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CAIA Level 2 2021 > Current & Integrated Topics > Flashcards

Current & Integrated Topics Flashcards

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1
Q

Four dynamic strategies

A

buy-and-hold, constant mix, constant proportion portfolio insurance, and option-based portfolio insurance

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2
Q

General features of a buy-and-hold strategy (payoff diagram)

A
  1. Value is linearly related to that of the stock market
  2. Portfolio value increases as a function of stock market value
  3. Value will never fall below initial investment in bills
  4. The greater the % in stocks the better performance
  5. Upside potential is unlimited
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3
Q

Risk tolerances constant-mix policies

A

varies proportionately with their wealth (they will hold stocks at all wealth levels)

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4
Q

Rebalancing of constant-mix vs CPPI

A

Constant-mix: buy stocks as they fall in value, sell stocks as they rise in value

CPPI: buy stocks as they rise in value, sell stocks as they fall in value

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5
Q

Buy-and-hold vs. constant-mix vs. CPPI in various markets

A

In a rising or declining market a buy-and-hold and CPPI strategy will outperform the constant-mix strategy. (trending)

In a flat but oscillating market constant-mix will outperform the buy-and-hold strategy. (reversal)

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6
Q

Constant-proportion portfolio insurance (CPPI) formula

A

Dollars in Stocks = m(Assets-Floor) where m is a fixed multiplier and greater than one

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7
Q

How to implement a CPPI strategy?

A

select the multiplier and a floor below which he does not want the portfolio to fall (the floor grows at the rate of return on bills and must initially be less than total assets)

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8
Q

How far can the market fall before the floor of a CPPI strategy is endangered?

A

1/m

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9
Q

Concave payoff vs. convex payoff strategies

A

Concave: “Buy stocks as they fall” do well in flat but oscilating markets, and “sell insurance”

Convex: “Buy stocks as they rise” do well in trending markets and “buy insurance”

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10
Q

Option-based portfolio insurance (OBPI) set up and does it have a concave or convex payoff.

A

Begin by specifying a horizon and a desired floor; the payoff at the horizon is the same as a portfolio of bills and call options.

OBPI sell stocks as they fall so they must have a convex payoff.

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11
Q

How can ESG benefit the bottom line?

A
  1. Improved ESG performance can create operating efficiencies
  2. Energy efficiency can have a positive impact
  3. Development of new products/improved innovation
  4. Reduce possibility of fines and penalties
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12
Q

PRI Principle 1 and actions for LP/GPs

A
  1. We will incorporate ESG issues into investment analysis and decision marking processes

Action LP: Factor responsible investment consideration into fund selection/terms/fund monitoring processes

Action GP: Identify material ESG factors in pre-investment process. Ensure ESG is deeply rooted in investment approach by teams.

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13
Q

PRI Principle 2 and actions for LP/GPs

A
  1. We will be active owners and incorporate ESG issues into our ownership policies and practices.

Action LP: Within limited liability status, set up parameters for how LPs might engage with pf. company management and remain engaged post-acquisition.

Action GP: Establish processes to understand and manage material ESG risks and opportunities in partnership with the portfolio company.

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14
Q

PRI Principle 3 and actions for LP/GPs

A
  1. We will seek appropriate disclosures on ESG issues from the entities in which we invest.

Action LP: Request information from GPs about their RI practices and ESG characteristics of investments.

Action GP: Implement monitoring processes to assess pf. companies’ management of ESG factors.

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15
Q

PRI Principle 4 and actions for LP/GPs

A

We will work together to enhance our effectiveness in implementing the Principles.

Action LP/GP: Collaborate with peers and GPs to build consensus around RI practices in PE.

