AL 26-27 Flashcards

Question

relative value fixed income arbitrage convertible bond arbitrage

Answer 1

fixed income arbitrage - extract cheap implied volatility by buying undervalued convertible bond and short overvalue common stock. - arbitrage arise from variations/mispricing inve. characteristics: 1. few mispricing opportunities in the U.S due to its highly liquid treasury market 2. significant leverage used 3. high correlations across different securities

Answer 2

pm benefit from long and sell fi securities with different maturity with expectation that the curve will steeper, flatten the opposite position typically are from the same issuer (credit, liquidity, risks are hedged) if not, the issues should be in the same sector

Answer 3

long lower liquidity, off -the-run T bond short higher liquidity, duration, matched on-the-run bond 1/R and credit risks are hedged with liquidity risk remained

Answer 4

= long convertible bond, short equity/ long put option = straight debt +long equity call option - high leverage used - liquidity issue surface for this strategy in 2 ways: 1. naturally less-liquid securities because of their relatively small issue sizes and inherent complexities 2. availability and cost to borrow underlying equity for short-selling

Answer 5

implementation: exploit the fact that the options within convertible instruments usually exhibit low implied volatilities when compared to the historical volatilities of the equities that underline the option 1.short selling the stock owner may subsequently want his shares returned at potentially bad time. 2. credit issue: it complicates valuation. when there's a change in credit spread, mismatch appears in the value of stocks and convertible 3. time decay of call loss money during the periods of reduced realized equity volatility/ or from a compression market implied volatility level 4. extreme market condition it performs best when issuance is high market volatility is moderate and liquidity is ample

Answer 6

seek to profit from investment opportunities - use both fundamental and technical analysis - use systematic and discretionary implementation - take a top-town approach to make macro investments on a global basis across regions, sectors and asset classes. - returns are impacted by market cycle, global developments, and international interactions manager use discretionary process instead use their instinct to detainee when to trade.

Answer 7

focus on a global relationship across a wide range of asset classes and investment instruments -managers typically hold views in relative economic health and central bank policies of different countries, global yield curve relationships, trends in inflation, and relative purchasing power parity and capital trade flow. inv. characteristics - right tail skewness 1. due diligence and close attention is required 2. high use of derivative (use of leverage) 3. key source of returns is from capitalizing on trends in global markets can be directional or thematic

Answer 8

- both fundamental and technical analysis to value markets - use discretionary and systematic modes of implementation. The key source of returns in global macro strategies revolves around correctly discerning and capitalizing on trends in global markets.

Answer 9

demonstrated natural positive skewness that has been useful in balancing negative skewed strategies inv. characteristics 1. uncorrelated return of managed futures with stocks and bonds 2. return profile tends to be cyclical 3. high leverage is embedded in futures contracts high liquidity most traded global and continuously

Answer 10

volatility increase lower the size of contract increase correlation to other ass/futures lower size - price target exist methodology - momentum reversal exist methodology - time based exist methodology - trailing stop-loss exist methodology

Answer 11

PM go long asset that are increase in prices and go short assets that are falling in price -work best when past returns are good predictor of future return

Answer 12

go long those that are increase in price the most and by shorting asset that are decrease the most net zero/market neutral position work well when a market out or underperforming relative to other market is a reliable predictor of its future performance

Answer 13

require high specialized skill sets for trading in niche market

Answer 14

good of relative value volatility arbitrage - to source and buy cheap volatility and sell more expensive volatility while netting out the time decay aspect normally associated with option portfolio inv. characteristics: 1. long volatility position exhibits positive convexity which is useful for hedging purposes 2. option sellers extract steadier returns in normal market environments 3. liquidity varies across different instruments volatility levels tend to go up when equity market fall, with options pricing skew reflecting such a tendency

Answer 15

a secondary market transaction on an insurance policy PM look for the following policy characteristics: 1. the surrender value being offered to an insured individual is relatively low 2. the ongoing premium payments to keep the policy active are also relatively low 3. the probability is relatively high that the designated insured person is indeed likely to die within a certain period of time catastrophe insurance 1. obtain sufficient policy diversity in terms of geographic exposure and type of insurance being offered 2. receive a sufficient buffer in terms of loan loss reserves from the insurance company 3. receive enough premium income

Answer 16

1. build various option strategies, straddle, bull spread, using simple exchange traded options LT has more absolute exposure to volatility ST has more delta sensitivity to change of price 2. build various option using OTC option tenor and X can be customized 3. use VIX futures or options on VIX futures 4. purchase on OCT volatility swap or a variance swap from a creditworthy counterpart

