIN WISSEN

Name three economically motivated investment styles? 

Lösung anzeigen
TESTE DEIN WISSEN
  1. Value investing --> risk premiums + overreaction
    • buying cheap securities
  2. Quality investing --> slow price adjustment
    • buying high quality stocks
  3. Low-risk investments --> leverage risk premium
    • buying safe stocks and using leverage
  4. Carry trading --> risk premiums + frictions
    • buying stocks with high carry
  5. Liquidity Investing --> liquidity risk premiums
    • buying stocks with high liquidity risk
  6. Trend-following investing --> initial under-reaction + delayed overreaction 
    • buying already increasing stocks
Lösung ausblenden
TESTE DEIN WISSEN

Briefly explain the concept of adaptive markets

Lösung anzeigen
TESTE DEIN WISSEN
  • people are neither rational nor irrational but rather biological entities who's behaviour and features are shaped by the forces of evolution
  • subject to behavioral biases and make suboptimal decisions but can learn from past and negative feedback to adapt heuristics
  • people have capacity for abstract thinking (forward-looking what if analysis)
  • financial markets are driven by our interactions
  • survival is the ultimate force driving competition, innovation and adaptation
Lösung ausblenden
TESTE DEIN WISSEN

What is the typical correlation between stocks and bonds measured over long periods of time (approximate value)? 

Lösung anzeigen
TESTE DEIN WISSEN
  • it is positive and from 1900-2010 it is 0.24
  • over last 30 years it is negative
Lösung ausblenden
TESTE DEIN WISSEN

The correlation between stock and bond returns fluctuates over time: What is the fundamental explanation of a negative correlation? What is the fundamental explanation of a positive correlation? 

Lösung anzeigen
TESTE DEIN WISSEN

negative

  • times of high risk aversion (e.g. crisis) --> bonds and stocks less correlated because investors sell stocks and flee to bonds


positive

  • high inflation increases correlation between bonds and stocks (consumption today)
Lösung ausblenden
TESTE DEIN WISSEN

Explain the typical relationship between the volatilities on two stock markets and the correlation between the markets 

Lösung anzeigen
TESTE DEIN WISSEN

Empirical Evidence:

  • Stock market volatility is higher when markets go down
  • in periods of high volatility --> stock markets more correlated (vice versa)
  • high correlations observed when equity markets go down simultaneously and when real economic activity is shrinking
Lösung ausblenden
TESTE DEIN WISSEN

Volatilities and correlations between markets vary over time: briefly explain the stylized empirical facts and the implications for investors: 

Lösung anzeigen
TESTE DEIN WISSEN

Implications for investors:

  • optimal portfolios are unstable because market parameters are time varying
  • bad news lead to higher volatility than good news
  • international diversification benefits seem to vanish in those market environments where they are most needed 
  • widely used portfolio risk measurements such as VaR or shortfall are affected by asymmetric parameters
Lösung ausblenden
TESTE DEIN WISSEN

What is roughly the long-term equity risk premium in accordance with the study of Dimson, Marsh and Staunton? 

Lösung anzeigen
TESTE DEIN WISSEN
  • 3,8% "world market" 1900-2010 (2000-2010 on most markets negative)
  • returns between 2,5 - 7,4% (world market 5,5%)
Lösung ausblenden
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Q:

Explain the core problem of international asset pricing: 

A:

Heterogeneous Investors:

  • Deviations from absolute and relative PPP at all times
    • different composition of consumption baskets
    • relative prices of goods

--> Investors from different countries have different purchasing power

  • Investment opportunities are different across countries, because:
    • regulations and restrictions
    • capital control

--> Investors face different investment opportunity sets


Consequence:

  • different setting for portfolio optimisation
  • investors value return from international assets differently
  • investors evaluate cross section of internationally traded assets differently 


Q:

Comment on critical assumptions and the practicability of the base-line ICAPM: 

A:

Critical assumption:

  • inflation rate changes do not systematically affect the cross-section of asset returns


Practicability:

  • If covariance between inflation rate changes and asset return is small --> formula can be used as approximation

