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CFA L3 > Portfolio Management Pathway (11.17.24) > Flashcards

Portfolio Management Pathway (11.17.24) Flashcards

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1
Q

Overlay

A

A derivative position(s) used to adjust a pre-existing portfolio closer to its objectives

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2
Q

Completion overlay

A

A type of overlay that addresses an indexed portfolio that has diverged from its proper exposure

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3
Q

Rebalancing overlay

A

A type of overlay that addresses a portfolio’s need to sell certain constituent securities and buy others

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4
Q

Currency overlay

A

A type of overlay that helps hedge the returns of securities held in foreign currency back to the home country’s currency

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5
Q

Program trading

A

A strategy of buying or selling many stocks simultaneously

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6
Q

Tracking error

A

Indicates how closely the portfolio behaves like its benchmark and measures a manager’s ability to replicate the benchmark return

square root of variance of excess return

excess return = (return on portfolio - return on benchmark)

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7
Q

Excess return

A

Tell the investor how the manager performed relative to the benchmark

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8
Q

Sources of tracking error in an indexed equity fund

A

1) Fees
2) Number of securities held vs. the benchmark
3) Cash drag

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9
Q

Cash drag

A

Tracking error caused by temporarily uninvested cash

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10
Q

What could make net expenses negative in low cost index portfolio

A

Securities lending

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11
Q

Risks of securities lending

A

1) Credit quality of the borrower (credit risk)
2) Value of the posted collateral (market risk)
3) Liquidity risk
4) Operational risk

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12
Q

Special situations investment style

A

Focuses on the identification and exploitation of mispricings that may arise as a result of corporate events such as divestitures or spinoffs of assets or divisions or mergers with other entities

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13
Q

Portfolio overlay

A

An array of derivative positions managed separately from the securities portfolio to achieve overall intended portfolio characteristics

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14
Q

Factor-mimicking portfolio (FMP)

A

Theoretical long/short portfolio that is dollar neutral with a unit exposure to a chosen factor and no exposure to other factors

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15
Q

Fundamental investment process

A

1) Define the investment universe and the market opportunity (investment thesis)

2) Prescreen the universe to obtain a manageable set of securities for further analysis

3) Study screened set by performing industry, competitive, and financial report analysis

4) Forecast company performance, in terms of cash flows or earnings

5) Covert forecasts to valuations and identify ex ante profitable investments

6) Construct a portfolio of these investments with the desired risk profile

7) Rebalance the portfolio with buy and sell disciplines

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16
Q

Value trap

A

Stock that appears to be attractively valued (low P/E, etc.) because of a significant price fall but that may still be overpriced given its worsening future prospects

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17
Q

Growth trap

A

Stock that is overpriced and so above average or in-line earnings/cash flow growth does not cause the price to move higher

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18
Q

Categories of data used in quantitative investing

A

1) Company mapping
2) Company fundamentals
3) Survey data
4) Unconventional data

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19
Q

Company mapping

A

Used to track many companies over time and across data vendors (names, tickers, and other identifiers that change across different data vendors)

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20
Q

Survey data

A

Details of corporate earnings, forecasts and estimates by various market participants, macroeconomic variables, sentiment indicators, and information on funds flow

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21
Q

Unconventional data

A

Also known as unstructured data

Include satellite images, measures of news sentiment, customer-supplier chain metrics, and corporate events

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22
Q

Pearson IC

A

Simple correlation coefficient between the factor scores (essentially standardized exposures) for the current period’s and the next period’s stock returns

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23
Q

Spearman rank IC

A

Pearson correlation coefficient between the ranked factor scores and the ranked forward returns

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24
Q

Implicit vs Explicit trading costs

A

Explicit is commissions, fees, and taxes

Implicit is bid-ask spread and market impact

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25
Q

Two types of active equity management approaches

A

1) Fundamental
2) Quantitative

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26
Q

Two approaches to style analysis

A

1) Returns-based
2) Holdings-based

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27
Q

Holdings based approach

A

Aggregates the style scores of individual holdings

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28
Q

Returns based approach

A

Analyzes the investment style of portfolio managers by comparing the returns of the strategy to those of a set of style indexes

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29
Q

4 main building blocks of portfolio construction

A

1) Factor weightings
2) Alpha skills
3) Position sizing
4) Breadth of expertise

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30
Q

Three factors that describe the sources of manager’s active returns

A

1) Exposure of rewarded risks
2) Timing of exposures to rewarded and unrewarded risks
3) Position sizing and its implications for idiosyncratic risk

