Chapter 17 Flashcards
Two components of return
Income (dividends or coupons)
Capital gains
What is the terminal value of of a dividend reinvested equation
Terminal value = dividend x (1+r)^n
Excess returns can be broken into 4 sub components
Asset allocation effect l
Currency effect
Security selection affect
Interaction effect
How can bond returns be decomposed
Credit quality, sector and maturity
What is it called when changes in interest rates change the yield curve
Yield curve twists
What is the income effect for bond returns
Return an investor would receive if th shield curve was unchanged
What does interest rate effect measure for bonds
What happens if yield curve shifts
That is the residual effect formula
Total return - YTM effect - I rate effect - sector/quality effect = residual
What does a large residual effect mean for bond managers
Superior bond selection
Excess returns for stocks driven by
Stock/sector selection
Market timing
What does total excess return relative to benchmark equal
Total asset allocation effect + stock selection effect + total interaction effect
Money weighted rat Eid return, what does it do and what is it
Takes into account cash inflows and cash outflows
IRR of a portfolio
How do inflows affect the result of the money weighted rate of return
Give overstated return when fund does well
Understated return when fund does poorly ( negative return)
Limitation of money weighted rate of return
Places greater emphasis on performance in periods where account size is higher
Hence being money weighted
What does time weighted rate of return do
Gives equal weight to the returns achieved in each portion of the particular period of interest
Why is time weighted rate of return preferred to money weighted rate of return
Bc money weighted rate of return inflates fund manager performance
What is key when picking bench mark
Overall performance ace goals and tolerance for risk
Liquidity for investor and bench mark should be similar
Criteria for constructing a benchmark
Specified in advance - so investor cannot pick an underperforming benchmark after period
Appropriate risk
Measurable
Transparent with names of underlying securities
Investable
Historical data
Low turnover of securities
Broad market indices examples
S and p 500
MSCI world
Limitation of broad benchmarks
Too broad for some managers
Style for benchmarks
Some managers match benchmarks on style
Ie small cap or mid cap
These narrow benchmarks aren’t suitable for all managers
Absolutely benchmark
This is just a clear target return for manager to hit, no index for it
Why are benchmarks useful for absolute return investors (market neutral )
Provide element of risk control
Help to establish market neutral strategies
What are customised benchmark and why good
Made up of multiple investment indices and good for complex investor needs
Sharpe measure ratio
(Rp - Rf) / SDp
(Return on portfolio - risk free rate) divided by standard deviation of portfolio
What’s a good sharpe
Higher sharp mean BETTER value for investor
Limitation of sharpe ratio
CANNOT INTERPRET NEGATIVE SHARP RATIOS
Treynor measure
(Rp-Rf) / Bp
Bp is the is the capm beta of the portfolio
What value of treynor is better
Higher the value of treynor, the better the value
Higher beta indicates higher systematic risk
Who might prefer the treynor measure
Preferred by investors with well diversified portfolios since the measure does not consider unsystematic risk
What is the information ratio
(Rp - Rb) / SDsurplus
Rb is the benchmark return
Standard deviation surplus is the standard deviation of Rp - Rb
What does negative info ratio mean
Manager has failed to beat index
Jensons alpha ratio what does it measure
Risk adjusted returns
Benchmark can be constructed so risk inherited in benchmark is equal to risk in portfolio
What is jenson alpha interpretation
If manager beats benchmark with equal risk characteristics, the difference is due to managers skill, this is known as jensons alpha.
Jensons alpha equation
J = Rp - Rb
Rb = Rf + B(Rm - Rf)
Measuring performance of bond portfolios
Portfolio return in excess rope risk less return divided by relative duration
(Rp - Rf) / (Dp / Dm)
Dm is duration of bond market
When is jenson alpha inappropriate
If fund manager takes on a lot of specific risk
Standard deviation of a well diversified benchmark portfolio
Beta of benchmark x SD market
Limitation of risk measure
Only account for average risk whereas actual risk may massively vary over time
Return of benchmark portfolio
Sum of (weights of asset class x return of benchmark asset classes)
Return from stock selection formula
Sum of (weights of asset class x actual return of asset class)
Implementing tactical asset allocation decision returns formula
Sum of ( weights of actual asset classes x benchmark returns for asset)
Actual portfolio retruns formula
Sum of ( actual weights x actual returns)
How is timing attribution worked out
Tactical asset allocation(changed weights compared to benchmark) returns - benchmark returns
How is selection attribution worked out
Stock selection (weights same as benchmark but retruns different) returns - benchmark returns
Interaction attribution formula
Benchmark returns - actual returns - asset allocation returns - stock selection returns
Total contribution formula
Actual returns minus benchmark returns
Tracking error
Measured as the standard deviation of the differences between an investment funds retruns and its benchmark returns over given period
Why may tracking error occur
Timing of income payments
Taxation
Dealing costs
What is standard deviation surplus equal to
Tracking error
Time weighted rate of return, how do you work it out
Work out return in each period
Multiply all the returns together and then minus 1
(1+r) (1+r2) (1+r3) -1
