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CFA Level II 2020 COPY (552) > Portfolio Management > Flashcards

Portfolio Management Flashcards

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CFA flashcards
1
Q

Multi-factor models

A
  1. Macroeconomic models; returns explained by surprises (GDP, interest rates, inflation, etc.)
  2. Fundamental factor models; explained by factors (P/E ratio, market cap, small, value, etc)
  3. Statistical factor models; variance and covariance explain models
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2
Q

Stock Price Sensitivity

A

(P/Es - P/Em) / Std of P/E

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3
Q

Arbitrage Pricing Theory (APT) Purpose and Assumptions

A

Purpose: Describes the equilibrium relationship between expected returns and systematic risk

Think: factor * sensitivities

Assumptions

  1. Unsystematic can be diversified away
  2. No arbitrage opportunities
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4
Q

Active Return

A

Rp - Rb

OR

IR * active risk

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5
Q

Active Standard Deviation

A

Purpose: is the standard deviation of the active return

Sq rt [(Rp-Rb)² / n - 1

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6
Q

Information ratio (IR)

A

Purpose: active return per unit of active risk. Measures manager’s consistency

R = (Rp - Rb) / Std(p) -Std(b)

OR

IR = IC * √BR

Note: It is affect by leverage

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7
Q

Active specific risk

A

Active specific risk = (Wp - Wb)² * residual risk²

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8
Q

Tracking vs Factor Portfolio

A

Tracking portfolio; tracks an index by matching the underlying factors

Factor Portfolio; looks at the sensitivity of one factor while setting all others to zero

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9
Q

Ex-Ante

A

Purpose: based on expectations (cannot be negative)

Formula: Return = ExpectedRp - ExpectedRb

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10
Q

Ex-Post

A

Ex-post: after the fact (can be negative)

Formula: Realized Return - benchmark return

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11
Q

Sharpe Ratio

A

Sharpe Ratio = Rp - Rf / Std Dev P

is unaffected by the addition of cash or leverage

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12
Q

Targeting Risk: Simple

A

To get the risk down you can just have cash

Std Dev of what you want / Std Dev of what you have

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13
Q

IR Analysis

A

The IR in unaffected by the aggressiveness of the active weights (return goes up but so does risk)

You can decrease risk by investing in the fund AND the benchmark

Can increase by shorting the by shorting benchmark and doubling down on the fund

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14
Q

Sharpe Ratio of an Active Portfolio

A

SRp² = SRb² + IR²

highest IR will produce the highest SR

Note: DONT FORGET TO TAKE THE SQUARE ROOT

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15
Q

Optimal active risk

A

Optimal active risk = (IR / SRb) * Std(b)

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16
Q

Total portfolio volatility

A

Total portfolio volatility = Std(b)² + Std(a)²

Std(a) = volatility of active return

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17
Q

Information coefficient (IC)

A

Measures manager skill

Ex-Ante: Expected correlation between active returns and forecast active returns (typcially small positive (<0.2)

Ex-post: IC measures actual correlation between active returns and forecast active returns

18
Q

Breadth (BR)

A

Number of independent bets

Needs active returns correlated cross-sectionally and uncorrelated over time

19
Q

Transfer Coefficient (TC)

A

Purpose: Correlation between actual active weights and optimal weights

TC = 1 for unconstrained portfolios

TC < 1 with constraints

20
Q

Grinold (1994) Rule

A

Forecast of AR = IC * Std * S

S = scores

21
Q

Fundamental Law

A

Basic Fundamental Law (unconstrained)

Full Fundamental Law (constrained)

Only difference is TC if they are constrained.

