Portfolio Management Flashcards
AP
+ shares by delivering the creation basket
ETFs trades in _ market(s)
primary & secondary
Tracking Error
Annualized std of daily tracking diff.
ETF Premium/discount
(ETF Price -NAV)/NAV
Risk of investing in ETF
- Counterparty risk
- fund closures
- expectation-related risk
APT
describes equilibrium relationship b/w EXPECTED returns for well-diversified portfolios and their multiple sources of systematic risk
APT assumptions
- unsystematic risk can be diversified away
- returns are generated in a factor model.
- no arbitrage opp. exist
APT is based in part on the assumption that as assets are added to a portfolio, the portfolio becomes well diversified and asset-specific risk is eliminated. Therefore, adding assets to a diversified portfolio should decrease its specific risk.
expected return formula
rf + factor sensitivity * factor risk
Macroeconomic factor model
assume asset returns are explained by SURPRISES in macroeconomic risk factors
Fundamental factor model
assume asset returns are explained by returns from multiple firm-specific factors
statistical factor model
use multivariate statistics to identify statistical factors that explain the COVARIATION among asset returns, weakness: no economic interpretation
active risk squared
active factor risk (factor tilt/weight) + active specific (asset selection)
Information ratio
Active return/active risk;
altered by the addition of cash or use of leverage;
for an UNCONSTRAINED portfolio, the information ratio is unaffected by the aggressiveness of active weights
multifactor models
good for active and passive
factor model
factor sensitivity of 1 to 1 factor and 0 to all other, used for speculation or hedging
VAR
- minimum loss
- given prob
- specific period
var model - parametric
use est. var and cov of securities to est the distribution of possible values, assuming normal distribution
var model - historical
use historical over prior LOOKBACK period
var model - monte carlo simulation
draws each risk factor change from an assumed distribution and calculates portfolio values based on a set of changes in risk facts, repeated 1000 times
Adv of VAR
- widely accepted
- simply to understand
- expresses risk as a single number
- useful for comparing the risk of portfolios, portfolio components, and business units
disadv of VAR
- Subjective to time and probability by choice
- sensitive to est. and assumption
- focuses only on left-tail outcome
- vulnerable to misspecification by user
conditional var
expected loss given that the loss exceeds VaR
INCREMENTAL VAR
est change in var from a specific change in the size
marginal var
est of the change in var for a small change in position, use as an est of contribution to overall var
risk measure by bank
asset-liability, market, leverage, duration, convexity, overall risk to economic capital
risk measure by asset manager
return vol, prob distribution of absolute losses or losses relative to benchmark
risk measure by pension fund manager
mismatch b/w A/L, volatility of the surplus
risk to p&c
sensitivity of investment portfolios to risk factors, var, scenarios incorporate market and insurance risks as stress tests
risk to life insurers
market risk, mismatch b/w a/l
Short-term interest rates
positively related to GDP growth and expected volatility in GDP growth;
In recession, short-term policy rates tend to be low. Positive slope of yld curve.
BEI
expected inflation and risk premium for uncertainty in inflation;
yld on no-inflation-index - yld on inflation-indexed bonds
Credit spreads
widen during economic downturns, narrow during expansion.
