Portfolio Management

Question 1

What investments are preferred for a taxable account?

Answer 1

– Index and other passive funds
– Growth funds with low turnover
– Tax-managed funds
– REITs (could be better for either type of account)
– Municipal bonds

Question 2

What types of investments are preferred in a tax deferred account?

Answer 2

– Dividend stocks
– Most taxable bonds
– Actively management, high turnover funds
– Partnerships “IF” they avoid UBTI

Question 3

What are components of tax efficiency

Answer 3

– Tax rates
– Tax rules
– Turnover
– Tax lot identification and management
– Tax gain/loss harvesting
– Wash sale-rules
– Asset location
– Measurements

Question 4

how to calculate the pretax rate of return?

Answer 4

Divide the total income received while owned by the price paid.

or the after-tax rate of return divided by one, minus the tax rate.

Question 5

how do you calculate the after tax rate of return

Answer 5

Subtract your percentage tax rate on the security’s income from 1. Multiply your result by the pretax return to calculate the after-tax return on the income.

Question 6

How do you calculate the tax equivalent yield

Answer 6

Tax Equivalent Yield = Tax Free Rate of Return / (1 - Tax Rate)

Find the reciprocal of your tax rate (1 – your tax rate). Divide this amount into the yield on the tax-free bond to find out the tax equivalent yield.

For example, if the bond in question yields 3%, use (3.0 / .75) = 4%.

Question 7

What is the tax adjusted alpha hurdle for a traditional equity manager needed to outperform passive or indexed alternative?

Answer 7

3%

Question 8

What is Pair-Wise Trading?

Answer 8

matching a long position with a short position in two stocks with a high correlation.

Question 9

Capital Gains Realization Rate

Answer 9

the percentage of the fund’s net unrealized capital gains that the manager chose to realize

Question 10

Relative Wealth Measure

Answer 10

A more helpful metric for measuring after-tax efficiency for separate accounts.

The Relative Wealth Measure (RWM) measures the amount per $1,000 of assets that needs to be invested at the pre-tax return to pay the tax liability

the higher the better; zero indicates little tax impact

Question 11

What does tax-efficiency measure?

Answer 11

Tax efficiency measures how much of a pre-tax return an investor keeps after paying tax liabilitieson realized or unrealized gains.

There are three commonly used measures or efficiency ratios:

Capture Ratio
RAT/ RBT

Relative Wealth Measure
( [RAT – RBT ] / [ 1 + RBT ] ) X 1,000

Morningstar Tax-Cost Ratio
(1 – [ (1 + RAT) / (1 +RBT) ] ) X 100

where:
RAT = return after tax return
RBT = return before tax

Question 12

What is the Consultant Capture Ratio

Answer 12

captures the percentage of return that taxable investors retain

CCR = after-tax return divided by before-tax return

works well in smooth, upward-trending markets

Question 13

What is the Accountant’s Ratio

Answer 13

equals the ratio of short-term capital gains realized to total capital gains realized

Question 14

What are some characteristics of AI?

Answer 14

Concentrated or diversified
Often illiquid
High fees and expenses
Lowly or uncorrelated to traditional investments
Low to high-risk spectrum
Not very transparent
Not highly regulated
Constraints for investments and withdrawals
Reporting inaccuracies and biases

Question 15

Benefits and Risks of AI?

Answer 15

Benefits: diversification, hedging, performance, innovation, leverage, etc.

Risks/Disadvantages: lock-up periods, high fees, taxes, lack of transparency, reporting standards, less regulation, risk of total loss, leverage, volatility, illiquidity, etc.

Question 16

What is Contango and backwardation?

Answer 16

terms used to define the structure of the forward curve.

When a market is in contango, the forward price of a futures contract is higher than the spot price.
contango indicates immediate supply

Conversely, when a market is in backwardation, the forward price of the futures contract is lower than the spot price.

backwardation good for investors who are “net long”
backwardation indicates short supply

Question 17

What is the J Curve

Answer 17

relates to the expectation that for some investments, such as private equity, there are negative cash flows for several years before leading to positive cash flows in later years.

Question 18

What is the Vintage Year Concept?

Answer 18

The first year of an investment.