Answer 17

1. creating one's own mix-of managers by investing directly into individual hedge funds running different strategies 2. FOF: involve investing in a style FOF manager who the allocates across a set of individual hedge fund managers running different strategies 3. multi-strategy funds which entails investing in a single fund that includes multiple internal management teams running different strategies under the same roof

Answer 18

aggregate investor's capital and allocate it to a portfolio of separate individual hedge funds following different less correlated strategies - to provide diversification across hedge fund, to make occasional tactical, sector based reallocation decisions to engage in underlying manager selection and due diligence; to perform ongoing pM, risk assessment and consolidated reporting dis adv: - double layer of fees - lack of transparency into individual hedge funds - no performance fees netting - addiontal principal-agent issues inv. characteristics: - serve as entry-point into HF strategy - liquidity FOF require a one-year initial lock-up from investor the greater liquidity afterwards

Answer 19

1. use fund ab plus personal introductions to become familiar with hedge funds avilable for investor 2. choose an appropriate strategies allocation to different hedge fund strategies 3. the manager selection process is initiated using both top-down and bottom-up techniques 4. cash hedge fund strategy, consider a # of candidates following that strategy 5. interview the candidate hedge fund managers 6. review relevant materials such as audit reports 7. examine the funds' personal, operational process and risk mgmt 8. negotiate with individual fund managers for lower fees, improved liquidity 9. ongoing maturity process begins

Answer 20

provide steady low volatility return inv. characteristics adv: - can reallocate capital into different strategy areas more quickly and efficiently than would be possible by the FOF manager - has full transparency and a better picture of the interactions of the different teams’ portfolio risks - react faster to different realtime market impact -less complex fee strategy then FOF GP is responsible for netting risk only investor level incentive fees paid are those due on the total fund performance after netting the poise and negative performance of the various strategy teams

Answer 21

- Tailored to each investor's needs - allows flexibility within defined parameters - enables portfolio managers to tactically allocate between asset classes and to seek the best risk-adjusted credit opportunities throughout market cycles. - generally outperform FOF

Answer 22

equity l/s | event driven

Answer 23

arbitrage managers

Answer 24

opportunistic managers

Answer 25

- allows for the analysis in a specific market environment to determine whether hedge fund strategies are exposed to certain risks under abnormal market conditions. - A conditional model can show whether hedge fund risk exposures to equities that are insignificant during calm periods become significant during turbulent market periods.

Answer 26

alpha skill committed factors random errors

Answer 27

useful for direct linear conditional factor model that avoid multicollinearity problems by avoiding the use of highly correlated risk factors. 1. identify important risk fact 2. calculate pairwise correlation 3. regress the return series excluding one factor resulting in higher adj. r^2

Answer 28

when add 20% allocation to most hedge fund strategy to a traditional portfolio std decrease sharpe ratio increase Sorinto ratio increase max drawdown decrease in approx 1/3 of portfolio

Answer 29

measure risk adjusted performance where risk is defined as std it penalize both upside and downside variability

Answer 30

measures risk adj. performance, where defined as downside deviation realize only downside variability beblow a minimum target return

Answer 31

dedicated short-biased bear market neutral low std systematic futures fof equity market neutral

Answer 32

1. capital growth 2. income generation (ri and real estate) 3. risk diversification (overstated) 4. safety

Answer 33

private equity/vc expected to provide a sufficient return premium due to liquidity risk and heightened structural complexity

Answer 34

PE Return enhancer -return premium due to iliquidity - limited diversification due to strong link between private and public company - use public index to access/ adj. volatility

Answer 35

L/S equity: deliver equity like return with less than full exposure to the equity premium Short-biased: lower overall equity beta while producing some measure of alpha arbitrage event drive: exploit small inefficiencies in at the public market while exhibiting low to no correlation with traditional asset classes - short volatility risk opportunistic: very volatile as stand-alone strategies, provide exposures not otherwise readily accessible in traditional stock and bond strategies

Answer 36

underlying is physical assets with a relatively high degree of correlation with inflation broadly or with a sub-comment of inflation - own commodity as a hedge against a core constituent of inflation

Answer 37

for energy investment rarely take ownership of energy asset

Answer 38

provide protection against unanticipated increase in inflation

Answer 39

involve ownership of FI

Answer 40

required volatility < equity return correlation with equity return is low, yet biased data for the reason below: - appraisal based valuation for private held investment, result in smoothing of reported return - DB: subject to sampling biases, such as survivorship bias and backfire bias which result in downside risk being understated in the reported data - indexes of alternative investment return reflect some degree of diversification because funds in an index may have low correlation of return with each other. Thus the volatility of returns on the index is less than avg. volatility of returns on index comment

Answer 41

faling to achieve a minimum required rate of return bonds have been a more effective volatility mitigator than alternative or ST but in long term, a heavy allocation to bond reduce the prob. of achieving the investment goal

Answer 42

- inflation in low & stable market, the negative equity/bond correlation should lead to highest reduction in volatility limitation: negative stock/bond correlation maybe temporary furthermore, if the bond's exp(r) is low, a heavy allocation to bonds may reduce the prob. of achieving the LT return objective.

