Portfolio Management

Question 1

What are the assumptions of the arbitrage pricing theory?

Answer 1

1. Only risk is systematic
2. Returns can be explained by a factor model
3. There are no arbitrage opportunities

Question 2

Which of these risk measures uses a lookback period?

1. Monte Carlo simulation
2. Parametric method
3. Historical Simulation

Answer 2

Parametric method & Historical Simulation

Question 3

What is a tracking portfolio?

Answer 3

A portfolio that has the same factor sensitivities as the benchmark, but different security weights.

Question 4

What is a factor portfolio?

Answer 4

A portfolio with a factor sensitivity of 1 to a specific factor, and 0 to all other factors. It represents a pure bet on that factor.

Question 5

What is the principle of diminishing marginal utility?

Answer 5

The principle of diminishing marginal utility is that as wealth increases, marginal utility of current consumption decreases.

Question 6

What is the formula for Break Even Inflation (BEI)?

Answer 6

BEI = Expected Inflation + Risk Premium for Inflation Uncertainty

Question 7

Are equities a good or bad consumption hedge?

Answer 7

Bad. They are positively related to economic growth.

Question 8

What is the effect of economic downturn on equity risk premium?

Answer 8

In a downturn, equity risk premium falls as investors are willing to take on more risk for the same return.

Question 9

In order for value added to be positive, what does end of period asset returns have to be correlated with?

Answer 9

End of period asset returns must be correlated with the asset weights that the manager selected at the beginning of the period.

I.e. Did the manager overweight the stocks that contributed most to the return.

Question 10

What do execution algorithms do?

Name three types.

Answer 10

Break orders down into smaller parts to lessen the market impact.

1. Volume Weighted Average Price
2. Implementation Shortfall
3. Market Participation

Question 11

What do high-frequency trading algorithms do?

Answer 11

Continuously monitor trading data in search of patterns that can be traded on profitably.

Question 12

What do implementation shortfall algorithms do?

Answer 12

They adjust the trading schedule in order to lessen the gap between decision price and execution price.

Question 13

What do Volume Weighted Average Price (VWAP) algorithms do?

Answer 13

They divide an order into slices proportional to historical daily trading volume.

Question 14

What is wash trading?

Answer 14

Repeatedly buying and selling a security in order to artificially inflate market volume.

Question 15

What is “Painting the tape”?

Answer 15

Making small trades in one direction in order to push up the price before making one large trade in the opposite direction.

Question 16

What is Conditional VaR?

Answer 16

Conditional is VaR given that VaR has been breached.

Question 17

What is Marginal VaR?

Answer 17

Marginal VaR is the change in VaR resulting from a small change in the portfolio weight of a security.

Question 18

What is Incremental VaR

Answer 18

Incremental VaR is the change in VaR resulting from a specific change in portfolio weight of a security.

Question 19

What is the corresponding number of standard deviations to a 95% confidence interval?

Answer 19

1.65 Standard Deviations.

Question 20

What is the inter temporal rate of substitution?

Answer 20

Inter temporal substitution is the rate at which people will forego current consumption in order to consume in the future.

Question 21

What is the formula for the yield on corporate debt?

Answer 21

Corporate Debt Yield = Risk-Free Rate + Expected Inflation + Premium for Unexpected Inflation + Credit Spread

Question 22

What happens to equity risk premium in an economic expansion?

Answer 22

Equity risk premium falls because investors become less risk-averse and are willing to accept less premium on equity investments.

Question 23

Is the Information Ratio applied ex ante or ex post?

Answer 23

Either.

Question 24

What is the formula for Information Ratio? (Not the fundamental law version)

Answer 24

IR = Rp - Rb / σ(rp - rb)

i.e. Active Return/ Active Risk

Question 25

What is the fundamental law of active management formula?

Answer 25

Information Ratio = (TC) x (IC) x √B

Where:
TC = Transfer Coefficient - PM Restrictions
IC = Information Coefficient - PM Skill
B = Breadth - No. of Investment Decisions

Question 26

What is an optimal portfolio?

Answer 26

One which has the highest sharpe ratio - i.e. The highest excess return for a given level of risk.

Question 27

What is the formula for the Sharpe Ratio of the Optimal Portfolio?

Answer 27

SR = √ SRb2 + IRp2

Question 28

What is the formula for Optimal Active Risk?

Answer 28

Optimal Active Risk = (IRp/SRb) x σb

Question 29

What is the formula for Portfolio Excess Return (Active Return)?

Answer 29

Active Return = IR x Active Risk

Question 30

What is the formula for Benchmark Excess Return?

Answer 30

Benchmark Excess Return = SR x Total Risk

Question 31

Will portfolio with the optimal sharpe ratio also have the optimal information ratio?

Answer 31

Yes.

SRp = √ SRb2 + IRp2

All similar active portfolios have similar SRb2, so the only way to get the highest SRp is to have the highest IRp2.

Question 32

Which component of the information ratio represents the the risk-adjusted correlation between active returns and active weights?

Answer 32

Transfer Coefficient.

Question 33

What is the formula for information coefficient?

Answer 33

IC = (2*(% Correct)) - 1

Question 34

If you are are long a currency forward, are you long the price currency or the base currency?

Answer 34

The base currency.