Asset Management Flashcards
5-year interest rates go down by 2% - how much is the drop in %?
Value of position in 5-yr. notes would go down by about 2% * 4 year duration (of 5 year bonds) = 8%
Sharpe ratio formula
Beta anomaly from data in the real world:
cross-sectional vs time series predictability - and what is the Beta anomaly?
- Beta anomaly: Cross-sectional
- Cross-sectional predictability involves analyzing and making predictions across different entities at a single point in time. This method examines differences between units (like stocks, individuals, or companies) at the same moment.
- Time-series predictability involves analyzing and making predictions based on data collected from the same entity over multiple time periods. This method focuses on the temporal sequence of data points.
Low beta: Data snooping?
What is Berkshire Hathaway’s ratio of leverage to equity and where does the leverage come from?
- equals 1.6
- 40% of debt comes from insurance float whose annual cost is 3% below the T-bill rate
factor regression (with b the factor loading)
3-factor FF model statistical significance
Fund flows chase…
…past performance
Mispricing: Can behavioral biases explain momentum?
Disposition effect - Mispricing: Price reaction to good news (and other way around for bad news)
What happens with momentum strategies during market crashes?
- Perform very poorly
- When markets are down, momentum is likely to be long low-beta stocks and short high-beta stocks
- The long-short portfolio, in turn, has a very low beta and rebounds much less than the marke
Manual correction for t-stats
P-hacking
Data dredging (also known as data snooping or p-hacking) is the misuse of data analysis to find patterns in data that can be presented as statistically significant, thus dramatically increasing and understating the risk of false positives.
The balance of the bank’s account at the Federal Reserve bank is called:
Federal Funds
Main monetary policy tools
Taylor rule
Repurchase agreement:
- Fed Reserve buys a security (e.g. Treasuries) from a primary dealer and agrees to sell it back within 1 to 7 days.
- The amount of money/credit in the economy increases
- Easier to borrow, the interest rate goes down
- Doing repo = “borrowing liquidity from Fed”
Reverse repo:
- Federal Reserve lends a security (e.g. Treasuries) to a primary dealer and agrees to buy it back within 1 to 7 days.
- The amount of money/credit in the economy decreases
- It becomes more difficult to borrow, the interest rate goes up.
- Doing reverse repo = “Fed borrows liquidity from the market”
turns around FOMC announcements: S&P500 & International evidence
Misclassification of credit quality of funds
- On average, 30% of high and medium credit quality funds are misclassified
- Some funds report 100% of assets in AAA and hold essentially 0
- Misclassified funds have higher risk. They misreport specifically to make it appear that they have safer holdings and then are re-classified based on this into “overly safe” peer groups.
- Misclassified funds have significantly higher returns than the correctly reported funds in their official MS categories
R-squared: How much does the manager deviate from the benchmark.
The standard deviation of e is often referred to as…
tracking error
Information ratio:
Decomposing returns: Policy vs. Timing vs. Selectivity
What is an appropriate IRR for PE, according to research?
Ways to manipulate IRR
Implementation shortfall is the difference between the pre-cost paper return on a simulated strategy and the actual realized return - It consists of the following components:
Benchmark considerations: Window dressing - what is it and why is it bad?
Before publishing the report, the fund may do some window dressing to look better: it sells losers and buys winners.
Flow-performance relationship is nonlinear:
Measuring risk shifting
Two types of arbitrage:
- Riskless arbitrage: Zero cost upfront and future cash flows are non-negative.
- Risky arbitrage: Zero cost upfront and small probability of negative future cash flows
How is a negative value on the asset side to balance BS based on market values called?
Plug / Stub value
Shareholders of Creative (10.24 million shares outstanding) own 7.33 million shares in Ubid (9.15 total – 1.82 issued in IPO to public); So, each share of Creative entitles you to:
7.33/10.24 = 0.72 shares in Ubid
There were two important frictions that restricted arbitrage capital from flowing freely:
- Short sales constraints: Arbitrageur must locate shares for shorting
- Funding constraints: Arbitrageurs may have to liquidate or post additional capital when prices diverge
Merger arbitrage, like hedge fund returns in general, have time-varying market beta - example with merger arbitrage
Paul Tudor Jones II: One of my No. 1 rules as an investor is as soon as … (not relevant)
- I find out that [a] manager is going through divorce, I redeem immediately. Because the emotional distraction that comes from divorce is so overwhelming. … You can automatically subtract 10 to 20 percent from any manager if he is going through divorce.
