CME R4

Question 1

Approaches for setting expectations for fixed-income returns

Answer 1

DCF Method - most precise, analyzes Maculay duration and YTM. It determines if the expected yield will be a positive or negative return (works for equity as well)

Risk premium method = risk free rate + term premium + credit premium + liquidity premium

Equilibrium (Black-Litterman), uses the covariance matrix and market weightings as equilibium weightings. Causes the CML line to touch the market portfolion on the efficient frontier

Question 2

Discuss risks faced by investors in emerging market fixed income and country risk analysis techniques

Answer 2

Higher risks due to foreign governments ability or willingess to repay debts.
Indicators:

Deficit-to-GDP > 4%

Debt-to-GDP >70%

Real growth < 4%

Current Account Deficit > 4% GDP

Foreign debt > 50% GDP or 200% of current account

FX reserves < 100% short term debt

Question 3

Discuss risks faced by investors in emerging market equities

Answer 3

Political and policy instability, weaker legal protections, eak disclosures and enforcement

Question 4

Real Estate:

Cap Rate

Expected Return

Expected Return with finite time period

Relationship with equities

Answer 4

Cap Rate = NOI / Property Value

E(R) = Cap Rate + NOI Growth Rate

E(R) = Cap Rate + NOI Growth Rate - % ΔCap Rates

REITs are generally correlated with equities in the short term, while direct shows less correlation (possible due to smoothing)

Question 5

Major approaches to forecasting exchange rates

Question 6

Methods to forecast volatility

Answer 6

Variance-Covariance Matrix - problems is that it cannot be used for large data sets due to sampling error

Facotr Based VCV - allow VCV to work on large data sets, but may be biased and inconsistent

Shrinkage esitmate - weighted average estimate of the sample and target matrix with same weights used for all elements of the matrix

ARCH Models can be used for portfolios with multiple assets to address volatility clustering

Question 7

Singer-Terhaar

Answer 7

Perfect Integration ERP: p(i,m) * σi * Market Share Ratio

Perfect Segregation ERP = σi * Market Sharpe Ratio

ERP = (Degree of Integration * ERPi) + (Degree of segregation * ERPs)

Question 8

Grinold-Kroner

Answer 8

Dividend/Price - Change in S/O + Inflation + Real Earnings Growth + Change in P/E Multiples