Asset Allocation

Question 1

Higher transaction cost

Answer 1

Wider corridor

Question 2

Higher risk tolerance

Answer 2

Wider corridor

Question 3

Higher correlation of asset class with rest of the portfolio

Answer 3

Wider the corridor

Question 4

Higher volatility

Answer 4

Narrower the corridor

Question 5

What’s forward rate bias?

Answer 5

Forward rate bias is defined as an observed divergence from interest rate parity conditions under which active investors seek to benefit by borrowing in a lower-yield currency and investing in a higher-yield currency.

Question 6

pretax has more volatility than post tax returns

Answer 6

and hence the lower corridors

Question 7

mean variance optimization

Answer 7

• most common approach to asset allocation
• identifies the portfolio allocations that maximize return for every level of risk

Question 8

criticism of mvo

Answer 8

• GIGO
• Concentrated asset class allocations
• Skewness and kurtosis - in return distribution does not look that much into skewness and kurtosis
• risk diversification
• Ignores liabilities
• single period framework

Question 9

reverse optimization

Answer 9

instead of starting with expected returns and deriving portfolio weights, start with what should be the ideal portfolio weights and drive the expected return consistent with those weights. this use this answer for the traditional MVO

Question 10

black litterman model

Answer 10

extension of the reverse optimisation model where the implied returns (or rather implied excess returns) from a reverse optimization are subsequently adjusted to reflect the investor’s unique views of future returns

Question 11

resampled MVO

Answer 11

resampling can also be used to address the GIGO and highly concentrated issues.

Question 12

absolute contribution to total risk

Answer 12

asset classes contribution to total volatility

Question 13

marginal contribution to total risk

Answer 13

• We can see what happens to the portfolio risk as we change individual allocations
• identify optimal allocations
• develop a risk budget

Question 14

surplus optimization

Answer 14

this is an extension of MVO in which we determine an efficient frontier based on the surplus with its volatility as our measure of risk, stated either in money or percentage terms

Question 15

two portfolio approach

Answer 15

we separate the asset portfolio into 2 sub portfolios: a hedging portfolio and a risk seeking portfolio

Question 16

two portfolio approach

Answer 16

we separate the asset portfolio into 2 sub portfolios: a hedging portfolio and a risk seeking portfolio

Question 17

integrated asset-liability approach

Answer 17

this approach integrates both the assets and the liabilities in a joint optimization method