Portfolio Management Flashcards
What are the assumptions of the arbitrage pricing theory?
- Only risk is systematic
- Returns can be explained by a factor model
- There are no arbitrage opportunities
Which of these risk measures uses a lookback period?
- Monte Carlo simulation
- Parametric method
- Historical Simulation
Parametric method & Historical Simulation
What is a tracking portfolio?
A portfolio that has the same factor sensitivities as the benchmark, but different security weights.
What is a factor portfolio?
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.
What is the principle of diminishing marginal utility?
The principle of diminishing marginal utility is that as wealth increases, marginal utility of current consumption decreases.
What is the formula for Break Even Inflation (BEI)?
BEI = Expected Inflation + Risk Premium for Inflation Uncertainty
Are equities a good or bad consumption hedge?
Bad. They are positively related to economic growth.
What is the effect of economic downturn on equity risk premium?
In a downturn, equity risk premium falls as investors are willing to take on more risk for the same return.
In order for value added to be positive, what does end of period asset returns have to be correlated with?
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.
What do execution algorithms do?
Name three types.
Break orders down into smaller parts to lessen the market impact.
- Volume Weighted Average Price
- Implementation Shortfall
- Market Participation
What do high-frequency trading algorithms do?
Continuously monitor trading data in search of patterns that can be traded on profitably.
What do implementation shortfall algorithms do?
They adjust the trading schedule in order to lessen the gap between decision price and execution price.
What do Volume Weighted Average Price (VWAP) algorithms do?
They divide an order into slices proportional to historical daily trading volume.
What is wash trading?
Repeatedly buying and selling a security in order to artificially inflate market volume.
What is “Painting the tape”?
Making small trades in one direction in order to push up the price before making one large trade in the opposite direction.
What is Conditional VaR?
Conditional is VaR given that VaR has been breached.
What is Marginal VaR?
Marginal VaR is the change in VaR resulting from a small change in the portfolio weight of a security.
What is Incremental VaR
Incremental VaR is the change in VaR resulting from a specific change in portfolio weight of a security.
What is the corresponding number of standard deviations to a 95% confidence interval?
1.65 Standard Deviations.
What is the inter temporal rate of substitution?
Inter temporal substitution is the rate at which people will forego current consumption in order to consume in the future.
What is the formula for the yield on corporate debt?
Corporate Debt Yield = Risk-Free Rate + Expected Inflation + Premium for Unexpected Inflation + Credit Spread
What happens to equity risk premium in an economic expansion?
Equity risk premium falls because investors become less risk-averse and are willing to accept less premium on equity investments.
Is the Information Ratio applied ex ante or ex post?
Either.
What is the formula for Information Ratio? (Not the fundamental law version)
IR = Rp - Rb / σ(rp - rb)
i.e. Active Return/ Active Risk
What is the fundamental law of active management formula?
Information Ratio = (TC) x (IC) x √B
Where:
TC = Transfer Coefficient - PM Restrictions
IC = Information Coefficient - PM Skill
B = Breadth - No. of Investment Decisions
What is an optimal portfolio?
One which has the highest sharpe ratio - i.e. The highest excess return for a given level of risk.
What is the formula for the Sharpe Ratio of the Optimal Portfolio?
SR = √ SRb2 + IRp2
What is the formula for Optimal Active Risk?
Optimal Active Risk = (IRp/SRb) x σb
What is the formula for Portfolio Excess Return (Active Return)?
Active Return = IR x Active Risk
What is the formula for Benchmark Excess Return?
Benchmark Excess Return = SR x Total Risk
Will portfolio with the optimal sharpe ratio also have the optimal information ratio?
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.
Which component of the information ratio represents the the risk-adjusted correlation between active returns and active weights?
Transfer Coefficient.
What is the formula for information coefficient?
IC = (2*(% Correct)) - 1
If you are are long a currency forward, are you long the price currency or the base currency?
The base currency.