--> strong and unrealistic assumption


Model does not adequately fit reality because:

  • investors in different countries dont have same preferences
  • Transportation costs, taxes, tariffs, etc. cause difference in structure of relative prices across countries
  • prices change differently over time across countries 

--> no reason for PPP to hold

Q:

Explain the priced sources of risk in the Adler-Dumas model and the determinants of expected returns in equilibrium 

A:

Priced sources of risk:

  • World market risk and inflations risk


Determinants of expected returns in equilibrium:

  • Asset hedging potential in each country
  • Investors willingness to pay for hedging in each country


Q:

Explain the three forms of market efficiency

A:
  1. Weak form efficiency:
    • security prices fully reflect all information in past prices
    • increase returns through fundamental analysis (not technical)
    • no prediction of future prices by using past ones
  2. Semi-Strong form efficiency:
    • security prices fully reflect all publicly available information
    • increase returns through use of insider information
    • markets are at least semi-strong
  3. Strong form efficiency
    • security prices fully reflect all publicly available information and insider information
    • impossible to achieve higher returns (--> Passive investments way to go)
Q:

Name three major fields for harvesting risk premiums?

A:
  1. Asset premiums (currencies, FI, Equity)
  2. Style premiums (momentum, value, size, high-yield spreads, TERM spread, credit spreads)
  3. strategy premiums (momentum, value, carry trading, merger arbitrage, convertible arbitrage)
Mehr Karteikarten anzeigen
Q:

Name three economically motivated investment styles? 

A:
  1. Value investing --> risk premiums + overreaction
    • buying cheap securities
  2. Quality investing --> slow price adjustment
    • buying high quality stocks
  3. Low-risk investments --> leverage risk premium
    • buying safe stocks and using leverage
  4. Carry trading --> risk premiums + frictions
    • buying stocks with high carry
  5. Liquidity Investing --> liquidity risk premiums
    • buying stocks with high liquidity risk
  6. Trend-following investing --> initial under-reaction + delayed overreaction 
    • buying already increasing stocks
Q:

Briefly explain the concept of adaptive markets

A:
  • people are neither rational nor irrational but rather biological entities who's behaviour and features are shaped by the forces of evolution
  • subject to behavioral biases and make suboptimal decisions but can learn from past and negative feedback to adapt heuristics
  • people have capacity for abstract thinking (forward-looking what if analysis)
  • financial markets are driven by our interactions
  • survival is the ultimate force driving competition, innovation and adaptation
Q:

What is the typical correlation between stocks and bonds measured over long periods of time (approximate value)? 

A:
  • it is positive and from 1900-2010 it is 0.24
  • over last 30 years it is negative
Q:

The correlation between stock and bond returns fluctuates over time: What is the fundamental explanation of a negative correlation? What is the fundamental explanation of a positive correlation? 

A:

negative

  • times of high risk aversion (e.g. crisis) --> bonds and stocks less correlated because investors sell stocks and flee to bonds


positive

  • high inflation increases correlation between bonds and stocks (consumption today)
Q:

Explain the typical relationship between the volatilities on two stock markets and the correlation between the markets 

A:

Empirical Evidence:

  • Stock market volatility is higher when markets go down
  • in periods of high volatility --> stock markets more correlated (vice versa)
  • high correlations observed when equity markets go down simultaneously and when real economic activity is shrinking
Q:

Volatilities and correlations between markets vary over time: briefly explain the stylized empirical facts and the implications for investors: 

A:

Implications for investors:

  • optimal portfolios are unstable because market parameters are time varying
  • bad news lead to higher volatility than good news
  • international diversification benefits seem to vanish in those market environments where they are most needed 
  • widely used portfolio risk measurements such as VaR or shortfall are affected by asymmetric parameters
Q:

What is roughly the long-term equity risk premium in accordance with the study of Dimson, Marsh and Staunton? 

A:
  • 3,8% "world market" 1900-2010 (2000-2010 on most markets negative)
  • returns between 2,5 - 7,4% (world market 5,5%)
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