- Marriages and divorces are associated with lower fund alpha, during the six-month period surrounding and the two-year period after the event.
- Worse, when you’re trading solo or manage several funds
- Load more on the index, and produce larger disposition effect
Hedge fund returns (just general interesting information)
Portfolio rebalancing effects could be massive! Quant Meltdown in 2007: Interesting quotes…
Funding constraints may lead to liquidity spirals:
When prices start decreasing:
1. Margin requirements increase
2. Capital gets moved away (redemptions / internal capital reallocation)
3. Risk management tightens (stop loss orders)
Slow moving capital - effects:
- If capital does not move quickly, the case for mispricing and inefficient markets is much stronger
- Mispricing is more likely when capital is constrained. Unconstrained investors, on the other hand, can benefit from these mispricings
- Thinking about why capital is not moving and when it is likely to start moving helps to predict returns
Carry Trade
You observe a time series of independent log-returns on the strategy. Sharpe ratio of the annual return to the strategy is 2 times larger than that of the quarterly returns.
- True. Rate of return increases linearly with the horizon, but standard deviation grows at the rate of the square root, hence Sharpe ratio for annual returns should roughly be higher by a square root of 4.
- Generally: The rate of return and standard deviation increase proportionally, hence proportionally affecting alpha
Buying stocks during the recession provides higher rate of return than during booms, yet does not imply temporary arbitrage opportunities on the market.
True. Higher rate of return during the recession generally provides compensation for higher exposure to risk, and higher price of risk (during the times of financial distress). This is not an arbitrage opportunity, but a reflection of the quantity and price of risk in the economy.
On average, country-level CDS spreads (weakly) overstate credit risk of the country.
True. Liquidity premium and hedging demand from the industry (e.g., banks and hedge funds being natural buyers of the CDS) imply that the CDS spread is likely to (weakly) overstate default probability and the recovery rate.
What are Hedge fund strategies characterized by? Do SR take that into account?
- the tail risk
- SR takes into account only volatility, not the tail risk - they are not an appropriate measure of the hedge fund performance. On top of that, SR does not take into account the sources of risk (e.g, alpha and beta decomposition)
Why are post-money valuations overestimated?
Because late-stage investors on average have better protection rights, not the early-stage ones (with liquidation preferences being part of the reason)
People say that markets have a lot of cross-sectional predictability, but very little time-series. What does this statement mean?
It refers to the fact that while we cannot predict the level of returns of securities relative to any fixed benchmark (e.g., positive or negative), we can often say whether securities with certain characteristics on average tend to perform better of worse than others.
How could you use stock options to implement a trading strategy around index reconstitution? What are its empirical properties? What could be the reason to implement a strategy in options instead of the underlying stocks?
- What is the Sharpe ratio of individual funds and your portfolio?
- What are the betas of your portfolio with respect to SmartMarket and LowVolBonds ETFs?
How could you modify a conventional cut-off for a t-stat of 1.96 to address the problem of dealing with the best out of N managers, and not a representative one from the sample? Outline the argument formally.
What are the most widespread concerns when trying to implement a particular long-short portfolio?
Describe the Fed funds rate
- The target fed funds rate is set by the FOMC and is a tool of monetary policy in the U.S.
- The effective fed funds rate is influenced by open market operations (e.g. repo)
- Fed funds rate is set for overnight borrowing, and is only U.S. dollars
What are the systematic factors driving government bond yields of different maturities, e.g. Treasuries? Describe them intuitively.
It is sometimes said that benchmarking fund performance contributes to an increased demand for risky securities and the beta anomaly. Do you agree with this statement? Why/why not?
Describe the Uncovered interest rate parity (UIP). Discuss the empirical evidence on the benefits and risks of exploiting it.
One of the leading explanations for the low beta anomaly is the presence of borrowing constraints on financial markets that leads to excessive demand for high beta stocks. Explain this argument.
Difference of risk premia of assets with lower/higher returns in good vs. bad times:
- Assets that have negative returns in bad states must have higher expected returns, i.e., positive risk premia
- Assets that have positive returns in bad states must have lower expected returns, i.e., negative risk premia
