PM Flashcards
Describe the process of ETF share creation
The authorized person (market maker) buys all the underlying securities, then gives them to the ETF issuer in exchange for ETF shares. Then these shares get sold on the open market
What is an AP
Authorised person
How does an AP make an arb profit (say if the ETF price is above the underlying price of the underlyings)
So, the market maker will go out and buy the underlying securities, and then trade them for an ETF worth MORE than what they paid, then sell that on the open market. Boom profit.
Alternativley, the AP could take an ETF ticket they have, and recieve a redemption baset, then sell them instantly for a profit. Boom
What is smart beta
Smart beta is like quant. It is a long term risk management strategy that take out, or cater toward certain charecteristics, like quality, or dividend growth or credit duration
How do you calc tracking error
Annualised daily standard deviation
What are the tax benefits of ETFs
Cheaper capital gains laws that mutual funds, mutual fund redemptions effect other shareholders, Return of capital is not taxed, ETFs distribute less capital gains
What is the difference between rebalancing and completion
Rebalancing is ensuring that all target weights are satisfied
Completion is ensuring you have no cash drag. Making sure you’re fully invested.
Why is there a buy/sell spread
Reduce liquidity risk, creation and redemption process or ETFs, market maker compensation
Does NAV = Price?
No, not on ETFs
What is the Arb Pricing Theory formula
it is the same as the multifactor model
Return = a + beta1 + beta2 + error etc.
OR
Expected return = risk free + beta 1 + beta 2 + error
What is a factor risk premium in arb pricing model
It is the Lambda, so like in multiple regression, not the beta, but the X variable
Name the 3 types of multifactor models, and what each one does
Macroeconomic, Fundamental and Statisitcal
Macro does macro factors, fundamental does fundamental and stat is a regression (which is not easily interperted.
What is the formula for a macroeconomic multifactor model
Return = expected return + beta1 variable + beta2 variable + error
What are the x variables in a macro model?
The suprises/ differences in the expected results from the actual results. Everything before that is already priced in
How do you determine the beta/sensetivities of a fundamental model
It is the value - average / sample SD
If the benchmark has a 1% weight to Scotland, and you have a 0% weight to scotland stocks, are you taking an active position?
Yes
Formula for tracking error
Sample SD (Portfolio return - BM return)
Formula information ratio, do you want it high or low
HIGH
Av Return Portfolio - Av return BM / Tracking error
What does profit do to equity?
Increase equity yoy
WHat is VAR
The amount one could lose of a portfolio in a certain amount of time
What are the three methods of calculating VAR, give me a quick 411 on how they work
Paraemteric Method - USES PARAMETRES, like mean (expected return) and SD. Takes the mean, and subtracts standard deviation times number of standard deviations UNDER the mean to get VAR . e.g. -1.65 to get 95%
Histortic - Get the distribution, what is the 5th percentile? Thats the VAR
Monte carlo - get the computer to do it
How to do VAR calculation, first 2 steps
Convert all data to risk data, then get all historic data
Limitation of Parametric VaR
Cant calculate options
The god and bad of VAR?
Good:
Easy, reliable, accepted by regulators, good for asset allocation
Bad:
Subjective, does not take right tail events into consideration, oversimplified
What is conditional and incremental VAR
Conditional is VAR if normal VAR is breached,
Incremental is VAR is portfolio size increases
Parametric Method formula
Mean - (omega * z) = VAR
What does increased correlation do to standard deviation?
Increase
If expectations are future times will be good (pay rises etc.) what will this do to current interest rates and why?
Current interest rates will INCREASE because current consumption will INCREASE because people arent concerned about the future
High volatility does what to interest rates?
Raises them
Investor breadth pretty much means I correlated returns
Not a question
Formula for allocation return and then portfolio return
Allocation = (Wportfolio - Wbm) * Return bm Security = (Rp - Rbm) * Weight portfolio
Sharpe ratio formula to make ideal combination of passive and active portfolio
Sharpe sqaured * Info ratio squared = New standard deviation squared (improved?)
from alts, exaplin spot, roll and collateral yield
Total return = Spot return + Roll return + Collateral return + Rebalancing return
The spot return is simply the price appreciation in the spot price, which is based on immediate delivery, of the commodity.
The roll yield is how the VALUE OF THE CONTRACT CONVERGES TO THE FUTURE PRICE AS THE CONtrACT COMES TO EXPORATION. UP IN BACKWARDATION AND NEG in Contango
Collateral return is the return accruing to any margin held against a futures position and which is normally the U.S. T-bill rate.
Which type of portfolio has a higher info ratio? Constrained or unconstrained
Unconstrained, because the transfer coefficient is always 1, whereas a constrained portfolio has a transfer coefficient of less than 1
If i increased the active share of a portfolio , would it effect the info ratio
No
Does cash effect the sharpe ratio
No
What are the 3 components to the EX ANTE (predictive) info ratio?
Transfer coefficient
Investor Breadth
Info coefficient
What is investor breadth
How many active investment decisions are made
What is the formula for the ex ante information ratio
Info coefficient (the regression coefficient) * sqaure root Investor breadth * transfer coefficient
What is the formula for the optimal amount of active risk?
Active risk = (Info ratio / Sharpe of BM) * omega BM
Does rebalancing effect the information ratio
Does adding cash effect the sharpe ratio
No No
What is the fundamental law of active management, and what is its output
Information coefficient * Transfer coefficient * square root of investor breadth = Information ratio
What is the fundamental law of active management, and what is its output
Information coefficient * Transfer coefficient * square root of investor breadth = Information ratio
Name and describe all the implicit costs in electronic trading
Buy sell spread (yes it is implicit)
Market Impact (buying liquidity and making the price go up)
Slippage (doing smaller trades instead of big ones, meaning your price may not be constant)
Opportunity Cost
What is the effective spread, and what if it is less than the bid ask spread
it is a good calcualtion of transaction costs. It is 2*(execution price - midpoint). That is for a buy. If it is less than the actual buy sell spread, there is a liquid market or you are an effective trader
Which two IMPLICIT costs are inversly related (as one goes up, the other goes down) and why
The market impact and slippage. It is because if you buy in a big quantity and one transaction (market impact), you are not trading over time when the prices could change.
Which two IMPLICIT costs are inversly related (as one goes up, the other goes down) and why
The market impact and slippage. It is because if you buy in a big quantity and one transaction (market impact), you are not trading over time when the prices could change.
What are the 3 ways of measuring transaction costs, explain them
Effective spread
Volume Weighted Average Price (average price of the day based on volume, if you bought for lower, you did well)
Shortfall implemendation. Imagines you invested under ideal conditions and compares that investment against what actually happened. The difference in performance reflects ALL explicit and implicit transation costs
which is the best measure of transaction costs?
Shortfall implementation
How can VWAP be manipulated
Trading at times during the day that suit you to make you look like you got the best deal
What is the Taylor rule? Hard
i* = rneutral + inflation expectation + 0.5(GDP expected - GDP trend) + 0.5(Inflation expectation - inflation target)
This is the policy rate the central bank should implement
Is a lower or higher shortfall implementation better and why
Lower shortfall implementation is better because you operated closer to the paper portfolio (imaginary portfolio) meaning you did well
Derivatives - does implementing a delta neutral strategy hedge out large moves in the underlying?
No, only small moves, you need a gamma neutral strategy to account for large moves
What does market impact mean
Change in trade price
What is market fragmentation?
Having a securiy trade on multiple different exchanges. It increases the arb potential and decreases transaction costs
Are low latency or high latency traders better?
Low
Is VAR the min or max loss>
Min
