CME

Question 1

Initial recovery capital market expections

Answer 1

Short-term rates and government bond yields are low. Bond yields may continue to decline in anticipation of further disinflation but are likely to be bottoming. Stock markets may rise briskly as fears of a longer recession (or even a depression) dissipate. Cyclical assets—and riskier assets, such as small stocks, higher-yield corporate bonds, and emerging market equities and bonds—attract investors and typically perform well.

Question 2

Early expansion
capital market expectations

Answer 2

Short rates are moving up as the central bank starts to withdraw stimulus put in place during the recession. Longer-maturity
bond yields are likely to be stable or rising slightly. The yield curve is flattening. Stocks trend upward.

Question 3

Late expansion CME

Answer 3

Interest rates are typically rising as monetary policy
becomes restrictive.
Bond yields are usually rising, more slowly than short rates, so the yield curve continues to flatten. Private sector borrowing puts pressure on credit markets.
Stock markets often rise but may be volatile as nervous investors endeavor to detect signs of looming deceleration. Cyclical assets may underperform while inflation hedges such as commodities outperform.

Question 4

Slowdown CME

Answer 4

Short-term interest rates are high, perhaps still rising, but likely to peak.

Government bond yields top out at the first clear sign of a slowing economy and may then decline sharply.

The yield curve may invert, especially if the central bank continues to exert upward pressure on short rates.

Credit spreads, especially for weaker credits generally widen.

The stock market may fall, with interest-sensitive stocks such as utilities and “quality” stocks with stable earnings performing best.

Question 5

Contraction

Answer 5

Short-term interest rates drop during this phase, as
do bond yields. The yield curve steepens substantially. The stock market declines in the earlier stages of the contraction but usually starts to rise in the later stages, well before the recovery emerges. Credit spreads typically widen and remain elevated until signs of a trough emerge and it becomes apparent that firms will be able to roll over near-term debt maturities.

Question 6

Econometric analysis

Answer 6

Uses statistical methods to explain economic relationships and formulate forecasting models

Question 7

Checklist approach

Answer 7

An analyst considers a series of questions
Then he uses judgement and perhaps statistical modeling to interpret answers

Question 8

Rules of immunizing a single liability

Answer 8

1. Initial portfolio market value (PVA) equals (or exceeds) PVL. (There are exceptions to this for more complex situations where the initial portfolio IRR differs from the initial discount rate of the liability.)
2. Portfolio Macaulay duration matches the due date of the liability (D = DL).
3. Minimize portfolio convexity (to minimize dispersion of asset cash flows around the liability and reduce risk to curve reshaping).
4. Regularly rebalance the portfolio to maintain the duration match as time and yields change. (But also consider the tradeoff between higher transaction costs from morefrequent rebalancing versus the risk of allowing durations to drift apart.)

Question 9

Rules of immunizing multiple liabilities

Answer 9

1. Initial portfolio market value (PVA) equals (or exceeds) PVL. (There are exceptions to this for some situations where the initial portfolio IRR differs from the initial discount rate of the liability.)
2. Portfolio and liability basis point values match (BPV = BPVL)
3. Asset dispersion of cash flows and convexity exceed those of the liabilities. (But not by too much, in order to minimize structural risk exposure to curve reshaping).
4. Regularly rebalance the portfolio to maintain the BPV match of A and L as time and yields change.

Question 10

What’s shrinkage estimation

Answer 10

Shrinkage estimation involves taking a weighted average of a historical estimate of a parameter and some other parameter estimate, in which the weights reflect the analyst’s relative belief in the estimates.

Question 11

Deficit to GDP ratio

Answer 11

Shouldn’t be more than 4%

Question 12

Debt to GDP ratio

Answer 12

Not more than 70-80%

Question 13

Real growth rate

Answer 13

More than 4%

Question 14

Current account deficit

Answer 14

Not more than 4%

Question 15

Foreign debt levels

Answer 15

Not more than 50% of GDP
Not more than 200% of current account receipts

Question 16

Appraisal data bias

Answer 16

Appraisal data bias occurs when asset valuations are based on subjective appraisals rather than market prices, leading to smoothed or understated volatility and risk in reported data. This can cause an overestimation of portfolio stability, as the appraised values may not reflect true market fluctuations. correlations are understated

Question 17

prudence bias

Answer 17

The prudence bias is the tendency to temper forecasts so that they do not appear extreme or the tendency to be overly cautious in forecasting.

Question 18

Econometric model advantages

Answer 18

Advantages
- Models can be quite robust, with
many factors included to approximate
reality.
■ New data may be collected and
consistently used within models to quickly generate output.
■ Delivers quantitative estimates of
impact of changes in exogenous
variables.
■ Imposes discipline/consistency on
analysis.

