Owner: Sharpe Investing URL:http://investingandfinanceinformation.blogspot.com/ Join Date: Wed, 13 Jun 2007 00:57:49 -0500 Rating:0 Site Description: Building a foundation for the future by studying quality information is key to success in any field. This site is devoted to organizing and posting quality information gathered from online and traditional study of finance and investing. Site statistics:Click here
Introduction to Financial Derivatives 2007-06-11 19:23:00 "By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives. These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it - a process that has undoubtedly improved national productivity growth and standards of living." -Alan GreenspanFinancial
derivatives are financial instruments that "derive" value from an underlying item such as an asset or index. The use of derivatives provides exposure to the linked underlying item without necessitating the trade or exchange of the item itself. This allows specific risks, such as commodity or equity price fluctuations, to be traded in financial markets. Derivatives
may be traded on exchanges such as the New York Stock Exchange(NYSE) and Chicago Mercantile Exchange(CME). Every derivative has unique features and provisions, and each derivative is used for a special financial purpose.Derivative Uses Read more:Introduction
Sortino Ratio 2007-06-09 01:41:00 The Sortino ratio is a financial ratio, similar to the Sharpe ratio, that measures the risk-adjusted return of investments or portfolios. Unlike the Sharpe ratio, the Sortino uses downside-volatility(sometimes referred to as semi-volatility) as the denominator instead of standard deviation. The use of downside-volatility allows the Sortino ratio to measure the return of "negative" volatility.Downside deviation differentiates "positive" volatility from "negative" volatility, unlike standard deviation. Standard deviation is the square root of volatility. However, using standard deviation as a measure of risk may not be completely accurate. For example, assume investment A has a return of 10% in year one and -10% in year two. Investment B has a 0% return in year one and a 20% return in year two. The total variance in these investments is the same, 20%. However, investment B is obviously more favorable. Because the Sharpe ratio measures risk using standard deviation, the Sharpe ratio does Read more:Ratio
Sharpe Ratio 2007-06-07 18:05:00 The SharpeRatio
is a formula used to measure risk/return. The ratio describes the amount of extra return received for the extra volatility of a more risky asset. The higher the Sharpe Ratio, the greater returns are for each unit of risk. The Sharpe Ratio is calculated by subtracting the risk free rate or return from the return of the portfolio and then dividing by the portfolio's standard deviation. By using the Sharpe Ratio, investors can theoretically compare risk adjusted returns of investments or portfolios that have different returns and risk levels. The higher the ratio is the better.FormulaE = Expected ValueR = Expected Portfolio ReturnRf = Risk Free RateThe numerator of the ratio is the expected return that an asset is expected to provide above the risk free rate.The denominator is the portfolio's standard deviation. Standard deviation is the square root of the variance of the portfolio. Possible outcomes fall within standard deviations. Possible returns are most likely with
Mortgage-Backed Securities 2007-06-06 21:47:00 A Mortgage
-Backed security(MBS) is a debt obligation (bond) that represents claims to the cash flows from pools of mortgage loans. Mortgage providers sell the loans to an Agency or company that packages or pools loans together for sale to investors, creating a MBS. As the loans are paid, the MBS owner receives payments of interest and principle. Because mortgagors are have the option to pay more than the required monthly payment(curtailment) or pay off the loan in its entirety(prepayment)the monthly cash flow is not completely known in advance, increasing risk. Mortgage-Backed Securities
are purchased at issuance or in the secondary market.Most Mortgage-Backed Securities
are issued by the Government National Mortgage Association (Ginnie Mae), the Federal National Mortgage Association (Fannie Mae), or the Federal Home Loan Mortgage Corporation (Freddie Mac). Ginnie Mae is a U.S. government agency backed by the full faith and credit of the U.S. government. Ginnie Mae guarantees that inve
