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CFA Level 3 > CFA Level3 > Flashcards

CFA Level3 Flashcards

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1
Q

Geometric Smoothing

A

Determines foundation distributions partly by Beginning MV X distribution % and partly as previous distribution increased for inflation, this creates a less volatile distribution %

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2
Q

Output gap

A

Below trend line growth and associated with a declining rate of inflation

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3
Q

Taylor Rule

A

Forecast the next change in ST rates

R target = policy neutral ST rate + 0.5 (expected inflation - target inflation) + 0.5 (expected GDP - trend GDP growth)

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4
Q

Cobb Douglas (CD) Production Function

A

Change Y/Y = Change A/A + a(Change k/k) + (1-a)Change L /L
Y = real output
A = total factor productivity
a = output elasticity

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5
Q

Solow Residual

A

Estimating TFP

Change in A = Change in Y - a(K) - (1-a)(L)

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6
Q

Total Factor Productivity (TFP)

A

labor + capital + technology

Measures the ability of an economy to produce more real output for the same inputs of labor and capital

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7
Q

Fed Model

A

S&P earnings yield (E/P) / 10 year treasury yield

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8
Q

Yardeni Model

A

Fair EY = E1 / P0 = Yb - d(LTEG)

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9
Q

Tobin’s Q

A

asset market value / asset replacement cost

MV of debt + MV of equity / asset replacement cost

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10
Q

Grinold-Kroner Model

A

Expected income return + expected nominal earnings growth + repricing return

(D1/P0 - change S) + (i + g) + change in P/E

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11
Q

Macaulay Duration

A

PV weighted average of when cash flows are to be received; less than maturity for a coupon bond

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12
Q

Modified Duration

A

Macaulay divided by (1 + discount rate)

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13
Q

Effective Duration

A

Takes into account embedded options

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14
Q

Key rate duration

A

Price sensitivity to specific points on the yield curve

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15
Q

Components of Fixed Income return

A
  1. Yield income (coupon / price)
  2. Rolldown return (projected ending / beg price) - 1
  3. Manager predicted price change based on D,C, and spread change
  4. Projected credit losses
  5. Projected foreign currency G/L
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16
Q

Duration Gap

A

BPVa - BPVl

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17
Q

Rules for Immunizing a single liability

A
  1. Initial PVA >= PVL
  2. Portfolio Macaulay duration Da = Dl
  3. Minimize portfolio convexity (min dispersion of asset cash flows around the liability and reduce risk to curve reshaping)
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18
Q

Money Duration (BPV)

A

BPV = MD * V * .0001
MD = Modified Duration
V =

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19
Q

Adjusting the Duration Gap

A

Target - Current / Instrument

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20
Q

Total Return Mandates (3)

A

Do not seek to fund future liabilities but may target an absolute rate of return

  1. Pure Indexing
  2. Enhanced Indexing
  3. Active Management
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21
Q

Collar

A

Long and short position in an out of the money call and put

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22
Q

Enhanced Indexing

A

Matching index duration but allowing deviations in other exposures

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23
Q

Key Rate Duration

A

Controls both interest rate and yield curve risk

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24
Q

Matrix / Evaluated Pricing

A

Price of similar, traded bonds is captured and used to calculate YTM

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25
Q

Modified Duration

A

Minimize tracking error due to parallel shifts in the yield curve
Change in value = -MD Change in rates

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26
Q

Key rate duration

A

Minimize tracking error due to nonparallel changes in the yield curve
Multiple key rates for single points in the yield curve = -D* change in rates

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27
Q

Advantages of a Laddered Bond Portfolio

A
  1. Natural liquidity
  2. Broadest diversification of cash flow across time and yield curve
  3. Diversification between price and reinvestment risk
  4. More convexity than the bullet, benefit from large parallel shifts
  5. Falls in middle of non parallel shifts
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28
Q

Strategies for an unchanged (Upward Sloping) Yield Curve (5)

A
  1. Buy and Hold
  2. Riding the yield curve
  3. Selling Convexity
  4. Carry Trades
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29
Q

Buy and Hold

A

Higher return by shifting to higher duration, buying duration risk to enhance portfolio yield under the assumption rates will remain stable