Question 19

econometric model disadvantages

Answer 19

■ Complex and time-consuming to formulate.
■ Data inputs not easy to forecast.
■ Relationships not static. Model may be mis-specified.
■ May give false sense of precision.
■ Rarely forecasts turning points well.

Question 20

Leading indicator advantages

Answer 20

■ Usually intuitive and simple in
construction.
■ Focuses primarily on identifying
turning points.
■ May be available from third parties.
Easy to track

Question 21

Leading indicator disadvantages

Answer 21

■ History subject to frequent revision.
- look ahead bias
● “Current” data not reliable as input for historical analysis.
● Overfitted in-sample. Likely overstates forecast accuracy.
■ Can provide false signals.
■ May provide little more than binary (no/yes) directional guidance.

Question 22

Checklist approach advantages

Answer 22

■ Limited complexity.
■ Flexible.
● Structural changes easily
incorporated.
● Items easily added/dropped.
● Can draw on any information, from
any source, as desired.
■ Breadth: Can include virtually any
topics, perspectives, theories, and
assumptions.

Question 23

Checklist approach disadvantages

Answer 23

■ Subjective. Arbitrary. Judgmental.
■ Time-consuming.
■ Manual process limits depth of analysis. No clear mechanism for combining
disparate information.
■ Imposes no consistency of analysis across items or at different points in time. May allow use of biased and/or inconsistent views, theories, assumptions.

Question 24

bonds during inflation

Answer 24

Because the cash flows are fixed in nominal terms, the effect of inflation is transmitted solely through the discount rates (i.e., the yield curve). Rising (falling) inflation induces capital losses (gains) as the expected inflation component of yields rises (falls). If inflation remains within the expected cyclical range, shorter-term yields rise/fall more than longer
yields but have less price impact as a result of shorter duration. If, however, As will be discussed later, compensation for taking duration risk (the “term premium”) is procyclical.
As a result, an inverted “horizon structure” of expected inflation does not necessarily imply an inverted yield curve. Inflation moves out of the expected range, longer-term yields may rise/fall
more sharply as investors reassess the likelihood of a change in the long-run
average level of inflation. Persistent deflation benefits the highest-quality
bonds because it increases the purchasing power of the cash flows, but it is
likely to impair the creditworthiness of lower-quality debt.

Question 25

Challenges in setting CME

Answer 25

• Limitations of economic data
• data measurement errors and biases
• model uncertainity

Question 26

Asset class charachteristics

Answer 26

Assets within an asset class should be relatively homogeneous; asset classes should be mutually exclusive; asset classes should be diversifying; asset classes as a group should make up a preponderance of the world’s investable wealth; asset classes selected for investment should have the capacity to absorb a meaningful proportion of an investor’s portfolio.

Question 27

usually equity increases with trend, not always though. why?

Answer 27

• Growth already priced in
• Diminishing return on capital
• Valuation multiples

Question 28

data driven models (in econometric model)

Answer 28

Heuristic approaches with limited theoretical backing.

Question 29

structural models (in econometric models)

Answer 29

specify functional relationships among variables based on economic theory. The functional form and parameters of these models are derived from the underlying theory.

Question 30

Nowcasting methodlogy

Answer 30

Nowcasting focuses on real-time forecasts of current-quarter GDP using partially released data. A notable example is the Atlanta Fed’s GDPNow model.

Question 31

short term interest rate movements

Answer 31

Initial recovery - Short-term rates and government bond yields are low. (probably because monetary policies are still based on contraction)

Early expansion - Short rates are moving up as the central bank starts
to withdraw stimulus put in place during the recession.

Late expansion - Interest rates are typically rising as monetary policy becomes restrictive

Slowdown - Short-term interest rates are high, perhaps still rising, but likely to peak.

Contraction - Short-term interest rates drop during this phase

Question 32

Bond yields and yield curve in different situations

Answer 32

Initial recovery - Bond yields may continue to decline in anticipation of further disinflation but are likely to be bottoming.

Early expansion - Longer-maturity bond yields are likely to be stable or rising slightly. The yield curve is flattening.

Late expansion - Bond yields are usually rising, more slowly than short
rates, so the yield curve continues to flatten.

Slowdown - Government bond yields top out at the first clear sign of a slowing economy and may then decline sharply. The yield curve may invert, especially if the central bank continues to exert upward pressure on short rates.

Contraction - Yields drop and The yield curve steepens substantially

Question 33

Stock performance during different times

Answer 33

Initial recovery - Stock markets may rise briskly as fears of a longer recession (or even a depression) dissipate.

