Comprehensive glossary for Chapter 21 of the CSC® Exam Prep Guide: Volume 2, covering key terms in alternative investments, strategies, and performance.
In this section, we delve into the essential terminology related to alternative investments, strategies, and performance. Understanding these terms is crucial for navigating the complex landscape of alternative investments, particularly within the Canadian financial context. This glossary serves as a reference to enhance your comprehension and application of the concepts discussed in Chapter 21.
Definition: Alpha represents the excess return of an investment relative to the return of a benchmark index. It is a measure of an investment’s performance on a risk-adjusted basis.
Example: If a Canadian equity fund has an alpha of 2%, it means the fund has outperformed its benchmark index by 2% after adjusting for risk.
Definition: Arbitrage involves the simultaneous purchase and sale of an asset to profit from an imbalance in the price. It is a strategy that exploits price differences of identical or similar financial instruments on different markets or in different forms.
Example: A trader might buy shares of a Canadian company on the Toronto Stock Exchange while simultaneously selling them on a U.S. exchange if there’s a price discrepancy.
Definition: Beta is a measure of an investment’s volatility relative to the overall market. A beta greater than 1 indicates that the investment is more volatile than the market, while a beta less than 1 indicates less volatility.
Example: A Canadian mutual fund with a beta of 1.2 is expected to be 20% more volatile than the market.
Definition: Convertible arbitrage is a strategy that involves buying convertible securities and hedging with short positions in the underlying stock. The goal is to exploit pricing inefficiencies between the convertible security and the stock.
Example: An investor might purchase a convertible bond issued by a Canadian company and short the company’s stock to capitalize on pricing discrepancies.
Definition: A convertible bond is a bond that the holder can convert into a specified number of the issuing company’s shares. This feature provides the bondholder with the potential to participate in the equity upside.
Example: A Canadian company issues a convertible bond that allows investors to convert the bond into shares at a predetermined price.
Definition: Credit arbitrage strategies seek to profit from pricing inefficiencies in fixed-income securities. These strategies often involve taking long and short positions in bonds to exploit differences in credit spreads.
Example: An investor might take a long position in a Canadian corporate bond and a short position in a government bond to profit from changes in credit spreads.
Definition: Distressed securities are the securities of companies that are in or near bankruptcy. Investors in distressed securities aim to profit from the potential recovery of the company.
Example: A hedge fund might invest in the bonds of a Canadian company undergoing restructuring, anticipating a turnaround.
Definition: Drawdown refers to a peak-to-trough decline in the value of an investment portfolio. It is a measure of downside risk over a specific period.
Example: A Canadian investor experiences a drawdown when their portfolio value decreases from $100,000 to $80,000.
Definition: The efficient frontier is a concept in modern portfolio theory representing the set of optimal portfolios offering the highest expected return for a defined level of risk.
Example: A Canadian financial advisor constructs a portfolio that lies on the efficient frontier, balancing risk and return for their client.
Definition: An equity market-neutral strategy is an investment strategy that attempts to eliminate some forms of market risk by taking offsetting long and short positions in stocks.
Example: A Canadian hedge fund employs an equity market-neutral strategy by going long on undervalued Canadian stocks and short on overvalued ones.
Definition: Jensen’s Alpha is a risk-adjusted performance measure that represents the excess return of a portfolio over its expected return based on the Capital Asset Pricing Model (CAPM).
Example: A Canadian pension fund calculates Jensen’s Alpha to evaluate the performance of its portfolio manager.
Definition: Kurtosis is a statistical measure describing the distribution of data points in the tails. High kurtosis indicates more data in the tails, suggesting potential for extreme outcomes.
Example: A Canadian investment analyst examines the kurtosis of a stock’s return distribution to assess the likelihood of extreme price movements.
Definition: A long/short equity strategy involves buying undervalued stocks while selling overvalued stocks. This strategy aims to profit from both rising and falling stock prices.
Example: A Canadian hedge fund manager implements a long/short equity strategy by buying shares of a promising tech startup and shorting shares of an overvalued retail chain.
Definition: Liquidity decay refers to the reduction in returns of a leveraged ETF over time due to daily rebalancing in volatile markets.
Example: A Canadian investor notices liquidity decay in their leveraged ETF investment during a period of high market volatility.
Definition: A managed futures strategy involves trading futures contracts to capitalize on price trends. This strategy is often used by hedge funds to diversify portfolios.
Example: A Canadian hedge fund uses a managed futures strategy to profit from trends in commodity prices.
Definition: Maximum drawdown is the largest peak-to-trough decline in a portfolio’s value during a specific period. It is a key risk metric for assessing investment performance.
Example: A Canadian mutual fund reports a maximum drawdown of 15% during a market downturn.
Definition: Merger arbitrage, also known as risk arbitrage, involves taking opposing positions in the stocks of companies involved in a merger. The strategy aims to profit from the spread between the acquisition price and the current market price.
Example: An investor engages in merger arbitrage by buying shares of a Canadian company being acquired and shorting shares of the acquiring company.
Definition: Skew is a measure of the asymmetry of the probability distribution of returns. Positive skew indicates a distribution with frequent small losses and a few large gains, while negative skew indicates the opposite.
Example: A Canadian portfolio manager analyzes the skew of their investment returns to understand the risk of extreme losses.
Definition: The Sortino Ratio is a variation of the Sharpe ratio that only considers downside risk. It measures the risk-adjusted return of an investment, focusing on negative volatility.
Example: A Canadian investor uses the Sortino Ratio to evaluate the performance of a mutual fund, emphasizing downside protection.
Definition: The Sterling Ratio is a risk-adjusted performance measure comparing excess return to maximum drawdown. It helps investors assess the efficiency of an investment strategy.
Example: A Canadian hedge fund manager calculates the Sterling Ratio to demonstrate the effectiveness of their investment approach.
Definition: Trend-following is an investment strategy that aims to capitalize on the continuation of existing market trends. It involves buying assets that are rising and selling those that are falling.
Example: A Canadian trader employs a trend-following strategy by investing in stocks with upward momentum.
Definition: Variable leverage refers to the use of borrowed capital to increase the potential return of an investment. It involves adjusting leverage based on market conditions.
Example: A Canadian investor uses variable leverage to enhance returns on their equity portfolio during a bull market.
Definition: Volatility decay is the loss of value in a leveraged ETF over time due to the compounding of daily returns. It is a risk factor for investors in volatile markets.
Example: A Canadian investor experiences volatility decay in their leveraged ETF during a period of market turbulence.
To further explore these concepts and enhance your understanding of alternative investments, consider the following resources:
Websites:
Books:
These resources provide valuable insights into the terminology and strategies used in the field of alternative investments, offering a deeper understanding of the Canadian financial landscape.
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This glossary and accompanying quiz are designed to solidify your understanding of key concepts in alternative investments, equipping you with the knowledge needed to navigate this dynamic field effectively.