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30
Q

Selling Convexity

A

In a stable rate environment, increase portfolio returns by reducing the portfolio convexity below the benchmark

  • Sell calls and sell puts
  • Buy callable bonds and MBS (negative convexity)
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31
Q

Carry Trade

A

Buying a security at a higher yield and financing the purchase by borrowing at a lower interest rate
- Do best in stable markets can be very risky in highly volatile markets

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32
Q

Interest Rate Parity

A

Higher yield currency will trade at a forward discount to the lower yield currency

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33
Q

Crowding Risk

A

Mass effort to unwind a trade

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34
Q

Strategies for Changes in Level, Slope, or Shape of the Yield Curve

A
  1. Adjusting duration
  2. Increasing convexity
  3. Bullet, laddered and barbell strategies
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35
Q

Rolldown price

A

Price in 12 months + yield / spot interest rate

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36
Q

Holding Period Return

A

(Projected Price + coupon) / beginning price

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37
Q

G Spread

A

Interpolated spread when government maturities do not exist

38
Q

I Spread

A

Computed and used the same way as the G-Spread but is based on the swap fixed rate

39
Q

OAS

A

Option Adjusted Spread

does not reflect the impact of options on expected return

40
Q

Benchmarks

SAMURAI

A
  1. Specified in advance
  2. Appropriate for the managers investment approach
  3. Measurable
  4. Unambiguous
  5. Reflective of the managers current investment opinions
  6. Accountable
  7. Investable
41
Q

Roy’s Safety-first criterion

A

Rp - RL / standard deviation of portfolio

42
Q

Myopic Loss Aversion

A

Macro issue when a large number of investors under-allocate to stocks, keeping their prices low and biasing upward their return

43
Q

Conservatism

A

Cognitive Error

Initially rational view is formed but then retained without further consideration as new information comes in

44
Q

Sharpe Ratio

A

Annualized Return - annualized risk free rate / Annualized standard deviation

45
Q

Contagion

A

During crisis periods of market decline, correlations between markets move upwards towards +1 and benefits of diversification are not present

Tool used to track = Conditional Correlation matrices (Correlation for normal and for crisis)

46
Q

Unhedged Return in Foreign Asset

A

R (FC) + R (FX)

47
Q

Hedged Return in a Foreign Asset

A

R (FC) - R (FX) + R (DC)

48
Q

Decision Risk

A

Investors investing in securities they do not really understand and then exiting the strategy at an inopportune time and at a high cost, higher for PE because it is an illiquid asset
- Ability to exit lowers decision risk

49
Q

Information Ratio

A

Active risk / Active return
IR = IC X IB (1/2)
IC = Information Coefficient
IB = investor Breadth

50
Q

Joint Probability

A

Prob 1 + Prob 2 - (Prob 1 X Prob 2)

51
Q

Advantages of Monte Carlo Simulation

A
  1. Focuses the client and manager on most important risk, outliving the assets. instead of short term volatility
  2. Visually displays for the client the prospects of outliving assets
  3. Can incorporate path dependency issues such as how changes in inflation affect both distributions and MC
  4. Can incorporate taxes and other factors in addition to return
52
Q

Event Risk

A

Company or situation specific and would be important if it causes bonds to decline relative to the stock of the company

53
Q

Market Liquidity Risk

A

Significant for distressed debt investors, illiquid securities that most investors avoid

54
Q

Market Risk (Distressed Investing)

A

Long company’s bonds and short the stick is designed to remove market (systematic) risk

55
Q

J Factor Risk

A

The effect of the judge on the results of any bankruptcy proceedings, may rule in favor of debt or equity which will impact returns

56
Q

Treynor Measure

A

Excess return over the risk free rate per unit of systematic risk
R portfolio - rfr / Beta

57
Q

M^2

A

Compares the risk adjusted portfolio return to the market return

Rf + (Rp - Rf)/std dev p) *stand dev market

58
Q

Information Ratio

A

Excess return for standard deviation of excess risk
Active Return / Active risk
(Rp - Rb) / standard dev (Rp - Rb)

59
Q

Jensen’s Alpha

A

Rp - (Rf + Bp(Rm - Rf))

60
Q

Utility Value

A

Um = E(Rm) - .005(a)(variance)

