Portfolio Management Flashcards
Who creates an ETF?
Where do they receive shares from?
AP’s Authorised Participants create the shares.
They receive shares from the ETF issuer when creation units are delivered to the AP.
Which factors are required for ETF Arbitrage Gap to exist?
ETF Nav is based on what?
Trading costs and liquidity factors
ETF Nav is based on the creation basket value.
When would an AP redeem ETF shares early? at a discount or premium?
At a discount as the AP can make more money selling the shares individually in the open market for more than the ETF is offering.
Round trip cost for $50,000 shares
commission $39
Bid-ask 0.2%
$30/$50k x 2 + 0.5 x 0.2% x 2 = 0.32%
What is an ETN?
What happens if creation of the ETN stops?
ETNs do not hold underlying securities. They promise to pay the returns and have higher default risk.
Any stop in creation causes remaining shares to trade at a premium or discount to NAV.
How is counterparty risk mitigated with syhteitc etfs?
Regular settlement throughout the term.
Do ETFs keep track of investor accounts?
Can ETF Managers influence tax efficiency of shares?
No ETF investor accounts are not tracked.
Yes ETF managers for active ETFs can influence which shares to redeem managing tax efficiency.
ETF tracking error lest likely for what period? What is the period for tracking error?
Tracking error least likely over short periods. Tracking error is the standard deviation of ETF and benchmark on an annualised basis.
ETF Cash drag
ETFS used to reduce portfolio cash drag is know as what?
Active ETF
Vs
Passive ETF
Equity or bonds?
ETF cash drag is where ETF holds uninvested cash for a period before investing.
Cash equitization reduces portfolio cash drag through use of ETFs.
Active ETFs are usually fixed income
Passive ETFs are usually equity markets.
Factor (smart beta) ETFs are long or short term investments?
Factor ETFs are usually long term buy and hold and not tactical. They are usually risk management ideas including volatility ETFs.
Portfolio Completion =
Using ETFs to plug gaps in strategic exposures by country, sector, industry, theme or factor.
Multifactor models are for systematic only as unsystematic risk can be diversified away from how?
Unsystematic risk can be diversified away from with diversification.
Multifactor model
Given rf, sensitivity factor A, B and C and Factor risk premium A, B and C.
Expected return = rf + (sensitivity A x Factor Risk Premium A) + (sensitivity B x FRP B) + (sensitivity c x FRP C)
Arbitrage Theory assets have what relationship with risk factors? What are the three assumptions?
CAPM models which risk?
Arbitrage Theory assets have linear relationship with risk factors.
- A factor model describes asset returns
- There are no arbitrage opportunities within a well diversified portfolio
- Well diversified portfolios can eliminate asset specific risk.
CAPM models for systematic risk as unsystematic risk is assumed diversified.
A Pure Factor aka Factor portfolio =
Used to estimate factor risk for multifactor equations.
A sensitivity factor of 1 to a single factor and a sensitivity of 0 to all other factors.
Given:
Er 5.7 sensitivity 1.4
Er 6.1 sensitivity 1.9
What is Rf?
Er = Rf + (sensitivity factor x Risk premium)
5.7 = rf + (1.4 x Rp)
6.1 = rf + (1.9 x Rp)
Subtract
0.4 = 0.5 x Rp
Rp = 0.8
5.7 = rf + (1.4 x 0.8)
Rf = 4.58%
Carhart Model
Er = Rf + RMRF + SMB + HML + WML
RMRF = return to a value weighted index SMB = Small minus big cap HML = High minus low book value WML = Winners Minus Losers
Factors used in:
Macroeconomic Model
Fundamental Model
Statistical Model
Which is best for analysing active managers?
Macroeconomic Model - GDP, Interest rates, Inflation
Fundamental Model - P/E, Mkt Cap, Leverage ratio, Standardised beta. Best for analyzing active managers.
Statistical Model - Factors defined by weights of security portfolio.
Two Factor Macroeconomic Model
R = Rf + (Actual Interest - Forecast interest) x b + (Actual GDP - Foreast GDP) x b
*Actual Minus Forecast
Information ratio =
Information ratio = active return / active risk
Excess returns / Tracking error
IR = Information Coefficient x Sq rt BR
Breadth will say some like “there are 20 actively selected forecasts in the portfolio.”
1% VaR =
5% VaR =
16% VaR =
1% VaR = 2.33 standard deviations
5% VaR = 1.65 standard deviations
16% VaR = 1 standard deviaitons
Step 1 of estimating VaR
Three methods of estimating VaR
Step 1 = Risk decomposition
Three methods:
- Parametric method
- Historical simulation
- Monte Carlo simulation
Required parameters to estimate parametric var =
- Expected value
2. Standard deviation
Portfolio SD =
Cov =
Annual portfolio SD =
Sq Rt / Wa^2SDa^2+ Wb^2SDb^2+2WaWbCovab
Cov = CC x Wa x Wb x SDa x SDb
Annual portfolio SD = 12.57% / 250 days
Note 250 days*
5% VaR =
Daily portfolio return =
Daily portfolio SD =
(Daily Portfolio return - 1.65 x Daily portfolio SD) x $value
Daily portfolio return = 15% / 250
Daily portfolio SD = 15% / Sq/rt 250
Which type of distribution of around factors:
- Parametric method
- Historical simulation
- Monte Carlo simulation
- Parametric method - Only normally distributed risk factors
- Historical simulation - Many types of distribution whatever occurred in the past.
- Monte Carlo simulation - Many types of distribution of factors. Very flexible model.
