Portfolio Management

Question 1

Defined Contribution Plan

Answer 1

A retirement plan in which the firm contributes a sum each period to the employee’s retirement account

Question 2

Defined benefit pension plan

Answer 2

firm promises to make periodic payments to employees after retirement

Question 3

3 steps in portfolio management process

Answer 3

1. Planning – risk tolerance, tax exposure, etc.
2. Execution – analysis of risk and return characterisitcs of each asset class
3. feedback step – rebalance portfolio

Question 4

Investor Policy Statement Objectives and Constraints

Answer 4

R - Risk
R - Return 
T - Time Horizon
T - Taxes
L - Liquidity
L - Legal & Regulatory
U - Unique

Question 5

Standardized Sensitivities

Answer 5

b = (PEi - PEbar) / SigmaPE

Question 6

Active Return

Answer 6

= Return on portfolio - Return on benchmark

Active return can be split into factor return and sensitivity selection factor

Question 7

Information Ratio

Answer 7

(Return Portfolio - Return Benchmark) / Sigma(Rp-Rb)

Question 8

Active risk squared

Answer 8

=active factor risk + active specific risk

Question 9

Active specific risk

Answer 9

= SUM(WeightPi - WeightPb)^2 * Sigmaerror^2

Question 10

Risk premium for ST and LT bond

Answer 10

ST risk premium = R + Pi
LT risk premium = R + Pi + Theta

R = interest rate
Pi = Inflation
Theta = uncertainty about inflation

Question 11

Taylor Rule

Answer 11

= R + Pi + 0.5 (Pi-Pi) + 0.5 (Y-Y)

Pi* = central banks target inflation
Y = Log of current level of output
Y* = Log of central banks target output

Question 12

Break Even Inflation Rate (BEI)

Answer 12

=Yield on non indexed bond - Yield on inflation indexed bond

= Pi * theta

Question 13

Required return on a credit risky bond

Answer 13

= R + Pi + Theta + Gamma

Gamma = credit spread, where gamma increases during economic downturns

Question 14

Discount rate of equity

Answer 14

= R + Pi + Theta + Gamma + k

k = additional risk premium relative to risky debt for an investment in equities,

Where, equity risk premium =
Gamma + k = credit spread + additional risk premium relative to risky debt for an investment in equities

Question 15

Discount rate for real estate

Answer 15

= R + Pi + Theta + Gamma + k + Phi

Phi = risk premium or illiquidity

Question 16

Credit Spread = Yield - BEI - R

Answer 16

When the credit spread narrows, lower rated bonds outperform higher rated bonds

Question 17

Term Spread

Answer 17

= Yield of LT gov’t bonds - Yield on ST gov’t bonds

Question 18

Information Ratio

Answer 18

=Information Coefficient * SqRt(Breadth)

= IC * SqRt(BR)

Question 19

Active Return

Answer 19

= return on portfolio - return on benchmark
= SUM(delta(wi) * Rb) + SUM(wpRa)
= {Weight(stocks)Return(stocks) + Delta(weight[bonds]) Return(bonds)} + {Weight(stocks)Return(stocks) + Weight(bonds) * Return(bonds)}

Question 20

Sharpe Ratio

Answer 20

absolute expected reward-to-risk measure. Compares the portfolio return in excess of a risk-free rate.

Question 21

Information Ratio

Answer 21

relative reward-to-risk measure. The portfolio return relative to a benchmark portfolio

Question 22

Information Ratio

Answer 22

= {Rp - Rb} / Sigma(Rp-Rb)
= Ra / Sigma (a)
= Active Return / Active Risk

Question 23

= SRp^2 = SRb^2 + IR^2

Answer 23

SR of Actively managed Prtflio^2 =

SR of benchmark^2 + Information Ratio ^2

Question 24

Sigma(Ra) = (IR/SRb) * Sigma(Rb)

Answer 24

…

Question 25

Sigma(Rp)^2 = Sigma (Rb)^2 + Sigma(Ra)^2

Answer 25

…

Question 26

Mean Variance optimal weights

Answer 26

Delta(w) = (Mew/Sigma(i)^2) * ( Sigma(a) / [IC*SqRt(BR)]

Question 27

Information Coefficient

Answer 27

anticipated cross sectional correlation between N forecasted active return , Mew(i), and the N realized active returns, Ra.

Question 28

Information Coefficient

Answer 28

anticipated cross sectional correlation between N forecasted active return , Mew(i), and the N realized active returns, Ra.

Question 29

Breadth

Answer 29

= #independent decisions made each year

= #securities * #rebalancing periods

Question 30

Basic Fundamental Law

Answer 30

E(Ra) = IC * SqRt(BR) * Sigma(a)

Question 31

For an unconstrained portfolio, IC

Answer 31

IC* = E(Ra*) / Sigma(a) = IC * SqRt(BR)

Question 32

Full Fundamental Law

Answer 32

E(Ra*) = TC * IC * SqRt(BR)
Then,
Sigma(a) = TC * (IR*/SRb) * Sigma(b)
Then,
SRp^2 = SRb^2 + TC^2*IR*^2

Question 33

Ex Post Performance Measure

Answer 33

= E(Ra given ICrealized) = TC * ICrealizedSqRt(BR)Sigma(a)

Question 34

TC^2 percent of the variation in performance is attributed to the sucess of the forecasting process, while (1-TC^2) percent is due to constraint induced noise.

Answer 34

TC measures the extent to which constraints reduce the expected value added of the investors’ forecasting ability

Question 35

To address the uncertainty of the portfolio manager’s skill, …

Answer 35

Sigma(a) = Sigma(IC) * SqRt (N) * Sigma(RiskModel)

Active Risk = Risk in IC * SqRt(N) * Risk in Risk Model

Question 36

A practical measure of breadth

Answer 36

BR = N / [1 + (N-1)*r]
where,
r=correlation between decisions

Question 37

For Market Timing, the IC =

Answer 37

ICmt = 2 *(% correct) - 1

Question 38

Annualized Active Risk

Answer 38

= Sigma(c) * SqRt(BR)

Question 39

Annualized Active Return

Answer 39

E(Ra) = IC * SqRt(BR) * Sigma(a)

Question 40

Sigma(c) = [ Sigma(x)^2 - 2Sigma(x)Sigma(y)*r(xy) + Sigma(y)^2]^(1/2)

Answer 40

…