Irrational Exuberance 2007-06-05 10:58:00 Irrational Exuberance, by Yale economist Robert J. Shiller, details historical indicators of stock market bubbles. The following is a list of these indicators.1. High consumer confidence. (from sources such as the Consumer Confidence Index and the Michigan Consumer Sentiment Index) For example, both indexes peak during the 2000 bubble.2. High PE ratios.When the market reaches PE ratio extremes on the high or low end there is a reversion to the mean. The pattern of market bubbles to be linked with high PE ratios is illustrated by the first graph above. Note the very high PE ratios in the 2000 bubble. To cause PE ratios to return to the average, prices must fall faster than earnings or earnings must rise faster than prices. The trend in S&P 500 price and PE ratios is an inverse relationship. The graph above illustrates that periods of low S&P PE ratio were followed by periods of greater price increase than periods with high S&P PE ratios.3. Increasingly optimistic analyst forecasts.4. I Read more:Irrational
Warren Buffet CNBC Interview 2007-06-04 23:31:00 Warren Buffet
is considered the most successful investor. Studying the methods, ideology, and background of this great investor is important. CNBC interviewed Buffet in the interesting segment posted below. Buffet's prospective on investing and life are unique and refreshing. Below are the video segments posted on YouTube.com. The first segment is located on top, directly below, followed by the remaining semgments in order. Read more:Warren
, Warren Buffet
, CNBC Interview
Volatility and Risk 2007-06-15 20:55:00 Volatility DefinitionIn finance, volatility is a statistical measurement of up and down asset price fluctuations over time. If an asset has rapid dramatic price swings, volatility will be high. If prices are consistent and rarely change, volatility is low. Volatility can be measured as the annualized standard deviation.Volatility as Measure of RiskVolatility is often used to measure risk. Many common measurements of risk, such as beta, utilize volatility in calculations. It makes sense that an asset that has had huge price swings is more risky than an asset that is not volatile. Upside vs. Downside VolatilityHowever, the actual effectiveness of using volatility as a measurement of risk is questionable. The main imperfection of volatility is that it does not differentiate upside and downside price movements. For example, assume a stock decreased in price from $10 to $2. Also assume that the stock exhibited low volatility before this price decrease. In this example, volatility was lower Read more:Volatility
Fat Tails and Limitations of Normal Distirbutions 2007-06-14 13:26:00 Normal distributions (a bell curve) of asset returns is a key assumption made by many financial models, including the capital asset pricing model(CAPM) and the Black-Scholes option pricing model(BSM). However, actual asset returns may not be so normal.Normal Distributions Overestimate the Improbability of Unlikely Market EventsUsing a normal distribution, events that diverge from the mean by five or more standard deviations, known as a five-sigma event, are very rare and ten-sigma events are nearly impossible. For example, the 1987 market plunge represents a change equalling 22 standard deviations. The odds of such a 22 standard deviation event occurring are 10^50. However, events deemed nearly impossible by models assuming normal asset return distributions are possible in the financial markets and do occur. In fact, there have been multiple fluctuations greater than five standard deviations. Thus, dramatic market swings do occur in a greater frequency than is possible assuming normal Read more:Tails
, Normal
Lessons from Long-Term Capital Management 2007-06-18 21:06:00 BackgroundLong Term Capital Management
(LTCM) was a hedge fund established in 1994 by John Meriwether, a very successful bond trader at Salomon Brothers. At Salomon, Meriwether was one of the first on wall street to hire top academics and professors. Meriwether established a team of academics who applied models based on financial theories to trading. At Salomon, Meriwether's group of geniuses generated amazing returns and demonstrated an unparalleled ability to precisely calculate risk and other market factors. In 1994, Meriwether left Salomon and established LTCM. The partners included two Nobel Price-winning economists, a former vice chairman of the Board of Governors of the Federal Reserve, a professor from Harvard University, and other successful bond traders. This elite group of traders and academics attracted inital investment of about $1.3 billion from many large institutional clients.StrategyThe strategy of LTCM was simple in concept but difficult to implement. LTCM utilized co Read more:Lessons
A Brilliant Financial Plan 2007-06-21 22:17:00 This is just a funny video from Saturday Night Live to break up the more serious finance posts. The video is about an innovative method to stay out of debt.... Read more:Brilliant
, Financial
Securities Lending 2007-06-19 19:40:00 What is SecuritiesLending