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16
Q

5 first steps an LP can take to get started with ESG

A
  1. Start a dialogue with your GPs
  2. Leverage the work across an organization
  3. Engage with industry peers at other LPs
  4. Review resources and leverage existing tools
  5. Identify and build current ESG processes
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17
Q

Recent supply chain regulations and legislations

A
  1. California’s Transparency in Supply Chain Act
  2. Dodd-Frank Act
  3. UK’s Modern Slavery Act
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18
Q

Two recent important changes in the market regarding ESG reporting

A

SASB, EU proposed taxonomy

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19
Q

Four modules for integrating ESG into the investment process

A

Module I - RI Policy, Beliefs and Goal Setting
Module II - Governance
Module III - Investment Process
Module IV - Monitoring & Reporting

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20
Q

100 day plan

A

post-transaction plan in a period where it is determined whether the investment evolves from potential to performance.

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21
Q

Emerging market factors vs developed markets

A
  1. Level of control and ownership
  2. Scope and volume of audited information
  3. Differences in regulatory regimes
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22
Q

Considerations when a LP wants to start monitor a GP

A 
Purpose
Frequency
Feasibility
Impact 
Change  
Published information
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23
Q

Eight key ESG monitoring practices

A
  1. exception-based reporting
  2. Using LPAC and AIM
  3. Using monitoring templates
  4. Assessment and scoring of GPs
  5. Using the PRI framework
  6. ESG incident & reporting
  7. Reviewing GPs’ internal ESG/CSR mgt.
  8. GP Feedback
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24
Q

ESG Principles of disclosure

A
  • Reporting on a whole fund basis
  • Alignment with existing financial reporting cycles
  • Disclosed information should be accurate & credible; balanced & objective
  • Clear allocation of responsibilities and oversight for ESG reporting
25
Q

Examples of ESG factors

A

Environmental:
Air & Water pollution
Biodiversity
Climate Change

Social:
Customer satisfaction
Data protection and privacy
Diversity and equal opportunities

Governance:
Accounting standards
Board composition
Business ethics

26
Q

3 issues of asymmetries embedded in the investment management process that frame the relationship between asset owners and asset managers

A
  1. Expertise (highly specialized functions)
  2. Information (Asset owners receive information that meet the test of relevance but fail test of decision criticality)
  3. Market power (large players, concentrated market)

They all favor the sell-side of the market

27
Q

Key characteristics of effective metrics and measurement (Lowenstein 1996)

A

Simplicity, transparency, and consistency

28
Q

Two assumptions that can be made that reflect the circumstances in every market

A
  1. Asset owners seek to maximize their risk-adjusted of return net of costs.
  2. Asset owners lack the skills and expertise to produce their own rate-of-return target net of costs.
29
Q

Two attributes of global financial markets that cause complications (with contracts, performance monitoring)

A
  1. Financial markets are subject to unexpected shocks that disrupt investment theories.
  2. Market behavior is heterogeneous
30
Q

Challenges in realizing benefits of insourcing over outsourcing

A

The effective management of the production process, and the capacity of senior managers to observe and motivate employees.

31
Q

Advantages of insourcing

A
  1. Ability to link parts of the investment production process to the ultimate goals of the organization
  2. Costs and consequences of not meeting the objectives of the organization can be directly observed.
  3. The acquisition and reconciliation of information can be framed around the asset owners’ needs
32
Q

Define culture

A

Norms and conventions that provide an asset owner’s employees with guidelines as to their expected behavior and relationships with other employees.

33
Q

Where can the capabilities of an asset owner be found? (key elements in the production function)

A

Quality of its staff, process of decision-making, and the information systems.

