Phase 2

Question 1

Markowitz Portfolio Thoery Suggests:

Answer 1

Overseas diversification can reduce risk and increase returns. Improving the efficient Frontier. BRIC and developed overseas multinationals (Microsoft & Apple) as well as companies with an economic moat provide access to speialist companies.

Question 2

What are the minimum S&P and Moody ‘s investment grades?

Answer 2

S&P = BBB- Junk = BB+
Moodys = Baa3 Junk =BA1

Question 3

Explain Key points of an Absolute Return Fund

Answer 3

Must comply with UCITS 3 portfolio concentration and illiquid assets
Restricted to 10% NAV for gearing.
Seek alpha.( Return in excess of cash rate)
Not benchmark hugging.
Like hedge funds they have ability to short and use derivative.
More regulated than hedge funds

Question 4

Explain key points of a Hedge Fund

Answer 4

Highly Geared
High minimum sums and high charges often 2:20
lack transparency
Offshore and non reporting
special situations / aggressive growth
Not regulated to the same extent as absolute return funds.

Question 5

With SAA what is Dynamic Asset Allocation?

Answer 5

Constant Proportion Portfolio Insurance: As the portfolio value falls more is put in the safe asset. Two portfolios - Risk premium assets and a hedge portfolio to meet liabilities.

Question 6

What is the objective of a default fund?

Answer 6

Supports payment of a pension.
Direct Contribution scheme so investor bears risk.
A balanced portfolio to protect downside and fit in with the investment cycle and outperform inflation by 3%

Question 7

What is the efficient frontier

Answer 7

Selecting high risk adjusted returns.
Risk vs Return Optimal weighting.
“Pairwise covariance as low as possible”

Question 8

What is the CC formula?
What is the Cov Formula?
What is the Coefficient of determination?

Answer 8

CC = COV / (SDa x SDb)
Cov=SDa x SDb x CCab
CoD = CC^2

Question 9

What is the CAPM formula?

Answer 9

Rj = Rf + B (Rm-Rf)
Expected return of stock
Grph x=beta y= expected return

Question 10

What is the Total Risk Calculation?

What is the three factor model?

Answer 10

Total Risk^2 = sqr root of unsystematic risk ^2 + systematic risk^2

3Factor = Rf + multiple1 + multiple2 + multiple3

Question 11

What is the securities Market Line?

Answer 11

Line shows expected return for a given level of risk
Shows return to systematic risk calculated by CAPM
Moves along represent change in stock risk characterisitics
Moves up show increased expected return for increased risk.
change in slope = new attitudes so higher return for a level of risk.
A shift represents change in risk free rate/inflation or real growth.

Question 12

How is arbitrage Pricing theory similar to CAPM

Answer 12

Both are equilibrium theories.
Both use Rf as the intercept
In equilibrium all expected returns derive from systematic common factors.

Question 13

How many stocks to efficiently reduce portfolio risk?

Answer 13

15 - 30 after this the benefits reduce.
Portfolio risk is reduced around 34.5% relative to holding a single stock.
Doesn’t neccesarily have to be negatively correlated stocks although a spread of across sectors will see greater diversification benefits sooner than say all oil stocks.

Question 14

4 Reasons full tracking index funds will unlikely ever be zero?

Answer 14

-Rebalancing and the costs asociated due to contributions and withdrawals/dividends received.
-Timing of buying and selling stocks and changes in price of stock after entering or leaving the index.
-round lot purchases if stocks can only be baught in 100s will result in a slight mismatch in the weight of a stock in an index.
Dividend reinvestment may be performed gross on index when it is reinvested net. Divs may be too small to reinvest.

Question 15

what are the three Market Indexes?

Answer 15

Market Cap Weighted (FTSE 100)
Price Weighted (DJIA)
Equal Weighted (Nikkei 225)

Question 16

List three techniques for constructing an index portfolio?

Answer 16

Full replication -buy stocks in correct proportions
Sampling - Buy representative sample of stocks
Quadratic programming - Portfolio weights chosen by an optimiser to minimise returns deviation from benchmark.

Question 17

list four things to be mindful of in Designing a portfolio

Answer 17

Diversification
Liquidity
Costs and charges
betas and risk
active vs passive strategies
Sources of risk premia

Question 18

betas applied

Answer 18

balanced - 0.8
equity growth - 1.2
global equity - 0.95
global high yield - 0.4
direct property securities - 0.7
Direct property - 0.5
money market - 0.1

Question 19

Behavioural Finance. What is CPPI, regret aversion and Myopia?