22
Q

Fundamental Law:

IR

Expected Return

A

Expected active return

IR = (TC) * IC * √BR

ER = (TC) * (IC) √BR * Stdactive

Note: remove (TC) if uncontrained

23
Q

Fundamental Law:

Optimal SR

Optimal Level of Active Risk

A

SRp² = SRb² + (TC)² * IR²

Stdactive = [TC * (IR/SRb)] * Stdb

Note: Remove (TC) if it is unconstrained

24
Q

Conditional expected active return

A

CER = (TC) * (IC) * √BR * Stdactive

25
Q

Clarke, de Silva, and Thorley

A

Ex-post decomposition of realized active return variance

Two Components:

Variation due to realized IC: TC²

Variation due to constraint induced noise: 1 - TC²

Example:

A (TC) of 0.8

64% (0.8²) of variation in performance is attributed to the realized IC

36% comes from constraint induced noise

26
Q

IC of a market timer

A

IC = [2 * (# of bets correct/# of bets)] - 1

Example:

Dash is correct 53% of the time. Nunos makes monthly bets on 10 stocks. Has IC of 0.04. Calculate the # of bets Dash needs to make to match the IR of Nunos:

  1. Nunos IR = IC√BR = 0.04 * √10*12 = 0.438
  2. Dash IC = 2(% correct) - 1 which is 2(0.53) - 1 = 0.06
  3. Then solve for BR (this is where you can plug in the answers into the IC * √BR
27
Q

Quarterly Information

A

If given quarterly standard deviations, you need to annualize. Multiply by the square root of 4

28
Q

Marginal Utility

A

Consumption is higher during period of scarcity

Higher expected incomes =

  1. Consumption is lower
  2. Real rates are higher
29
Q

Investors increase savings rate when

A

Expected returns are high

When uncertainly about future income increases

30
Q

If GDP growth rates are high

A
  1. Investors expect higher income in the future
  2. Current consumption is preferred over future
  3. Rate of substitution will be low
  4. Interest rates high
31
Q

Nominal Risk-Free Rates

A

r(short-term) = r + i

r(long-term) = r + i + rp

R = real risk free rate, i= inflation, rp = risk premium

Short-term, policy rates are positivity related to inflation gap and output gap

Gap is the difference between actual and expected

32
Q

Traylor Rule

A

real rate + inflation + 0.5(inflation - target inflation) + 0.5(log of output - log of sustainable output)

33
Q

YC and Business Cycle

A

S/t rates are low during recessions, long-term rates are high (due to expectations)

Positively sloped YC during recessions. Expectations are that things will go up

Inverted YC is indicative of late stages of economic expansions (indicator of recession)

34
Q

Term Spread

A

Term Spread = yield on l/t bond - yield on s/t bond

Normal term spread is positive and attributable to the risk premium for uncertainty in inflation

35
Q

Break-Even Inflation Rate (BEI)

A

BEI = nominal yield on default-free bond - real yield on default-free bond

THINK: treasury - TIP

BEI = i + rp

36
Q

Credit Spread on Risky Bonds

A

credit spread = additional risk premium for credit risk

Increase during recessions, shrink during good times

When spread narrows, lower rated bonds outperform

When it widens, opposite occurs

THINK: of the value of bonds as the yield changes

37
Q

Industry Sensitvity to Recessions

A

1, Cyclical industries are more sensitive (durable goods, consumer discretionary)

2, Customer stapes/nondiscretionary are more stable

3, Value performs well during recession

  1. Growth performs well during economic expansions
38
Q

Factors Affecting Ability to Take Risk

A
  1. Spending needs
  2. l/t wealth target
  3. Financial strength
  4. Liabilities
39
Q

Return objectives

A

Desired return (stated by client)

Required return (determined by l/t goals)

Must be consistent with risk objective

40
Q

Return/Risk Tolerance for Different Client Types

A

Investor Return Requirement Risk Tolerance

Defined Benefit Sufficient to fund pension Depends on plan

Endowment/ Cover spending avg or above avg
foundation

Life Insurance Function of policy holder Regulations so below avg

41
Q

Investment Constraints

A

Purpose: factors that limit available investment choices

  1. Liquidity: cash outflows > income
  2. Time horizon: time period for the portfolio

l/t is more than 10 years

  1. Taxes
  2. Legal/regulatory: external constraints
  3. Unique circumstances

CFA Level II 2020 COPY (552) (13 decks)

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