Credit spread = Yield - BEI - R
Sharpe Ratio
(Rp-Rf)/ vol(p)
Unconstrained portfolio optimial active risk*
IR/SRb*VOL(b)
optimal weighht = optimal active risk*/active risk
Sharpe ratio comprised of an optimal proportion of bmk and active portfolio
sqr(SRb^2+IRp^2)
Fundamental law of active portfolio management
- IC measures manager’s skill
- The breadth measures number of independent active bets
- the transfer coefficient measures the degree of constrains on manager’s active management
IR = (TC)(IC)SQR(BR)
E(Ra), for unconstrained portfolio TC=1
IC of market timer
2*(%correct)-1
Limitation of fundamental law
bias in measurement of the ex-ante information coefficient
and lack of true independence while measuring the breadth of an active strategy
Explicit trading costs
brokerage, taxes, fees, implicit costs include bid-ask spread, price impact, slippage, and opportunity cost
Effective bid-ask spread
2*(per share effective spread transaction cost)
2*(trade price - midpoint of the trade)
VWAP transaction cost for buy/sell order
trade size * direction * (trade VWAP-benchmark VWAP)
Impementation shortfall
diff in value b/w a hypothetical portfolio (no cost) and the value of actual portfolio
drivers of development of electronic trading system
lower cost, higher accuracy, provision for audit trails, fraud prevention, and a continuous market during trading hours
market fragmentation
when a security trades in multiple markets
smart order routing seek to overcome the challenges posed by it
Latency
time lapse b/w the occurrence of an event and execution of a trade based on that event;
electronic trading system allow low-latency traders to gain competitive advantage
Hidden orders (impact of electronic trading)
hidden from the market except for the exchange receiving them;
seek to remove the valuable option that exposed standing orders provide to the rest of the market
Leapfrog (impact of electronic trading)
beating the best bid or ask price, narrows the inside spread
flickering quotes (impact of electronic trading)
exposed limit orders that are submitted and cancelled almost immediately
Runaway algorithms (systemic risk of electronic trading systems)
a series of unintended orders, cause increase in volatility
fat finger errors (systemic risk of electronic trading systems)
input error
overcharge orders (systemic risk of electronic trading systems)
demand liquidity significantly higher than what’s available in the market
malevolent orders (systemic risk of electronic trading systems)
created to specifically manipulate the market
front running (surveillance and monitoring)
low latency trading ahead of known large trades
market manipulation (surveillance and monitoring) -trading for market impact
activities that produce false market data, including price and volume data
-rumormongering
- dissemination of fake information about fundamental values or about other trades’ trading intentions in an attempt to alter investor’s value assessments
-wash trading
create false liquidity
-spoofing/layering
- fake limit orders posted to create fake optimism/pessimism about the security
-bluffing
-preying on momentum order
-gunning the market
- forces other traders into bad trades (rapid short selling triggering stop loss)
-squeezing/cornering
- obtaining control over resources needed to settle contracts and then withdrawing triggering default
inside bid-ask
highest bid - lowest ask
market impact relating to a trade
price of trade 2 - trade 1 from two different time
discount rate
- rf
- expected influation
- risk premium reflecting the uncertainity about cash flows
inter-temporal rate of substitution = m
marginal utility of consumption 1 unit in the futures/
marginal utility of consumption 1 unit today
taylor ruls
set policy rates to
1) maintain price stability
2) achieve maximum sustainable level of employment
r= Rn +pai + 0.5(pai-pai) + 0.5(output-output)
term spread
LT bond yld - short term bond yld
P/E, P/B & expected earnings growth rate
positive related
P/B, P/B & required returns
negative related
growth stock
- high p/e
- low dividend yld
- economic expanision
value stock
- low p/e
- high dividend yld
- stable earnings
perform well during & immediate following recession
Return of capital distribution
amount paid out in excess of ETF’s earnings and serve to reduce and investor’s cost basis by the amount of the distribution
-not taxable
good hedge
short-term bond
Soft closures entail
creation halts and changes in investment strategy
When a bank ETN issuer is no longer interested in additional borrowings
, the resulting creation halts may cause those ETNs to trade at a premium.
Portfolio liquidity management
entails equitizing excess cash
Portfolio completion strategies
use ETFs to fill temporary gaps in portfolio allocation.
Arbitrage gap
is the band around NAV at which the ETF should trade at and is not affected by the in-kind creation/redemption process.
Liquidity aggregation refers to
the process of monitoring a number of trading venues and then compiling the data into a “super book” that summarizes price and liquidity across these markets.
This allows trades to be routed appropriately.
A dark pool is
a trading venue that is only open to certain clients, and that does not publish its liquidity.
A parent order is
a large order (e.g. buy 1 million shares of Facebook) that is divided up by an execution algorithm into smaller child orders that are less likely to move the market.
VAR Calculation
=E(r)-critical value * volatility
5% = 1.65
purpose of ap procession
lower cost
tax efficiency
market prices in line with NAV
Arbitrage Gap
ETF trades within a bank
wider for iliquid, trading with time zone diff
Maximum spread
creation/redemption fees
+trading cost
+spread of underlying securities
+risk premium for carrying until close of day
+ap’s normal profit margin
-discount based on probability of offsetting the trade in a secondary market
Low-latency traders
include news traders who subscribe to high-speed electronic news feeds reporting news releases made by corporations, governments, and other aggregators of information. They can quickly analyze these releases to determine whether the information will move markets and can profit when they can execute against stale orders that do not yet reflect the new information.
