ASSET ALLOCATION Flashcards
18.a: Explain the function of strategic asset allocation in portfolio
management and discuss its role in relation to specifying and controlling the
investor’s exposures to systematic risk.
Strategic asset allocation combines capital market expectations (expected return,
standard deviation, and correlation) with the investor’s risk, return, and investment
constraints (from the IPS).
18.b: Compare strategic and tactical asset allocation.
Tactical asset allocation is the result of active management wherein managers deviate
from the strategic asset allocation to take advantage of any perceived short-term
opportunities in the market.
18.c: Discuss the importance of asset allocation for portfolio performance.
Asset allocation is performed as two distinct processes: (1) strategic and (2) tactical asset
allocation. The first, strategic allocation, responds to the interaction of the investor’s
long-term strategic (policy) needs and long-run capital market expectations.
18.d: Contrast the asset-only and asset/liability management (ALM) approaches to asset allocation and discuss the investor circumstances in which they are commonly used.
In asset-only strategic asset allocation, the focus is on earning the highest level of return
for a given (acceptable) level of risk without any consideration for liability modeling.
18.e: Explain the advantage of dynamic over static asset allocation and
discuss the trade-offs of complexity and cost.
Dynamic asset allocation takes a multi-period view of the investment horizon.
it recognizes that asset (and liability) performance in one period affects the required rate of return and acceptable level of risk for subsequent periods.
18.g: Evaluate return and risk objectives in relation to strategic asset
allocation.
loss aversion makes investors focus on gains and losses rather than risk and return as prescribed by modern portfolio theory.
18.g: Evaluate return and risk objectives in relation to strategic asset allocation.
Roy’s Safety-First Measure is one of the oldest and most cited measures of downside risk. The measure is stated as a ratio of excess return to risk:
Up = Rp -0.005(A)( Sigma)^2
Shortfall risk is the risk of exceeding a maximum
acceptable dollar loss.
Semivariance is the bottom half of the variance (i.e., the variance calculated using only the returns below the expected return).
Target semivariance is the semivariance using some target minimum return, such as zero.
**Roy’s Safety-First Measure is stated as a ratio of excess return to risk: **
18.h: Evaluate whether an asset class or set of asset classes has been appropriately specified.
asset classes have been appropriately specified if:
- Assets in the class are similar from a descriptive as well as a statistical perspective.
- They are not highly correlated so they provide the desired diversification.
- Individual assets cannot be classified into more than one class.
- They cover the majority of all possible investable assets.
- They contain a sufficiently large percentage of liquid assets.
18.j: Evaluate the theoretical and practical effects of including additional
asset classes in an asset allocation.
18.k: Demonstrate the application of mean-variance analysis to decide whether to include an additional asset class in an existing portfolio.
Mean-variance analysis assumes asset classes can be analyzed and described by expected
return, standard deviation, and correlation.
18.l: Describe risk, cost, and opportunities associated with nondomestic equities and bonds.
The correlation of LMR and LCR is generally less than + 1.0.
The mean-variance frontier is the outer edge of a
graphical plot of all possible combinations of risky assets
MVO identifies at each level of return the portfolio with the lowest standard deviation
and the asset allocation for that portfolio.
The capital allocation line is the staight line drawn from market portfolio ( tangency portfolio) to risk free rate.
If Investor required rate of return is higher than tangency protfolio he borrows from the risk free rate.
