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CPWA Test Prep > Portfolio Management > Flashcards

Portfolio Management Flashcards

1
Q

What is asset location in portfolio management?

A

Asset location involves placing certain assets into different account types (taxable, tax-deferred, tax-exempt) based on tax status to minimize taxes during growth and distribution.

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2
Q

List examples of assets suitable for taxable accounts.

A

Index funds, low-turnover growth funds, tax-managed funds, municipal bonds, and possibly REITs.

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3
Q

What are examples of assets for tax-deferred accounts?

A

Dividend stocks, taxable bonds, high-turnover funds, and some partnerships that avoid UBTI.

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4
Q

Define tax-loss harvesting.

A

Tax-loss harvesting involves selling securities at a loss to offset capital gains, reducing overall tax liability.

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5
Q

What is the wash-sale rule?

A

The wash-sale rule disallows a tax loss on a security if a substantially identical security is repurchased within 30 days.

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6
Q

What is the Capital Gains Realization Rate (CGRR)?

A

It measures the percentage of a fund’s net unrealized capital gains that are realized within a period.

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7
Q

Define the Relative Wealth Measure (RWM).

A

RWM is used to assess tax impact, with higher values indicating better tax efficiency; zero indicates little tax impact.

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8
Q

Explain the Consultant Capture Ratio (CCR).

A

CCR captures the percentage of return taxable investors retain after taxes, calculated as after-tax return divided by before-tax return.

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9
Q

What is the Accountant’s Ratio?

A

It’s the ratio of short-term capital gains realized to total capital gains, indicating tax sensitivity in trading.

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10
Q

What is socially responsible investing (SRI)?

A

SRI integrates ethical, social, and environmental criteria in investment decisions, often using ESG factors.

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11
Q

Define liability-driven investing (LDI).

A

LDI focuses on aligning portfolio assets to meet current and future liabilities, commonly used by pension funds.

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12
Q

What is the purpose of goal-driven investing?

A

Goal-driven investing focuses on achieving specific life goals, with performance measured by progress toward these goals.

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13
Q

Explain contango and backwardation in commodities markets.

A

Contango occurs when futures prices are higher than spot prices (expecting higher future supply), while backwardation occurs when futures prices are lower than spot prices (indicating short supply).

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14
Q

Describe the J-Curve effect in private equity.

A

In private equity, the J-Curve represents initial negative cash flows followed by positive returns as investments mature.

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15
Q

What is a vintage year in private equity?

A

The vintage year is the initial year of investment in a fund, used for performance comparison with similar funds.

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16
Q

Define alternative investments.

A

Alternative investments include assets like real estate, hedge funds, commodities, private equity, and structured products, often with high fees, illiquidity, and complex structures.

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17
Q

What are Master Limited Partnerships (MLPs)?

A

MLPs are publicly traded partnerships where most income comes from real estate, commodities, or natural resources; often unsuitable for tax-deferred accounts due to UBTI.

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18
Q

Describe risk budgeting.

A

Risk budgeting allocates risk across individual investments or assets in a portfolio to manage overall portfolio risk effectively.

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19
Q

What is risk parity?

A

Risk parity allocates risk equally across asset classes, often using leverage on lower-risk assets to achieve desired returns.

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20
Q

What is factor analysis in investing?

A

Factor analysis examines risks and returns associated with macroeconomic or style factors like value, momentum, and size to enhance diversification.

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21
Q

Explain the difference between systematic and unsystematic risk.

A

Systematic risk affects the entire market and cannot be diversified away, while unsystematic risk is specific to a company or sector and can be reduced through diversification.

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22
Q

What is mean-variance optimization?

A

A portfolio construction method that identifies the optimal mix of assets to achieve the highest expected return for a given risk level.

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23
Q

Define strategic asset allocation.

A

Strategic asset allocation is setting and maintaining a target mix of asset classes over time, adjusting only with significant changes in objectives or risk tolerance.

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24
Q

Describe tactical asset allocation.

A

Tactical asset allocation involves active adjustments to asset class weights based on short-term market forecasts, aiming to capitalize on market opportunities.

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25
Q

What is dynamic asset allocation?

A

Dynamic asset allocation adjusts portfolio weights based on changing market conditions, focusing on minimizing downside risk.

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26
Q

Define a put option.

A

A put option gives the holder the right to sell a security at a specified price within a set period, used as a hedge against price drops.

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27
Q

What is a call option?

A

A call option gives the holder the right to buy a security at a specified price within a set time, often used to benefit from anticipated price increases.

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28
Q

Explain the purpose of an option collar.

A

An option collar involves selling an out-of-the-money call and buying an out-of-the-money put to lock in gains while limiting downside risk.

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29
Q

What is a straddle in options trading?