61
Q

Components of Implementation Shortfall (4)

A
  1. Commissions
  2. Delay in execution [BP - DP] X # shares later executed
  3. Realized Profit / Loss [ EP - DP] X # of shares at EP
  4. Missed Trade [CP - DP] X shares canceled
62
Q

Fundamental Law of Active Management

A

IR = IC * Sq root of IB
Information ratio = Information coefficient (Depth of knowledge about individual securities) X number of investment decisions (IB)

63
Q

Investor Breadth (IB)

A

Number of independent decisions an investor makes

Ex: Buy ten energy stocks, IB = 1

64
Q

Information Coefficient (IC)

A

Investor’s forecast against actual outcomes

Skillful managers will have higher ICs

65
Q

Decentralized Risk Governance

A

Places responsibility for execution within each unit of the organization
- Benefit: putting risk management in the hands of those closest to each part of the organization

66
Q

Centralized Risk System (ERM)

A

Enterprise Risk Management System

Places execution within one central unit of the organization

67
Q

Financial Risks (3)

A
  1. Market Risk
  2. Credit Risk
  3. Liquidity Risk
68
Q

Non-Financial Risks (6)

A
  1. Operational Risk
  2. Settlement Risk (Herstatt Risk)
  3. Model Risk
  4. Sovereign Risk
  5. Regulatory Risk
  6. Tax, Accounting and Legal Contract Risk
69
Q

Analytical VAR

A
  • based on concept of one-tailed confidence intervals
    VAR = (Rp - (z)(standard dev))*Value of portfolio
    5% = 1.65 standard deviation below mean
    1% = 2.33 standard deviation below mean
70
Q

ROMAD

A

Rp / Max drawdown

71
Q

Sortino Ratio

A

Rp - MAR / standard dev return < MAR

MAR = minimum acceptable return

72
Q

Beta

A

Covariance (i,m) / Variance (m)

73
Q

Adjusting Portfolio Beta

A

(Bt - Bp)/Bf *(Vp/Pf(multiplier))

74
Q

Basis Risk

A

Item hedged in numerator, not perfect match for hedging vehicle in denominator

75
Q

Effective Beta

A

% change in value of the portfolio / % change in index

76
Q

Pre-investing

A

Buying contracts in anticipation of cash that will be received

77
Q

Bull Spread

A

Provides limited upside if underlying rises (bull) with limited downside
- Purchase a call with low exercise price Xl and subsidize with selling a call with a higher exercise price X

78
Q

Bear Spread

A

Limited upside if underlying declines (bear) with limited downside
Sell a call with a low strike price and buy a call with a high strike price

79
Q

Butterfly Spread with Calls

A

Purchase or sale of 4 different call options of three different types

  • Buy 1 call with low exercise price XL
  • Buy 1 call with higher exercise price XH
  • Write 2 calls with an exercise price in-between Xm
80
Q

Straddle

A

Purchase a call option and a put option with same exercise price and expiration

81
Q

Collar

A

Protective Put and Covered Call

  • Goal is for the owner of the underlying security to buy a protective put and then sell a call t pay for the put premium
  • Upside and downside are limited
  • Good strategy for locking in value of a portfolio at a minimal cost
82
Q

Interest Rate Call Option Payout

A

Payoff = NP (Max(0, LIBOR - strike price)(D/360)

83
Q

Delta

A

Change in price of the option / Change in price of the underlying
Range from 0 (OTM) to 1 (ATM)

84
Q

Delta Hedge Position

A

= - delta X number of options

85
Q

G spread

A

Similar to benchmark spread, but uses interpolated YTM of the two closest bracketing on the run government bonds

86
Q

I spread

A

Compare interpolated YTM of the two closes bracketed swap fixed rates

87
Q

OAS

A

Best estimate of spread for bonds with options

88
Q

Grinold - Kroner Model

Forecasting return

A

R = Div1/P0 + i + g - Change shares - change P/E

89
Q

Active Weight

A

= current allocation - benchmark

90
Q

Alpha / Beta Separation Strategy

A

Gain systematic risk exposure by allocating funds to (low cost) passive index strategies, while adding to alpha via market-neutral long/short managers

CFA Level 3 (1 decks)

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