?Securities lending is the temporary transfer of securities on a collateralized basis from one party (the lender) to another (the borrower) for a fee. The borrower must return the securities to the lender after an agreed period or on demand. Securities lending allows the lender to earn enhanced returns on securities through finance charges and provides the borrower with many beneficial opportunities. Most securities lending is collateralized using cash, other securities, or a letter of credit. Securities lending also plays a more general beneficial role by increasing market efficiency.Loan FrameworkSecurities lending transactions are more complicated than a simple loan. When a security is loaned, the ownership title transfers from the lender to the borrower. This transfer gives the borrower the shareholder's rights, such as voting rights and rights to dividends or interest payments. However, these coupon or dividend payments are normally transferred back to t
Lessons from Long-Term Capital Management 2007-06-18 21:06:00 BackgroundLong Term Capital Management
(LTCM) was a hedge fund established in 1994 by John Meriwether, a very successful bond trader at Salomon Brothers. At Salomon, Meriwether was one of the first on wall street to hire top academics and professors. Meriwether established a team of academics who applied models based on financial theories to trading. At Salomon, Meriwether's group of geniuses generated amazing returns and demonstrated an unparalleled ability to precisely calculate risk and other market factors. In 1994, Meriwether left Salomon and established LTCM. The partners included two Nobel Price-winning economists, a former vice chairman of the Board of Governors of the Federal Reserve, a professor from Harvard University, and other successful bond traders. This elite group of traders and academics attracted inital investment of about $1.3 billion from many large institutional clients.StrategyThe strategy of LTCM was simple in concept but difficult to implement. LTCM utilized co Read more:Lessons
Volatility and Risk 2007-06-15 20:55:00 Volatility DefinitionIn finance, volatility is a statistical measurement of up and down asset price fluctuations over time. If an asset has rapid dramatic price swings, volatility will be high. If prices are consistent and rarely change, volatility is low. Volatility can be measured as the annualized standard deviation.Volatility as Measure of RiskVolatility is often used to measure risk. Many common measurements of risk, such as beta, utilize volatility in calculations. It makes sense that an asset that has had huge price swings is more risky than an asset that is not volatile. Upside vs. Downside VolatilityHowever, the actual effectiveness of using volatility as a measurement of risk is questionable. The main imperfection of volatility is that it does not differentiate upside and downside price movements. For example, assume a stock decreased in price from $10 to $2. Also assume that the stock exhibited low volatility before this price decrease. In this example, volatility was lower Read more:Volatility
Fat Tails and Limitations of Normal Distirbutions 2007-06-14 13:26:00 Normal distributions (a bell curve) of asset returns is a key assumption made by many financial models, including the capital asset pricing model(CAPM) and the Black-Scholes option pricing model(BSM). However, actual asset returns may not be so normal.Normal Distributions Overestimate the Improbability of Unlikely Market EventsUsing a normal distribution, events that diverge from the mean by five or more standard deviations, known as a five-sigma event, are very rare and ten-sigma events are nearly impossible. For example, the 1987 market plunge represents a change equalling 22 standard deviations. The odds of such a 22 standard deviation event occurring are 10^50. However, events deemed nearly impossible by models assuming normal asset return distributions are possible in the financial markets and do occur. In fact, there have been multiple fluctuations greater than five standard deviations. Thus, dramatic market swings do occur in a greater frequency than is possible assuming normal Read more:Tails
, Normal
Introduction to Financial Derivatives 2007-06-11 19:23:00 "By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives. These instruments enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it - a process that has undoubtedly improved national productivity growth and standards of living." -Alan GreenspanFinancial
derivatives are financial instruments that "derive" value from an underlying item such as an asset or index. The use of derivatives provides exposure to the linked underlying item without necessitating the trade or exchange of the item itself. This allows specific risks, such as commodity or equity price fluctuations, to be traded in financial markets. Derivatives
may be traded on exchanges such as the New York Stock Exchange(NYSE) and Chicago Mercantile Exchange(CME). Every derivative has unique features and provisions, and each derivative is used for a special financial purpose.Derivative Uses Read more:Introduction
