Portfolio Management

Question 1

What are the four desirable qualities of a benchmark?

Answer 1

1. Representative of the assets in which the investor will want to invest
2. Allows investors to replicate benchmark positions at low cost
3. Weights should be verifiable ex ante
4. Return data should be timely ex post

Question 2

Give two examples of indices

Answer 2

Cap-weighted

float-adjusted

Question 3

State two characteristics of a Cap-weighted index

Answer 3

self-rebalancing

can be held simultaneously by many investors

Question 6

Explain the components of investment value that are affected by economic factors and growth expectations

Answer 6

1. Forecast future cash flows 2. Discount Rate applied by investors.

Question 7

What are the 3 components of the discount rate applied by investors that affect market values

Answer 7

These all relate to the PV of future cashflows of an investment 1. Default free rate (YTM of default free bond), R 2. Expected inflation rate, pi 3. Risk premium applied due to uncertainty in future cash flows

Question 8

How do changes in expectations affect market values

Answer 8

1. Future cashflows are anticipated based on current information 2. Surprises due to unanticipated changes from current information such as growth, earnings surprises cause a change in PV future cash flows which includes PV future growth opportunities. 3. Positive surprises are new information better than expected. 4. Negative surprises are new information worse than expected.

Question 9

How are real interest rates dependent on a) long term economic growth and b) volatility of the growth?

Answer 9

1. Rates for bonds go down when demand is high. (price goes up, discount down) 2. Demand for bonds goes up when aggregate savings goes up 3. Higher economic growth encourages optimism for future growth of cash flow and future prices of goods. A. Current spending increases, current saving decreases. B. MUc increases, MUf decreases - > ITSR descreases 4. Higher volatility of growth discourages optimism of future growth of cash flow. A. Current spending decreases, current savings increases B. MUc decreases, MUf increases - > ITSR increases

Question 10

What affects the ITSR, the choice to spend now or in the future

Answer 10

1. If the opportunity cost of not spending in now is higher than opportunity cost of spending now. (MUc increases) 2. If relative price of goods worth P today is higher than PV of future returns on a bond worth P purchased today (MUc increases)

Question 11

What is the Marginal Utility of consumption, MU

Answer 11

The additional satisfaction of one unit of consumption at t

Question 12

What is the ITR? What does it measure?

Answer 12

1. ITRS is inter temporal rare of substitution 2. ITRS is proportional to willingness of investors to increase future spending by saving now 3. MUc down, Savings up, Future spending up, ITRS up