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CFA Level III > Asset Allocation > Flashcards

Asset Allocation Flashcards

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CFA flashcards
1
Q

Asset Allocation Approaches

A
  1. Asset-Only: manage risk/ return of assets
  2. Liability-Relative: manage assets in relation to liabilities
  3. Goals-Based: manage subportfolios to meet goals
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2
Q

Factor Portfolio

A

isolate systematic risk exposure

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3
Q

Risk Budgeting

A

where/ how much risk to take

  • specify how risk is distributed regardless of expected returns
  • how much additional risk the investor is willing to take relative to benchmark
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4
Q

Rebalancing

A

when to rebalances to benchmark; calendar or percentage-range based

drift corridor width based on

  • transaction costs (+)
  • risk tolerance (+)
  • correlation w/ porfolio (+)
  • volatility of portfolio (-)
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5
Q

Mean Variance Optimization

A
  • approach to determining AA
  • lowest standard deviation for a given level of expected return
  • constraints: budget, no non-neg weights, client constraints
  • find optimal weights: max utility, efficient frontier, min return, max SD
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6
Q

MVO Criticisms

A
  1. GIGO
  2. concentrated AA
  3. diversification
  4. ignores liabilities
  5. single period
  6. ignores skewness/ kurtosis of returns
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7
Q

MVO Improvements

A
  1. reverse opt - derive weights from expected return of global market port
  2. Black-Litterman model - reverse opt adjusted for investor exp
  3. add more constraints
  4. resample MVO - Monte Carlo Sim; less extreme weights, includes all asset classes
  5. include skewness/ kurtosis in utility function; use an asymmetric definition of risk (conditional VAR)
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8
Q

Utility Maximization Equation

A

Um = E(r) - 0.5 * λ * Var

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9
Q

Roy’s Safety First Criterion

A

probability of portfolio exceeing min threshold return (want highest)

SF ratio = [E(RP) - RL ]/ σP

RL = min level of portfolio return

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10
Q

Sharpe Ratio

A

excess return per unit of risk (want highest)

( Rm - Rf )/ σm

ERPm / σm

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11
Q

Illiquid Assets and MVO

A
  1. calc MVO w/o illiquid assets classes, include in portfolio w/ set specific allocations for illiquid assets
  2. calc MVO w/ illiquid assets
  3. calc MVO w/ illiquid asset classes, include in portfolio w/ alt inv indexes
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12
Q

Incorporating Client Risk Pref in AA

A
  1. specifying additional constraints
  2. specifying a risk aversion factor for the investor
  3. monte carlo simulation
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13
Q

Factor-Based AA

A

multi-factor regression to derive return w/ MVO

  • use risk factors instead of asset classes
  • corr btwn factors typically lower than corr btwn asset classes
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14
Q

Contribution to Total Risk

A

MCTR (marginal): βac*σp

ACTR (abs): w*MCTR

opt allocation: excess return/ MCTR for each asset class = portfolio Sharpe Ratio

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15
Q

ALM

A

asset liability management

  1. surplus optimization (pension funds)
  2. hedging/ return-seeking approach (insurance companies, overfunded pensions) > mimics the liabilities it’s funding (fully hedge = conservative)
  3. integrated asset-liability approach (banks)
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16
Q

Strategic AA

A
  • reflects desired systematic risk exp
  • set target weights for portfolio
  • longer-term capital market expectations to inc portfolio value
17
Q

Tactical AA

A

use perceived short-term opportunities in the market to inc portfolio value; inc risk

  • discretionary vs systematic (value or momentum)
18
Q

TAA Performance Evaluation

A
  • compare Sharpe Ratio to SAA
  • compare realized risk/ return to SAA efficient frontier
  • calc info ratio/ t-stat of excess returns relative to SAA
  • attribution analysis to determine excess return
19
Q

Mark to Market

A

PV of any g/l that would be realized if the forward contract was closed early w/ an offsetting contract position

Value = (g or l)/ ( 1 + LIBORn-t )

20
Q

Put Option

A

right to sell the underlying sec if P < X

gains value delta closer to -1, loses value delta closer to 0

21
Q

Call Option

A

right to buy the underlying sec if X < P

gains value delta closer to 1, loses value delta closer to 0

22
Q

Domestic Currency Return

A

RDC = RFC + RFX + RFC*RFX​

RDC = ( EV - BV )/ BV

23
Q

Domestic Currency Risk

A

σ2RC = σ2RC​ + σ2RF + 2σRC​σRFρ(RFC,RFX)

corr = pos = inc volatility of returns

coor = neg = dec volatility of returns

24
Q

Currency Management Strategies

A
  1. passive hedging: benchmark
  2. discretionary hedging: benchmark w/ slight deviation
  3. active curr management: greater deviation from benchmark
  4. currency overlay: seperate manager for currency
25
Q

Influences on Whether to Fully Hedge Currency Position

A
  1. time horizon
  2. risk aversion
  3. liquidity needs
  4. FX bond exposure
  5. hedging costs
  6. opportunity costs
26
Q

Economic Fundamentals

A

assumes LT currency value will converge w/ fair value

inc value of currency

  1. undervalued relative to FV
  2. inc in FV
  3. higher real or nom int rates
  4. lower inflation
  5. dec risk premium
27
Q

Technical Analysis

A
  1. past price data can predict future
  2. patterns repeat: overbought/ sold reverse, support/ resistance levels, moving avg
  3. don’t need to know value of currency, just where it will trade
28
Q

Carry Trade

A

borrow lower int rate currency (developed), invest proceeds in higher int rate currency (developing)

RISK: higher int rate durrency depreciates by more than the diff in spot rates

29
Q

Covered Interest Rate Parity

A

F = S ( 1 + ip )/ ( 1 + ib ​)

30
Q

Volatility Trading

A

profit from changes in volatility

expect inc volatility: long straddle (call, put in the money), long strangle (call, put out of the money)

31
Q

Vega

A

change in value of option b/c change in volatility of underlying

inc volatility = inc value of options = inc price

32
Q

Roll Yield

A

roll yield = hedged curr return = F/S - 1

hedge = locks in forward price

  • S > F; iB < iP: long B = pos roll yield > yes hedge
  • S < F; iB > iP: long B = neg roll yield > no hedge
33
Q

Hedging

A
  • dynamic - change hege to cover additional exp
    • depens on trans costs, risk aversion
  • discretionary - imperfect hedge uj
  • hedge long curr exp = sell forward
34
Q

Hedging Types

A
  1. cross hedge: hedge w/ proxy deriv (not perfectly corr)
  2. macro hedge: hedge portfolio w/ deriv based on basket of curr
  3. MVHR: min var hedge ratio: reg to find % to hedge, min volatility of RDC

CFA Level III (12 decks)

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