Early expansion - Stocks trend upward.

Late expansion - Stock markets often rise but may be volatile as nervous investors endeavor to detect signs of looming deceleration. Cyclical most hit

Slowdown - The stock market may fall, with interest-sensitive stocks such as utilities and
“quality” stocks with stable earnings performing best.

contraction - The stock market declines in the earlier stages of the contraction but usually starts to rise in the later stages, well before the recovery emerges.

Question 34

If capital is mobile and exchange rates are fixed

Answer 34

interest rates between pegged currencies must converge.

Question 35

A monetary policy cannot simulataneously…

Answer 35

Allow unrestricted capital flows.

Maintain a fixed exchange rate.

Pursue an independent monetary policy.

Question 36

Quantitative bottom up

Answer 36

Quantitative bottom-up investors rely on models applied to quantifiable, company-level data.

Question 37

Performance of real estate

Answer 37

Retail and Office REITs: Higher returns and lower volatility than direct real estate.

Industrial Properties: Similar returns with higher volatility in REITs.

Apartments: Direct investments outperformed REITs with higher returns and lower volatility.

Question 38

Strenghts of vcv matrix using sample statistics

Answer 38

Simple and intuitive.
Unbiased estimator.
No assumptions about structure.
Easy to compute.

Question 39

Weaknesses of VCV Matrix Using Sample Statistics

Answer 39

Limited by sample size.
High variance/estimation error with small samples.
Inability to handle many assets.
No cross-sectional consistency.

Question 40

Strenghts of Factor-Based VCV Matrix

Answer 40

Reduces complexity.
Handles many assets.
Improves estimation precision.
Ensures cross-sectional consistency.

Question 41

Weaknesses of Factor-Based VCV Matrix

Answer 41

Risk of model mis-specification.
Reduced flexibility.
Dependent on factor selection.
Factor identification challenges.

Question 42

Shrinkage estimation method

Answer 42

Involves taking a weighted average of two estimates of the same parameter—one based on historical sample data and the other based on some other source or information. This “two-estimates-are-better-than-one” approach reduces forecast errors

Question 43

Key reporting elements include

Answer 43

• Performance evaluation
• Compliance with investment guidelines
• Progress toward stated goals and objectives

Question 44

management reporting in investment governance

Answer 44

Management reporting provides insights on which parts of the portfolio are performing ahead or behind the plan and ensures assets are managed according to guidelines.

Question 45

Governance reporting in investment governance

Answer 45

addresses the strengths and weaknesses in program execution, enabling efficient committee meetings.

Question 46

2 types of benchmarks used in investment governance

Answer 46

Investment manager performance relative to the purpose for which they were hired.

Policy portfolio performance compared to the actual portfolio.

Question 47

how to tackle key person risk

Answer 47

Good governance reduces this risk by diversifying responsibilities and ensuring that no single person is indispensable to the operation of the investment program.

Question 48

Economy during initial recovery

Answer 48

This period is usually a short phase of a few months beginning at the trough of the cycle in which the economy picks up, business confidence rises, stimulative policies are still in place, the negative output gap is
large, and inflation is typically decelerating. Recovery is often supported by an upturn in spending on housing and consumer durables.

Question 49

Economy during an early expansion

Answer 49

The economy is gaining some momentum, unemployment
starts to fall but the output gap remains negative, consumers borrow and
spend, and businesses step up production and investment. Profits typically rise rapidly. Demand for housing and consumer durables is strong.

Question 50

Economy in late expansion

Answer 50

The output gap has closed, and the economy is increasingly in danger of overheating. A boom mentality prevails. Unemployment is low,
profits are strong, both wages and inflation are rising, and capacity pressures boost investment spending. Debt coverage ratios may deteriorate as balance sheets expand and interest rates rise. The central bank may aim for a “soft landing” while fiscal balances improve.

Question 51

Economy in slowdown

Answer 51

The economy is slowing and approaching the eventual peak, usually in response to rising interest rates, fewer viable investment projects, and accumulated debt. It is especially vulnerable to a shock at this juncture. Business confidence wavers. Inflation often continues to rise as firms raise prices in an attempt to stay ahead of rising costs imposed by other firms doing the same.

Question 52

Economy during contraction

Answer 52

Recessions typically last 12 to 18 months. Investment spending, broadly defined, typically leads the contraction. Firms cut production sharply. Once the recession is confirmed, the central bank eases monetary policy. Profits drop sharply. Tightening credit magnifies downward pressure on the economy. Recessions are often punctuated by major bankruptcies, incidents of uncovered fraud, exposure of aggressive accounting practices, or a financial crisis. Unemployment can rise quickly, impairing household financial positions.