The vintage year analysis is common for venture capital projects and other pe investments and RE investments.

Question 19

Master Limited Partnerships require what percentage of cash flow comes from real estate, commodities, or natural resources?

Answer 19

90%

Question 20

What is the process that measures the efficiency of various mixes of assets or investments that seeks the optimal combination of choices through diversification that minimizes risk per unit of return gained

Answer 20

Mean-Variance Optimization

Question 21

What is Strategic Asset Allocation

Answer 21

crafting a portfolio of various asset classes with specific target mixes. The objective of strategic allocation is to maintain these mixes.

Usually, this mix will not be changed over time unless there are significant changes in the investor’s objectives or tolerance for risk. Other than possible changes that trigger an adjustment in the allocation, the advisor will simply rebalance the portfolio to bring it back to the original allocation over time when using the strategic asset allocation approach.

Question 22

What is Tactical Asset Allocation

Answer 22

an active management strategy.
Allows the advisor to change a portfolio allocation based on convictions about various asset classes looking forward. At its simplest level, an advisor using tactical asset allocation may overweight or underweight stocks or bonds in an investment portfolio.

Question 23

What allocation strategy is sometimes referred to as market timing.

Answer 23

Tactical Asset Allocation

Question 24

What is Dynamic Asset Allocation

Answer 24

changing the allocation of the portfolio based on market conditions.

Question 25

What is a collar

Answer 25

options strategy that involves buying a downside put and selling an upside call that is implemented to protect against large losses, but which also limits large upside gains.

intends to lock in profits by buying downside protection while calls are sold to generate income to help pay for this downside protection; properly
executed collars preserve capital and the holding period of low cost basis stock

Question 26

What is a straddel?

Answer 26

an investor purchases both a put and call on the same security with the same strike price and expiration.

used when an investor believes the stock price will move significantly but does not know which way the stock will go (up or down)

Question 27

What is a Strangle?

Answer 27

where investor holds a put and a call on the same asset, with the same maturity, but with different strike prices.

used when there is an expectation of large price swings in the underlying asset

Question 28

What are Spreads

Answer 28

the option derives its value from the price difference between two or more underlying assets.

A spread is a combination of two or more calls (or two or more puts) on the same stock with differing exercise prices or times to maturity.

Question 29

What type of spread option has an investor buying and selling options on the same underlying assets with the same strike price but different date?

Answer 29

Horizontal spread.

Question 30

What is the purpose of Value at Risk?

Answer 30

it can be used to budget portfolio risk.

To determine the value of the diversification, the advisor could take the sum of each manager’s VaR and subtract the VaR of the whole portfolio. This would give the VaR benefit from diversification keeping in mind that a variance/covariance matrix must be used.

Question 31

What is risk parity?

Answer 31

uses risk to determine allocations across various components of an investment portfolio.

Evolved a from Modern Portfolio Theory investing.

Targets specific levels of risk and to divide risk across the entire investment portfolio to achieve optimized portfolio diversification.

asset allocation should be designed to balance risk (although not perfectly)

common risk components include equities, credit,
interest rates and commodities

many risk parity portfolios leverage lower risk
assets to achieve an acceptable expected return

Question 32

What are 4 risk management strategies?

Answer 32

Low volatility funds
buy-write strategies
factor-analysis models
volatility index.

Question 33

What is factor analysis?

Answer 33

Method for analyzing risk and performance characteristics beyond the traditional asset classes
Often based on macroeconomic themes and “style” factors

Can be used in conjunction with mean-variance optimization models

Common macroeconomic factors include: growth, real rates, inflation, credit quality and spreads, liquidity

Common style factors include: value, momentum, volatility, quality, size and carry

Question 34

Goal-driven Investing Management

Answer 34

investment strategy that focuses on achieving specific life goals

separate accounts (sometimes called “investment pools”) for distinct goals may be established

success is measured by whether or not the client is moving positively toward his or her goal (i.e., focus on absolute return)

traditional indexes and benchmarks are not so heavily emphasized (i.e., less focus on relative return)

Question 35

When are liability driven strategies typically used?

Answer 35

pension and retirement funds such as defined benefit plans

Question 36

How does the geometric average compare to the arithmetic average?