34
Q

Metrics framework

A

Effective metrics are:

  • consistent
  • function/task relevant
  • parsimonious and transparent
  • few in number
  • flexible and/or adaptive
35
Q

Single most important metric underpinning investment performance and commitment

A

“the ultimate purpose of the organization”

36
Q

Research related to private asset cashflows generally falls into two categories

A

Cashflow prediction model and private asset commitment strategies

37
Q

Limitations Cash Flow Matching (CFM) strategy

A
  1. volatile commitment pattern
  2. no control over how NAV will grow as % of total pf.
  3. Investors with no prior private capital investment program and NAV have to wait until the first distributions before cash flow matching is possible.
38
Q

Four categories of portfolio liquidity demands

A
  1. GP Capital Calls
  2. Rebalancing
  3. Dry Powder Creation (tactical move into higher beta assets)
  4. Dry Powder Reversal (adjust public stocks/bonds) back to their initial relative weights.
39
Q

Definition liquidity event

A

When an investor must move down the waterfall to find liquidity

40
Q

PE has the following factor-tilts over public equities

A

equity risk, (il)liquidity premium, size, value

41
Q

Explanation for the post-2006 decline in PE’s realized excess returns?

A
  • Richening of PE valuations

- gradual decline in PE leverage

42
Q

Artificial intelligence

A

the ability of a machine to perform cognitive functions we associate with human minds

43
Q

Types of analytics

A

Descriptive (describe what happened)
Predictive (anticipate what will happen)
Prescriptive (provide recommendations on what to do to achieve goals)

44
Q

Major types of machine learning

A
  1. Supervised learning
  2. Unsupervised learning
  3. Reinforcement learning
45
Q

3 Types of Supervised Learning Algorithms and their use cases

A
  1. Decision tree - provide framework for hiring employees
  2. Random forest - predict call volume in call center for staffing decisions
  3. Simple Neural Network - predict probability that a patient joins a healthcare program
46
Q

3 Types of Unsupervised Learning Algorithms and sample use cases

A
  1. K-means clustering - Segment customers into groups by characteristics
  2. Hierarchical clustering - Cluster loyalty-card customers in more micro segmented groups
  3. Recommender system - recommend what movies consumers should view based on preference of consumers with similar attributes.
47
Q

2 Major deep learning methods and their use cases

A
  1. Convolutional Neural Network (CNN) - infer data from unstructured data set (e.g. images)
    - > detect diseases from medical images
  2. Recurrent Neural Network (RNN) - infer data from time-series data or sequences (e.g. audio or text)
    - > Provide language translation
48
Q

Three ways longevity risk impacts pension plans

A
  1. underestimate actual increases in human life spans
  2. Medical breakthroughs
  3. Not applying assumptions conservatively
49
Q

Drivers of underestimation of longevity risk

A

Rapid and unforeseen medical advances, healthcare delivery, and poverty alleviation

50
Q

Three-pronged approach to better address longevity risk

A
  1. Implement robust framework (to analyze/measure)
  2. Assess toolbox of investment and protection actions
  3. Evaluate the desirability, potential timing, and likely cost of risk transfer actions
51
Q

Effect of life expectancy on duration of liabilities

A

6 years’ increase in average life expectancy will increase duration by 1 year

52
Q

2 Ways of transferring pension risk

A

Buy-in: insurance contract that enables sponsors to transfer interest rate, investments and longevity risk to an insurer.

Buy-out: transferring assets/liabilities to an insurance company which guarantees the payments to participants for life.

53
Q

Blockchain

A

Allows for the creation of immutable records of transactions accessible by all participants in a network. It is fully peer to peer, with no trusted third party.

54
Q

Basic elements of Distributed Ledger Technology (DLT)

A

a digital ledger, a consensus mechanism to confirm transactions, and a network of node operators.

55
Q

Two characteristics of Bitcoin

A

Open network: open to any user who wishes to transact, and all users can see all transactions on the block chain.

Permissionless: Consensus mechanism

56
Q

Chief advantage of a permissionless network

A

it does not require a central authority to confirm or deny specific transactions

57
Q

Possible applications for blockchain

A

Digital assets/currencies/record keeping, Smart Contracts

58
Q

Benefits that may arise from the use of blockchain technology

A

Reduction in settlement periods (post-trade) and faster payments.

59
Q

Technical and business challenges regarding blockchain

A

Standardization, Interoperability, Scalability , Efficiency

CAIA Level 2 2021 (9 decks)

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