A

A straddle involves buying a put and call on the same security with the same strike price and expiration, betting on significant price movement in either direction.

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30
Q

Describe a strangle option strategy.

A

A strangle holds a put and call with different strike prices on the same asset, expecting large price swings but unsure of the direction.

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31
Q

What is a vertical spread option?

A

A vertical spread involves buying and selling two options with different strike prices but the same expiration, benefiting from price changes between the strikes.

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32
Q

Describe horizontal spread options.

A

Horizontal spread options involve buying and selling options with the same strike price but different expiration dates, profiting from changes as the options near expiration.

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33
Q

What is a diagonal spread option?

A

Diagonal spreads involve options with different strike prices and expiration dates, combining features of vertical and horizontal spreads.

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34
Q

Explain low-volatility funds in risk management.

A

Low-volatility funds aim to reduce portfolio risk by investing in assets with lower price volatility, providing smoother returns.

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35
Q

What is a buy-write strategy?

A

A buy-write strategy involves holding a security and selling a call option on it to generate income and limit downside.

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36
Q

Define the volatility index (VIX).

A

The VIX measures market expectations of future volatility, often referred to as the ‘fear index.’

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37
Q

What is VaR in risk management?

A

Value at Risk (VaR) estimates the potential loss in portfolio value over a specified period for a given confidence level.

38
Q

Explain the holding period return (HPR).

A

HPR calculates the total return on an investment over a period, including price changes and dividends.

39
Q

What is the geometric average return?

A

The geometric average return accounts for compounding, reflecting the average rate of return per period over time.

40
Q

Define the time-weighted return (TWR).

A

TWR measures investment performance independent of cash flow timing, focusing on manager performance.

41
Q

Describe dollar-weighted return (DWR) and when it is used.

A

DWR, or Internal Rate of Return (IRR), reflects returns based on the timing and size of cash flows, used to evaluate performance considering investor timing decisions.

42
Q

What is alpha in portfolio management?

A

Alpha measures the excess return of a portfolio relative to a benchmark, indicating the value added by the portfolio manager.

43
Q

Explain beta and its importance in risk measurement.

A

Beta measures an asset’s volatility relative to the overall market; a beta higher than 1 indicates greater risk than the market.

44
Q

What is the Sharpe ratio?

A

The Sharpe ratio calculates risk-adjusted return by dividing excess return by portfolio volatility, helping assess risk-adjusted performance.

45
Q

Define the Sortino ratio and its focus on downside risk.

A

The Sortino ratio is a variation of the Sharpe ratio that only considers downside risk, focusing on performance relative to negative returns.

46
Q

What is maximum drawdown, and why is it important?

A

Maximum drawdown measures the largest peak-to-trough decline in portfolio value, helping investors understand downside risk.

47
Q

Describe tracking error.

A

Tracking error shows the deviation of a portfolio’s returns from a benchmark, used to assess active management’s consistency.

48
Q

Explain downside capture ratio.

A

Downside capture ratio measures a portfolio’s performance during market declines relative to a benchmark, with lower values indicating better protection.

49
Q

What is the upside capture ratio?

A

The upside capture ratio measures a portfolio’s performance during market upswings, with higher values indicating better performance in rising markets.

50
Q

Define tactical asset allocation.

A

Tactical asset allocation involves adjusting asset weights based on short-term market forecasts to capitalize on market opportunities.

51
Q

What is rebalancing, and why is it essential?

A

Rebalancing maintains the target asset allocation, adjusting for market changes to keep risk and return aligned with investor objectives.

52
Q

Explain the concept of tax drag.

A

Tax drag is the impact of taxes on portfolio growth, reducing returns over time by decreasing compounding potential.

53
Q

Describe capital gains distribution and its effect on taxable accounts.

A

Capital gains distribution occurs when a fund realizes gains and distributes them to investors, which can create unexpected tax liabilities.

54
Q

What is value investing?

A

Value investing focuses on buying undervalued stocks based on intrinsic value, with the expectation that the market will recognize their worth over time.

55
Q

Define growth investing.

A

Growth investing involves selecting stocks expected to grow earnings faster than the market average, often with higher valuations.

56
Q

What is income investing?

A

Income investing prioritizes assets that generate steady income, like dividends and interest, suitable for conservative or retired investors.

57
Q

Explain core-satellite investing.

A

Core-satellite investing combines a stable core portfolio with actively managed satellite positions to enhance returns without excessive risk.

58
Q

Define impact investing.

A

Impact investing aims for measurable social or environmental outcomes alongside financial returns, often in sectors like clean energy or healthcare.

59
Q

Describe the difference between SRI and ESG investing.

A

SRI excludes specific industries based on ethical concerns, while ESG integrates environmental, social, and governance factors to guide investments.

60
Q

What is the purpose of the hurdle rate in private equity?

