IPT 1 Chapter 27

Question 1

What is the benchmark risk

Answer 1

The standard deviation of the tracking error

Question 2

How is the tracking error estimated?

Answer 2

Estimated from a time series of differences between the returns on the overall risky portfolio and the benchmark return

Question 3

How do Treynor & Black suggest that many low-quality signals still add up to efficiency again?

Answer 3

1. Regress historical actual alphas against alpha forecasts
2. Then use estimated coefficients to adjust current alphas

Question 4

How do we arrive at an optimal portfolio using the Black-litterman model?

Answer 4

1. Estimate the covariance matrix from historical data
2. Determine a baseline forecast by combining the estimated covariance matrix and a model of equilibrium returns
3. Integrate the managers private views
4. A new set of expected returns
5. Run the Portfolio optimization

Question 5

What is the Dollar cost Averaging (DCA)?

Answer 5

An investment strategy to reduce the volatility during large purchases of financial assets

Question 6

What are teh two option of DCA?

Answer 6

1. Lump sum investing: invest all your money into a diversified portfolio
2. Invest in stages

Question 7

What are reasons to make ones investment strategy dependent on time horizon?

Answer 7

1. You believe that in the extreme event the risk-free asset will also have a catastrophic return
2. You are willing to accept more risk for a longer time horizon
3. You believe that returns are not random but exhibit mean reversion