VaR Limitations
VaR Positives
VaR Limitations = can accomodate for small cumulative losses
Takes into account only left tail events
Underestimates extreme events.
LIQUIDITY is NOT taken into account.
VaR Positives = Widely accepted by regulators, Easily communicated.
Delta =
Gamma =
Delta vega and gamma measure small or large sensitivities?
Delta = Change in option price given a change in underlying share = N(d1) - 1
Gamma = Rate of change of delta. Highest when option is exactly at the money.
Delta vega and gamma measure only small sensitivities in price change not extreme events
Duration assumes correlation of fixed income exposure and rf =
One
Scenario risk measure
vs
Sensitivity risk measure
Scenario risk measures multiple factor movements of a size larger than a typical sensitivity test.
Sensitivity risk measures include things like ‘duration’
Economic capital
Actual capital must always be more than economic capital. Economic capital is the capital a firm must hold to survive severe losses. Ie how much equity can be lost by a portfolio in unfavorable circumstances?
Risk Budgeting
vs
Scenario limits
Risk budgeting uses VaR limits or ex-ante tracking error limits to set a total risk appetite.
Scenario analysis sets estimated loss for a given scenario and takes corrective action if limit is exceeded.
Present Value Model =
Price = Expected cash flow / (1+YTM of Rf + Expected inflation +risk premium)^n
Incremental VaR
vs
Marginal VaR
Vs
Conditional VaR
Incremental VaR in $ terms for a specified change in weight ie 2% increase in weight of a security will increase VaR by $216,000.
vs
Marginal VaR is estimation of the slope. IVaR estimates a very small change in price for just a 1% change in weight of a particular position although not fully accurate it can be used to test each factors effect on VaR.
Conditional VaR shows expected loss if VaR is exceeded.
Ex Ante tracking error =
Relative VaR measure of a manager vs benchmark.
Intertemporal rate of return =
Low rate =
High rate =
Marginal utility of consuming 1 unit in future / Marginal utility of current consumption
Low rate = Low wealth today, spend today
High rate = High wealth today save and invest for later which pushes up bond prices.
“If marginal utility of spending 1 unit in the future is going to be worth more in the future you will invest and save for the future”
Taylor rule =
Interest rates are set below equilibrium level if:
Central bank rate = Rf + 0.5 x current inflation + 0.5 x target inflation.
If output gap is negative and inflaiton is below target interest rates will be below equilibrium rate.
Bond Risk Premium =
= Yield on nominal govt bond - yield on real govt bond.
Bond risk premium strips out expected inflation from Breakeven inflation rates to show additional return required for inflation uncertainty.
Liquidity and inflation high or low for a high discount rate?
Low liquidity and high inflation will require a higher discount rate to represent increased risk.
Value added =
Value added = (Asset weight in portfolio - Asset weight in benchmark) x Asset return = (WP - WB) x Return
*A more simple calculation comparing returns from the portfolio.
Value added stock selection = (Asset return - Benchmark return) x Asset weight in portfolio
Sharpe ratio is unaffected by what?
Cash and leverage does NOT effect the sharpe ratio
Information ratio =
Active return =
TC = Transfer coefficient IC = Informaiton coefficient aka skill or signal quality BR = Breadth aka no of forecasts A = Active risk
Information ratio = Active return / Active risk
IR = TC x IC x sq rt BR
Active return = TC x IC x sq rt BR x A
TC = Transfer coefficient IC = Informaiton coefficient BR = Breadth A = Active risk
= Rp - Benchmark / SD portfolio - benchmark
Sharpe ratio of portfolio =
SR^2 =
SRp^2 = SRb^2 + IR^2
SR^2 = SRb^2 + TC^2 x IR^2
Unconstrained transfer coefficient =
one
Implicit trading cost
vs
Explicit trading cost
Implicit trading cost = bid/ask
Market impact = demanding liquidity
Delay cost/slippage = lag in executing trade
Opportunity cost = unfilled order cost
vs
Explicit trading cost = Broker commission and taxes such as stamp duty
Exchange fees.
Effective spread =
Opportunity cost =
Effective spread = 2 x (trade price - mid point bid/ask)
Opportunity cost = (mkt close - Ask price) x no shares not traded
Electronic front runners =
HFT =
Long or short term holders?
Low latency trading are long term holders
High frequency trading = short term holders
Superbook orders highlight?
Pinging =
Leapfrogging =
Superbook orders Highlight market depth
Pinging = Small immediate or cancel limit to detect hidden orders. A type of hidden order.
Leapfrogging = Placing wide bid offer and changing quickly to gain priority inside other deals if the market responds.
Latency =
Flickering =
Latency = Time between an action and another dependent action taking place.
Flickering = Indicating to the market a price you are willing to trade at.
Gunning the market =
Malovent order streams
Runaway algorithms
Gunning the market = aims to trigger stop orders with rapid trades
Malovent order streams = intentionally disrupting the marketing to create international manipulation
Runaway algorithms = multiple runaway unintended orders such as 2010 flash crash.
Wash trading =
Spoofing/layering =
Trading for market impact =
Wash trading = trading between your own accounts to give an impression of fale liquidity.
Spoofing/layering = fake transparent limit orders create fake optimism at prices you want the market to aim at.
Trading for market impact = Trades deliberately aimed at raising or lowering market price sometimes at large cost.
Average rerutn given Er = b0 + B1X1 x B2X2
Weighted average of B0 is the expected return
Ie weighted average of the intercept.