A

The hurdle rate is the minimum return a private equity fund must achieve before the manager earns performance fees.

61
Q

Describe the concept of a high-water mark in hedge funds.

A

A high-water mark ensures fund managers only earn performance fees on profits exceeding the fund’s previous highest value.

62
Q

What is absolute return?

A

Absolute return measures total portfolio return without comparing to a benchmark, focusing on achieving positive gains.

63
Q

Define relative return.

A

Relative return measures portfolio performance compared to a benchmark, evaluating how well it performs against similar investments.

64
Q

Explain the volatility drag in compounding returns.

A

Volatility drag reduces compounded returns, as fluctuations in returns lower overall performance over time.

65
Q

What are structured products?

A

Structured products are customized investments combining derivatives and assets to meet specific risk-return objectives, often for downside protection.

66
Q

Describe the purpose of Monte Carlo simulation in finance.

A

Monte Carlo simulation models potential outcomes using random variables, helpful in assessing risk and portfolio viability under uncertainty.

67
Q

What is dynamic asset allocation?

A

Dynamic asset allocation adjusts portfolio holdings based on market conditions, focusing on protecting against downside risk.

68
Q

Define risk tolerance.

A

Risk tolerance is the level of risk an investor is willing to accept to achieve financial goals, guiding asset allocation decisions.

69
Q

Explain portfolio duration.

A

Portfolio duration measures sensitivity to interest rate changes, important for managing fixed-income portfolio risk.

70
Q

What is a laddered bond portfolio?

A

A laddered bond portfolio staggers bond maturities, reducing interest rate risk and providing consistent reinvestment opportunities.

71
Q

What are leveraged ETFs?

A

Leveraged ETFs use debt or derivatives to amplify returns, aiming to provide multiples of daily index returns, often with increased risk.

72
Q

Describe hedging in portfolio management.

A

Hedging involves taking offsetting positions in investments to reduce potential losses.

73
Q

Describe hedging in portfolio management.

A

Hedging involves using financial instruments like options or futures to offset potential losses in investments.

74
Q

Explain re-investment risk in bond portfolios.

A

Re-investment risk is the risk that future cash flows from an investment may need to be reinvested at a lower interest rate.

75
Q

What is the primary benefit of alternative investments in a diversified portfolio?

A

Alternative investments often have low correlation with traditional assets, enhancing diversification.

76
Q

Define the capital allocation line (CAL).

A

The CAL represents risk-return combinations of a risk-free asset and a portfolio of risky assets.

77
Q

What is capital market line (CML)?

A

CML represents the risk-return tradeoff for an efficient portfolio, used in MPT to determine optimal risk allocation.

78
Q

Describe the Fama-French three-factor model.

A

The Fama-French model adds size and value factors to the CAPM, explaining stock returns through market risk, company size, and value.

79
Q

What is sector rotation?

A

Sector rotation involves shifting investments among industry sectors based on economic cycles, aiming to capitalize on cyclical trends.

80
Q

Explain downside deviation as a risk measure.

A

Downside deviation measures volatility only for negative returns, aligning with investors’ focus on loss aversion.

81
Q

Define the Jensen’s Alpha.

A

Jensen’s Alpha measures excess returns relative to a portfolio’s risk-adjusted benchmark, indicating value added by the manager.

82
Q

What is the Treynor ratio?

A

The Treynor ratio measures returns relative to beta, useful for portfolios with diversified systematic risk.

83
Q

Describe the concept of covariance in portfolio management.

A

Covariance measures how two asset returns move in relation to each other, critical for diversification analysis.

84
Q

What is the minimum-variance portfolio?

A

The minimum-variance portfolio has the lowest possible risk for a given set of assets, offering the best risk-reduction benefits.

85
Q

Explain the role of correlation in portfolio construction.

A

Correlation assesses the degree to which two assets move together, guiding diversification strategies to reduce risk.

86
Q

What is the difference between absolute and relative risk?

A

Absolute risk focuses on total potential loss, while relative risk evaluates performance compared to a benchmark.

87
Q

Define active share.

A

Active share indicates the percentage of a portfolio that differs from its benchmark, used to assess active management level.

88
Q

Describe leverage and its risks.

A

Leverage involves borrowing to increase investment exposure, amplifying gains and losses, and increasing risk.

89
Q

What is the information ratio?

A

The information ratio measures excess returns per unit of tracking error, assessing active manager performance relative to a benchmark.

90
Q

Explain asset-liability matching.

A

Asset-liability matching aligns portfolio assets to future liabilities, often used in pension fund management.

91
Q

What is convexity in bond investing?

A

Convexity measures the sensitivity of a bond’s duration to interest rate changes, enhancing understanding of bond price volatility.

CPWA Test Prep (8 decks)

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