2 - Macro

Question 1

TAA vs. SAA

Answer 1

TAA - Tactical Asset Allocation -> focuses on timing assets, like deciding between now equities or cash

SAA - Strategic Asset Allocation -> allocation to different long term asset premiums

Sometimes hard to distinguish, more of a question of horizon.

Question 2

Bonds Credit variance decomposition

Answer 2

Rate Component + Credit component

Rate component = (std(rate) + corr (rate, credit)) / std(portf)

Credit component = (std(credit) + corr (rate, credit)) / std(portf)

Question 3

Difference to account for between foreign equities and foreign bonds

Answer 3

Carry differential index in bonds

Question 4

Strategic Asset Allocation vs. Tactical Asset Allocation

Answer 4

SAA (usual 60-40) vs. TAA (market timing according to expectations)

Question 5

Predicting the Credit Premium

Answer 5

Value and Momentum to forecast Credit Premium. Momentum for continuation of recent trend, Value for reversal back to normal level

Question 6

Credit Premium Momentum what to use

Answer 6

Use average of 12-month corporate bonds excess returns

Question 7

Credit Premium Value what to use

Answer 7

Regression on 3 factors: Leverage (E+D / E), Profitability (Gross Profit / Total Assets) and Volatility. 3 factors measured using 12-month trailing data.

Question 8

Predicting credit premium, signals to create strategy

Answer 8

Carry (credit spread if structure remains unchanged), Momentum and Value (our prediction of Spread)

Question 9

Fair Value vs. Relative Value

Answer 9

Fair Value – should be priced like this, due to its own conditions.

Relative Value – Asset is over/under priced relative to all others, usually done with countries

Question 10

Fair Value Equities model

Answer 10

(1 + DP ratio) x EG x PE ratio return - 1

Question 11

Fair Value Bonds

Answer 11

Linear combination of forward rates (or yields) forecasts bond excess returns at different maturities.

The return-forecasting factor is unrelated to the level, slope, and curvature movements described by most term structure models.

Question 12

Measuring value in different asset classes (equity, commodity, currency and bond)

Answer 12

Country index stock -> aggregate individually by BM ratios (average value-weighted BM among index constituents)

Commodity -> Spot price 5-years ago / Spot price now (Negative of return over last 5 years)

Currency -> Negative of exchange rate return over last 5 years (interest earned on 3-month LIBOR)

Bond country selection -> Real-bond yield = yield on 10y – forecasted inflation next 12 months

Question 13

Simple version of Macro Momentum

Answer 13

1. Pick macro variables – make sure they are not seasonally adjusted and not revised (you want what came out at the time)
2. Lag data to account for announcements
3. Seasonally Adjust
4. Z-score ( x – avg(x) / std(x) )
5. Average all z-scores
6. (Possibly) scale volatility of final signal

Question 14

Challenges to cleaning macro data

Answer 14

1. Revisions (revised data is not the one you had available at the time, now-casting models update forecasts based on new data and historical revisions)
2. Seasonal Adjustments (might be problematic if it’s adjusted with data unavailable at the time)
3. Publication lags
4. Mixed frequencies

Question 15

Monetary policy surprises on equity returns

Answer 15

Returns are abnormally high before and after expansionary surprises (lowering rates). Also, the other way around (only) before contractionary surprises. The effect is concentrated in times of high uncertainty but is constant across industries, markets and asset classes.

Question 16

Carry accross asset classes (currency, equity, commodity, bond)

Answer 16

Currency carry -> Foreign Interest rate

Equity carry -> Dividend yield

Commodity carry -> Convenience yield

Bond carry -> slope (yield at t – rate at t) minus roll down (Mod. Duration x change in yield from t-1 to t)

Credit Slope -> Carry of 10y – Carry of 2y (Bonds)

Question 17

Where does Buffet’s alpha come from

Answer 17

Leveraging up low beta and high profitability stocks.