Answer 43

- HF would reduce an equity dominated portfolio' overall beta, with higher expected return than bonds, an allocation fo HF would make achieving the LT return target more feasible limitation: although a well-constructed HF portfolio may reduce portfolio volatility and beta, HF often highly managed, levered and individual HF may stuffer significant and permanent losses during turbulent times

Answer 44

involves statistically estimate asset classes sensitives to risk factors adv: - common risk factor identification - integrated risk framework limitation - sensitivity to historical look back period - implementation hurdle involving additional considerations for liquidity planning, manager’s selection, and rebalancing policy pe ~ public equity t private credit ~ hy bond ``` inv. consideration: operational liquidity issue - expense and fee consideration -tax consideration -build vs. buy ```

Answer 45

main strength: - easy to communication - relevant for liquidity management and operational considerations limitation: - over-estimation of portfolio diversification - uncertain primary drivers of risk inv. consideration: - properly defined risk characteristics - establishing return expectations - selection of the appropriate investment vehicle

Answer 46

assets that are not subject to fund's redemption terms are said to be held in a side pocket

Answer 47

max amount may redeem at once

Answer 48

a restriction on redemption during a period of time

Answer 49

appraisal-based valuations often lead to stale/smoothed returns stale pricing increase the serial correlation in reported return series - choose unsmooth the data series - return distribution is not normally distributed with skewness and fat tails - analyst can incorporate non-normality into their analysis - use advanced mathematical models

Answer 50

MVO cannot easily accommodate the characteristics of most alternative investments. MVO characterizes an asset’s risk using standard deviation. Standard deviation, a one-dimensional view of risk, is a poor representation of the risk characteristics of alternative investments for which asset returns may be not normally distributed. MVO typically over-allocates to alternative asset classes, partly because risk is underestimated because of stale or infrequent pricing and the underlying assumption that returns are normally distributed. small change in input led to significant change in optimal asset collation

Answer 51

sensitivity to risk factor exposure, might not be stable outcomes

Answer 52

= rate of contribution * (capital commitment - PIC)

Answer 53

navt-1 *(1+g)*rfd Expected distribution = [Prior-year NAV × (1 + Growth rate)] × (Distribution rate). Expected NAV = [Prior-year NAV × (1 + Growth rate) + Capital contributions – Distributions)] × (1 + Growth rate).

Answer 54

1. more diversification from a more quantitative methodology 2 lower standard deviation due to the removal of general market movement 3. more liquidity since positions are adjusted over shorter time horizon Because of often high leverage, EMN strategies typically do not meet regulatory leverage limits for mutual fund vehicles. So, limited partnerships are the preferred vehicle.

Answer 55

step: shorting the overvalued company purchasing an equal amount of the fair valued company based on historical trends, two stocks should converge in the future, at which time the profit of the strategy would be based on the amount of convergence.

Answer 56

use to self-reported index is - not likely to neutrally reflect the underlying performance of the strategy. Manager with better track records may be more likely to report their returns, which would bias index returns upward. - May also suffer from inconsistent reporting by the component managers over time.

Answer 57

1. short selling substantial losses during short squeeze 2. credit issue when credit spreads widen or narrow, mismatch in the values of the stock and convertible bond positions 3. time decay of call option lost money due to time decay embedded call option 4. extreme market volatility extreme market volatility implies heightened credit risks and face redemption pressure from investors, create left-tail risk.

Answer 58

1. use exchange traded option longer dated option have more exposure to volatility short dated option have more delta sensitivity to price changes 2. OCT options strike prices can be customized 3. VIC futures pure volatility view without constant debt hedging 4. purchase OTC volatility swap or a variance swap from a creditworthy counter-party

Answer 59

represent factors through ranking securities by the factor and buying top quantile securities whilst shorting bottom quantile securities. drawback: portfolios created are not pure factor portfolios since they will have significant exposure to other risk factors outside the factor being modelled.