Answer 36

A geometric mean is found by multiplying the different stock prices and then taking the nth root, where n equals the number of stocks. The geometric mean tends to produce a downward bias in the index when compared to the arithmetic mean.

We find that the geometric average is lower than the arithmetic average.

Question 37

What is the dollar-weighted rate of return?

Answer 37

applies the concept of IRR to investment portfolios. The dollar-weighted rate of return is defined as the IRR of a portfolio, taking into account all cash inflows and outflows.

investor’s return
Considers cash flows
IRR

Question 38

What is the time-weighted rate of return?

Answer 38

does not weigh the amount of all dollar flows during each time period. It computes the return for each period and takes the average of the results by finding the holding period for each period and averaging the returns. If the investment is for more than one year, the geometric mean of the annual returns should be computed to find the time-weighted rate of return for the measurement period.
Manager’s return
Does not consider cash flows

Question 39

How do you determine the inflation-adjusted interest rate?

Answer 39

The inflation premium is an adjustment to the real risk-free rate to compensate investors for expected inflation and tightening or easing of monetary policy due to inflationary expectations.

Nominal rate of return investors require is:
Nominal risk-free rate = (1 + real risk-free rate) (1 + inflation rate) − 1

Real risk-free rate = [(1 + nominal risk-free rate) / (1 + inflation rate)] − 1

Question 40

What is the required rate of return?

Answer 40

The minimum amount of profit (return) an investor will seek or receive for assuming the risk of investing in a stock or another type of security.
RRR is also used to calculate how profitable a project might be relative to the cost of funding that project.

Question 41

What is systematic risk?

Answer 41

Systematic risk is a broad category or composite of risk that affects the entire market rather than unique to a particular security.

In effect, all securities tend to move together in a systematic manner in response to these risks.

Beta is a measure by which systematic risk is determined.

Question 42

What is Standard Deviation

Answer 42

how actual values differ from the expected values for a given series of values. It is a measure of variability of returns of an asset compared to its mean or expected value. The standard deviation measures total risk (systematic and unsystematic risk).

• Measure of volatility (i.e., risk)
• Measures amount of variation or dispersion from an average
• SD is considered a measure of “total risk”

Question 43

What is the coefficient of variation?

Answer 43

The coefficient of variation is defined as the ratio of the standard deviation divided by the mean.
The larger value indicates greater dispersion relative to the arithmetic mean of the return.

Question 44

What is the beta coefficient?

Answer 44

The beta coefficient is a measure of systematic risk and should be used for a diversified portfolio

Question 45

What is Sharpe Ratio?

Answer 45

1. A risk-adjusted performance metric measuring how much return is achieved per unit of risk taken.
2. Measures total risk (using standard deviation).
3. MPT serves as the foundation for the Sharpe ratio (i.e., the higher the Sharpe ratio, the closer the portfolio is to the mean variance portfolio).
4. The higher the Sharpe ratio the better.
5. The Sharpe ratio is better used when analyzing portfolios with low volatility (vs. Sortino Ratio).

Question 46

What is Sortino Ratio

Answer 46

The Sortino Ratio is a risk-adjusted performance metric that measures return in relation to downside risk using downside semi-standard deviation.

Question 47

Jensen’s Alpha (CAPM)

Answer 47

Measurement of investment manager’s risk-adjusted performance based on security selection and market timing.

designed to show if the manager outperformed what should have been the result per the CAPM.

Measures the value-added by manager.

Alpha = Ra – [Rf + Beta(Rm - Rf)]

Question 48

describe Treynor Ratio

Answer 48

measures performance relative to risk taken as measured by beta.

Same formula as Sharpe Ratio except that it uses beta which measures systematic risk instead of standard deviation which measures total risk.

The higher the Treynor ratio the better.

Question 49

what is the calculation for Jenses alpha

Answer 49

Alpha = R(i) - (R(f) + B x (R(m) - R(f)))

where:
R(i) = the realized return of the portfolio or investment
R(m) = the realized return of the appropriate market index
R(f) = the risk-free rate of return for the time period
B = the beta of the portfolio of investment with respect to the chosen market index