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The document contains key financial concepts and formulas related to asset returns, equity valuation, and investment strategies. It discusses topics such as expected and required returns, the dividend discount model, and risk management in investment portfolios. Additionally, it highlights the importance of matching assets to liabilities and the benefits of passive investing.

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3 views

CP1_Revision_Flashcards_Printable_Cleaned

The document contains key financial concepts and formulas related to asset returns, equity valuation, and investment strategies. It discusses topics such as expected and required returns, the dividend discount model, and risk management in investment portfolios. Additionally, it highlights the importance of matching assets to liabilities and the benefits of passive investing.

Uploaded by

Fah Fah
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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CP1 Revision Flashcards

Q: What is the formula for expected return on an asset?

A: Expected return = income yield + expected capital growth

Q: What is the formula for required return on an asset?

A: Required return = real RFR + expected inflation + risk premium

Q: What is the simplified dividend discount model (DDM) formula for equity valuation?

A: V = D1 / (i - g)

Q: What does a negative (expected return - required return) indicate?

A: The asset is expensive / overvalued.

Q: What does an inverted yield curve typically suggest?

A: Market expects a recession and falling interest rates.

Q: What are the three components of the equity risk premium?

A: Default risk, income/capital volatility, low marketability

Q: What is the reverse yield gap formula?

A: GRY - dividend yield = IRP - ERP + g

Q: What is the expected return on a fixed-interest bond?

A: Gross Redemption Yield (GRY)

Q: What is the expected return on equities?

A: Dividend yield + dividend growth

Q: What's the best matching asset for inflation-linked liabilities?

A: Index-linked government bonds (ILBs)


Q: Why is property return riskier than bonds?

A: Voids, poor liquidity, high costs, obsolescence risk

Q: What are the three conditions for immunisation?

A: 1. PV assets = PV liabilities

2. DMT assets = DMT liabilities

3. Convexity assets > Convexity liabilities

Q: What is pure matching?

A: Structuring cash flows to match net liability outgo exactly

Q: What is liability-driven investment (LDI)?

A: Investing in assets that hedge key liability risks (e.g. inflation, interest rate)

Q: What determines a pension scheme's risk appetite?

A: Size of free assets

Q: Why might a life insurer prefer fixed-interest bonds?

A: To match guaranteed benefits and satisfy regulatory requirements

Q: Why are equities suited for with-profits policies?

A: To deliver discretionary bonuses based on performance (PRE)

Q: Why do non-life insurers prefer liquid assets?

A: To meet short-term claims and maintain solvency

Q: What is tracking error?

A: SD of portfolio return vs benchmark -> measures active risk

Q: What's the difference between stock selection and sector selection in active

management?
A: Stock selection: Picking under/over-priced individual assets

Sector selection: Shifting between asset classes

Q: What is mean-variance portfolio theory with liabilities?

A: Minimises surplus volatility for a target return

Q: Why might a stochastic ALM be more useful than deterministic?

A: It measures the probability of meeting objectives across scenarios

Q: Why is passive investing popular?

A: Low cost, less risk of underperformance, tracks benchmark

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