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FINA 411: Portfolio Management > class 3: Investment process and the IPS > Flashcards

class 3: Investment process and the IPS Flashcards

1
Q

asset allocation

A

the process used to determine what proportion of money we should put in each asset class

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2
Q

asset class

A

group of securities that exhibit similar characteristics

behave similarly in market place

subject to same laws

investable

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3
Q

steps to do asset allocation

A
  1. determine strategic asset allocation
  2. choose benchmark
  3. rebalance portfolio
  4. tactical asset allocation (optional)
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4
Q

the difference between strategic asset allocation and tactical asset allocation

A

strategic asset allocation is long term

tactical asset allocation is temporary

–> when we spot exceptional opportunities in the market

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5
Q

determining the asset allocation (steps)

A
  1. client’s investment objectives and constraints

2. capital expectations (like assignment #1)

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6
Q

IPS (investment policy statement) (components)

A
  1. objectives

2. constraints

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7
Q

IPS objectives

A

Risk

–> willingness to assume risk

–> ability to assume risk

Return

–> difficult to articulate (never give a certain amount)

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8
Q

VaR (value at risk)

A

an estimate of the minimum loss with a given probability over a specified period

–> expressed as a $ amount or a % of portfolio value

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9
Q

VaR components

A
  1. amount of loss
  2. probability
  3. period of time
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10
Q

IPS constraints

A
  1. time horizon
  2. taxes
  3. liquidity
  4. legal and regulation
  5. unique circumstances
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11
Q

investment horizon (time horizon) constraint

A

the planned liquidation date

affects portfolio risk and security maturity dates

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12
Q

taxes constraint

A

income tax

tax on interest

tax on dividends

capital gains tax

estate tax (not in canada)

gift tax (not in canada)

wealth tax (not in canada)

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13
Q

liquidity constraint

A

speed and easy with which an asset can be converted into cash

need for cash in short notice increases liquidity requirement

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14
Q

liquidity

A

how easy we can convert asset into cash without needing to drastically reduce price

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15
Q

legal and regulations constraints

A

specific regulations that may apply to institutional investors

prudent investor rule

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16
Q

prudent investor rule

A

the fiduciary responsibility of a professional investor

a legal principle that is used to restrict the choices of the financial manager of an account to the types of investments that a person seeking reasonable income and preservation of capital might buy for his or her own portfolio

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17
Q

unique needs constant

A

special considerations related to the underlying investors

18
Q

capital market expectations sub categories

A

expected return

risk

correlation

19
Q

how do we forecast the fixed income market?

A

we look at interest rates

20
Q

theory of the term structure

A
  1. liquidity preference theory
  2. the expectations theory
  3. market segmentation theory
21
Q

liquidity preference theory

A

yield curve should be upper sloping

a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings

Liquidity Preference Theory refers to money demand as measured through liquidity

22
Q

the expectations theory

A

attempts to predict what short-term interest rates will be in the future based on current long-term interest rates

The theory suggests that an investor earns the same interest by investing in two consecutive one-year bond investments versus investing in one two-year bond today

23
Q

market segmentation theory

A

long and short-term interest rates are not related to each other

the prevailing interest rates for short, intermediate, and long-term bonds should be viewed separately like items in different markets for debt securities

24
Q

what drives the stock market?

A

the GDP

all capital markets driven by miacroeconomic factors

25
Q

what drives the GDP?

A

intérêts rates / inflation

fiscal and monetary policy

unemployment

retail sailes

consumer confidence

durable sales

$US

Inventory

transportation and warehousing

budget deficit

etc.

26
Q

fundamental analysis (top down approach)

–> why is this recommended?

A
  1. macroeconomic analysis
  2. industry analysis
  3. company analysis
27
Q

choosing our benchmark (second step of asset allocation)

A

we need it to compare to see if we did well or nah

we need it to achieve client’s long term objectives

we need it to see if its consistent with risk tolerance

28
Q

what is a good benchmark

A

specified in advance

appropriate

measurable

unambiguous

reflective of current situations

accountable

investable

SAMURAI

29
Q

rebalancing our portfolio (third step of asset allocation)

A

should be rebalanced to periodically maintain Asset Allocation

Drift

30
Q

drift in rebalancing the portfolio

A

appreciation or decline in values (will influence our AA allocation)

interest income (we gotta put it somewhere and it will change the AA)

dividend income (we gotta put it somewhere and it will change the AA)

Macroeconomic factors

client

31
Q

the different types of clients

A
  1. individuals
  2. life insurance
  3. casualty insurance
  4. banks
  5. pension funds
  6. endowments/foundations
32
Q

life insurance

A

term insurance

whole life

think long term

33
Q

casualty insurance (non life)

A

short term

profit seeking and are willing to get more risk

34
Q

how long do we keep bank deposits for?

A

not longer than a few weeks

they think medium term

heavily regulate

work on spreads

35
Q

two types of pension funds

A

defined benefit plan

defined contribution plan

36
Q

defined benefit plan vs defined contribution plan

A

defined benefit plan is the best choice for us

–> pension is guaranteed even if the investments are terrible

defined contribution plan

–> if they fuck up, we won’t get our pension

37
Q

do pension funds pay taxes?

when could they pay taxes?

A

nooo they are tax free

only pay taxes if they have 40% of their assets outside Canada

38
Q

ar pension funds heavily regulated?

A

yeee

39
Q

AA approaches

A
  1. asset only
  2. liability driven investments (LDI)
  3. goal-based
40
Q

asset only AA approach

A

fixed income

equity

alternatives

maximize assets to be able to meet PBO

41
Q

liability driven investments (LDI)

A

PBO

have enough $ to meet future liabilities

42
Q

endowments/foundations

A

non taxable unless they fail they pay out around 5% of their money to different projects

FINA 411: Portfolio Management (13 decks)

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