Sortino Ratio 2007-06-09 01:41:00 The Sortino ratio is a financial ratio, similar to the Sharpe ratio, that measures the risk-adjusted return of investments or portfolios. Unlike the Sharpe ratio, the Sortino uses downside-volatility(sometimes referred to as semi-volatility) as the denominator instead of standard deviation. The use of downside-volatility allows the Sortino ratio to measure the return of "negative" volatility.Downside deviation differentiates "positive" volatility from "negative" volatility, unlike standard deviation. Standard deviation is the square root of volatility. However, using standard deviation as a measure of risk may not be completely accurate. For example, assume investment A has a return of 10% in year one and -10% in year two. Investment B has a 0% return in year one and a 20% return in year two. The total variance in these investments is the same, 20%. However, investment B is obviously more favorable. Because the Sharpe ratio measures risk using standard deviation, the Sharpe ratio does Read more:Ratio
Sharpe Ratio 2007-06-07 18:05:00 The SharpeRatio
is a formula used to measure risk/return. The ratio describes the amount of extra return received for the extra volatility of a more risky asset. The higher the Sharpe Ratio, the greater returns are for each unit of risk. The Sharpe Ratio is calculated by subtracting the risk free rate or return from the return of the portfolio and then dividing by the portfolio's standard deviation. By using the Sharpe Ratio, investors can theoretically compare risk adjusted returns of investments or portfolios that have different returns and risk levels. The higher the ratio is the better.FormulaE = Expected ValueR = Expected Portfolio ReturnRf = Risk Free RateThe numerator of the ratio is the expected return that an asset is expected to provide above the risk free rate.The denominator is the portfolio's standard deviation. Standard deviation is the square root of the variance of the portfolio. Possible outcomes fall within standard deviations. Possible returns are most likely with
Mortgage-Backed Securities 2007-06-06 21:47:00 A Mortgage
-Backed security(MBS) is a debt obligation (bond) that represents claims to the cash flows from pools of mortgage loans. Mortgage providers sell the loans to an Agency or company that packages or pools loans together for sale to investors, creating a MBS. As the loans are paid, the MBS owner receives payments of interest and principle. Because mortgagors are have the option to pay more than the required monthly payment(curtailment) or pay off the loan in its entirety(prepayment)the monthly cash flow is not completely known in advance, increasing risk. Mortgage-Backed Securities
are purchased at issuance or in the secondary market.Most Mortgage-Backed Securities
are issued by the Government National Mortgage Association (Ginnie Mae), the Federal National Mortgage Association (Fannie Mae), or the Federal Home Loan Mortgage Corporation (Freddie Mac). Ginnie Mae is a U.S. government agency backed by the full faith and credit of the U.S. government. Ginnie Mae guarantees that inve
Irrational Exuberance 2007-06-05 10:58:00 Irrational Exuberance, by Yale economist Robert J. Shiller, details historical indicators of stock market bubbles. The following is a list of these indicators.1. High consumer confidence. (from sources such as the Consumer Confidence Index and the Michigan Consumer Sentiment Index) For example, both indexes peak during the 2000 bubble.2. High PE ratios.When the market reaches PE ratio extremes on the high or low end there is a reversion to the mean. The pattern of market bubbles to be linked with high PE ratios is illustrated by the first graph above. Note the very high PE ratios in the 2000 bubble. To cause PE ratios to return to the average, prices must fall faster than earnings or earnings must rise faster than prices. The trend in S&P 500 price and PE ratios is an inverse relationship. The graph above illustrates that periods of low S&P PE ratio were followed by periods of greater price increase than periods with high S&P PE ratios.3. Increasingly optimistic analyst forecasts.4. I Read more:Irrational
Warren Buffet CNBC Interview 2007-06-04 23:31:00 Warren Buffet
is considered the most successful investor. Studying the methods, ideology, and background of this great investor is important. CNBC interviewed Buffet in the interesting segment posted below. Buffet's prospective on investing and life are unique and refreshing. Below are the video segments posted on YouTube.com. The first segment is located on top, directly below, followed by the remaining semgments in order. Read more:Warren
, Warren Buffet
, CNBC Interview
Bogle Cites ETFs' Drawbacks 2007-06-25 00:39:00 John Bogle is the founder of Vanguard, a leading client-owned investment management company. In this video, Bogle explains disadvantages of ETFs in comparison to traditional index funds.