Answer 19

Manage Client expectations as clients see upside not downside.
“bounded rationality - problems choosing due to wide choice of complex investments leads to choice overload. Choose carefully thought out base portfolio.
More concerned over loss than making gains and 3 year run of losses may stop investment.
CPPI constant proportion portfolio uinsurance and dynamic asset allocation may be applied
High risk starts may lead to a poor experience.
Regret aversion causes clients to hold onto poor investments longer.
Myopia shows when clients have made a decisionthey tend to stick to them

Question 20

Appraise how immunisation is a passive strategy.

Answer 20

Ability to match duration of assets and liabilites you meet either by barbell or bullet. Bond price risk and reinvestment risk cancel each other out.
Rebalancing is neccessary in order to ensure durations dont become unmatched.

Question 21

What is liquidity premium?

Why are dividends good and bad?

Answer 21

Companies who are not easily liquid will require a liquidity premium if cash cannot be easily generated.

Lower dividend paying companies could have higher long term growth prospects. However “dividend payments are a source of discipline for corporate boards”

Question 22

What are the EMH Strong form assumptions?

Answer 22

Large no. of profit maximizing participants.
Profit maximising investors adjust security prices rapidly to reflect effect of new info becoming available.
Relevant info available to a sufficient no. investors.

Question 23

What is the Pure Expectations Theory

Answer 23

You may as well hold 10 -1 year bonds than 1 -10 year bond as it is assumed expected interest rate changed are already priced in.

Question 24

What is liquidity preference Theory?

Answer 24

Price risk is more significant in longer dated bonds. Investors require a higher yield on longer dated bonds due to greater price volatility. - Modified duration measures % change in market price for a 1% change in redemption yield.

Question 25

What is segmented market theory? Aka preferred habitat theory?

Answer 25

Separating short medium and long term sections of the yield curve to be independent of each other with differing forces affecting supply and demand.

Question 26

What does the UK corporate governance code require?

Answer 26

Board leadership
Accountability
Remuneration policies
Best practice with shareholder relations.

Question 27

What does the Walker Report apply to?

Answer 27

Banks

• Introduces mandatory risk committee.
• Stewardship code for institutional investors.

Question 28

What is liquidity premium?

Why are dividends good and bad?

Answer 28

When the liquidity premium is high, then the asset is said to be illiquid, which will cause prices to fall, and interest rates to rise.

Lower dividend paying companies could have higher long term growth prospects. However “dividend payments are a source of discipline for corportate boards”

Question 29

What is the equation for the risk of Portfolio using a risk tolerance factor?

Answer 29

Risk of portfolio = Expected Risk - (SD/RTF)

Question 30

What is the Stewardship code 2012?

Answer 30

The UK Stewardship Code is aimed at Investors.

• improve long-term risk-adjusted returns to shareholders
• Owned and published by the Financial reporting council.
• Director accountability, consistency and persistence
• Mutual understanding of objectives
• Alerts the companies to investor opinion

Question 31

What is the shareholders rights directive?

Answer 31

The SRD empower private client and wealth management sectors to ensure the right decisions are made for longevity of a company.

• Transmission of info to shareholders
• Remuneration and related party transactions.
• Encourages use of voting rights on company decisions

Question 32

What is value investing?

Answer 32

Efficient firms
Seeking Inexpensive and undervalued although they will usually have high PTB ratios
Generally less risk and low beta
Long termView

Question 33

What is growth investing?

Answer 33

Rapid growth prospect stocks
Often early stage companies
Small / Mid caps
Low PTB ratios
EM and Special situations may be strategies
Long term view

Question 34

What is Momentum investing?

Answer 34

High returns for last 3-12 months on a stock
selling poor running stocks
exploiting behavioral shortcomings
Short term strategy

Question 35

What does the combined code on corporate governance state?

Answer 35

Under section D of the combined code of corporate governance the companies NED must understand the views of shareholders so he can communicate with the board.

Question 36

List 5 to 7 things you require from the outset of a client relationship.

Answer 36

Client circumstances
tolerances
constraints
tax position
liquidity needs
Income or growth
time horizon.

Question 37

list 3 active bond management strategies?

Answer 37

Anomoly Switch - Exact same bond in terms of coupon, maturity, quality. Capitalising on a market pricing difference
Policy Switch - Seeking long term bonds if interest rates are expected to FALL and vice versa
Riding the yield curve - Picking up increased yield from longer dated bonds with potential to realise capital gain if interest rates fall and selling before maturity.