Monkey Business - Investing Lessons from the Investment Banking World 2007-06-24 22:50:00 Monkey BusinessMonkey Business
is considered a must read book for anyone considering an investment banking career. The book is the true story of two graduates from Harvard and Wharton business school. Dreaming of magnificent wealth, elite social status, and power, the two graduates decide to become investment banking associates at Donaldson, Lufkin & Jenrette (DLJ), a prestigious New York investment bank. The associates think they will be making important deals, traveling to exotic locations by private jet, and living an extravagant lifestyle paid for by the company. However, these dreams are quickly destroyed by the realization that investment banking associates will be working 80+ hours per week on somewhat elementary and absurd tasks. Monkey Business presents an uncensored behind the scenes look at the chaotic nature of the Wall Street investment banking world.Monkey Business Investing
CommentaryAlthough Monkey Business is mostly an account of the absurdities of glorified investment Read more:Lessons
, World
Hedge Funds Risks 2007-06-27 20:36:00 This interesting PBS video explains the rise and the risks of hedge funds. The video does a good job of explaining the potential negative impact from the dramatic amount of leverage used by some hedge funds. Also, the video features hedge fund manager and author Nicholas Taleb, who discusses the posibility of black swan events. Read more:Hedge
, Funds
, Risks
, Hedge Funds
Return on Investment 2007-07-05 21:00:00 Return on Investment OverviewIn business, it is often said "it takes money to make money." Return on Investment (ROI) is a profitability ratio that helps measure the performance of this application of money. ROI allows managements' utilization of assets and overall company profitability to be measured. ROI measures the link between profits and the investment required to generate profits.ROI is frequently used by management to measure performance against internal goals, competitors, or a specific industry. Management also utilizes ROI to determine where to allocate future resources based on previous investment's profitability. ROI allows the return of investments generating different amounts of revenue to be compared. For example, an expensive piece of machinery may generate more revenue than a lower cost investment, but that lower cost investment may have a better ROI. ROI allows management to see past revenues, and view the effects of investment expenses on return.In addition to int Read more:Return
Stay the Course: A Critical Lesson for Long Term Investors 2007-07-13 17:52:00 "History shows that in the long run a thoughtfully designed, diversified strategy of "passive" funds typically beats all but a few active managers. It's not easy to structure and maintain such a strategy. It requires some initial research and discipline to stay the course. But it’s much easier than predicting which active managers will randomly beat this approach." - Eugene Fama, Jr., DFA
"Time Read more:Investors
Retirement Calculators Review 2007-07-12 17:58:00 Determining when to retire is a very difficult task. A variety of free retirement calculators are available online that allow users to analyize retirement strategies. However, these retirement calculators are not all built alike. Different retirement calculators require different information that effects the calculation quality.
Key Characteristics of a Good Retirement Calculator
While almost Read more:Calculators
A New Look and A New Mission 2007-07-12 00:23:00 As you can tell, the Sharpe Investing blog now has a new theme. I really like this theme and would be interested to hear any of your comments. I would especially be interested in hearing if you are experiencing any technical difficulties.
This first month of blogging has been very interesting. I have learned a large amount about finance and investing by reading and posting. I have also learned a Read more:Mission
Finance, Investing, and Economics Reading List 2007-07-16 19:44:00 The following are books I have read and am currently reading.
These books focus on a wide variety of finance, investing, and economics topics. I have learned a great deal by reading and studying a variety of information, including many books.
Many of these books are highly recommended by investment professionals and academics. I hope you will learn more by reading and enjoying some these texts.
Read more:Investing
, Economics
, Reading
, Reading List
Recommend Site To A Friend