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31
Q

Information coefficient

A

Correlation between forecast return and actual return

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32
Q

What does information coefficient measure

A

Effectiveness of investment insight

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33
Q

Breadth

A

The number of truly independent decisions made each year

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34
Q

Transfer coefficient

A

The ability to translate portfolio insights into investment decisions without constraint

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35
Q

Expected active portfolio return formula

A

IC * Sq(BR) * manager’s active risk * TC

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36
Q

Active share

A

A measure of how similar a portfolio is to its benchmark

A manager who precisely replicates the benchmark will have active share of zero

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37
Q

Active risk

A

The standard deviation of active returns

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38
Q

Absolute approach objective

A

maximize sharpe ratio

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39
Q

relative approach objective

A

maximize information ratio

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40
Q

Risk budgeting

A

Process by which the total risk appetite of the portfolio is allocated among the various components of portfolio choice

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41
Q

Incremental VAR (IVAR)

A

Change in portfolio VaR when adding a new position to a portfolio, thereby reducing the position size of current positions

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42
Q

Marginal VAR (MVAR)

A

Effect of a very small change in the position size; in a diversified portfolio, marginal VaR may be used to determine the contribution of each asset to the overall VaR

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43
Q

3 Rules of thumb for slippage

A

1) Slippage costs are more important than commission costs
2) Slippage costs are greater for smaller-cap securities than for large-cap securities
3) Slippage costs can vary substantially over time, especially when market volatility is higher

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44
Q

2 Inherent limitations of market neutral strategies

A

1) Difficult to maintain zero beta, as correlations between exposures are continually shifting

2) Limited upside in a bull market unless they equitized

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45
Q

Benefits of long/short strategies

A

1) Ability to more fully express short ideas than under a long-only strategy
2) Efficient use of leverage and of the benefits of diversification
3) Greater ability to calibrate/control exposure to factors, sectors, geography, or any undesired exposures

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46
Q

Inherent risk of a short strategy

A

1) Unlike a long position, a short position will move against the manager if the price of the security increases

2) Require significant leverage

3) Cost of borrowing can be prohibitive, especially if the security is hard to borrow

4) Collateral requirements will increase if a short position is squeezed

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47
Q

Systematic vs. discretionary approach

A

Systematic strategies incorporate research-based rules across a broad universe of securities, while discretionary strategies integrate the judgement of the manager on a small subset of securities

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48
Q

How much of global financial assets by market value does fixed income make up

A

75%

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49
Q

Immunization

A

An asset/liability management approach that structures investments in bonds to match (offset) liabilities’ weighted-average duration; a type of dedication strategy

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50
Q

Expected fixed-income portfolio returns

A

Coupon income +/- rolldown return +/- expected change in price due to investor’s view of:

1) benchmark yields +/-
2) yield spreads +/-
3) currency value changes

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51
Q

Primary factors that affect yield curve and how much they account for changes in yield curve

A

1) Level (parallel “shift”) - 82%
2) Slope (flattening or steeping “twist”) - 12%
3) Shape or curvature (“Butterfly movement”) - 4%

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52
Q

Butterfly spread

A

A measure of yield curve shape or curvature equal to double the intermediate yield-to-maturity less the sum of short- and long-term yields-to-maturity

= - (short-term yield) + (2 * medium-term yield) - long-term yield

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53
Q

Bullet portfolio

A

a fixed-income investment strategy that focuses on the intermediate term (or “belly”) of the yield curve

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54
Q

Barbell portfolio

A

A fixed income strategy combining short and long-term bond positions

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55
Q

When is convexity a valuable metric

A

when interest rate volatility is expected to rise

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56
Q

Two basic ways a manager may actively position a bond portfolio versus a benchmark index to generate excess return from a static yield curve

A

increase risk by adding either duration or leverage to the portfolio

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57
Q

Futures Basis point value (BPV)

A

BPV (CTD) / CF (CTD)

CF = conversion factor
CTD = cheapest to deliver

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58
Q

Swap BPV

A

ModDur (Swap) * Swap Notional/10,000

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59
Q

Bull Steepening

A

An increase in the yield spread between long and short-term maturities across the yield curve, which is largely driven by a decline in short-term bond yields-to-maturity

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60
Q

Bear Steepeing

A

An increase in the yield spread between long and short-term maturities across the yield curve, which is largely driven by a rise in long-term bond yields-to-maturity

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61
Q

Bear flattening

A

A decrease in the yield spread between long and short-term maturities across the yield curve, which is largely driven by a rise in short-term bond yields-to-maturity

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62
Q

Bull flattening

A

A decrease in the yield spread between long- and short-term maturities across the yield curve, which is largely driven by a decline in long-term bond yields-to-maturity

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63
Q

Butterfly strategy

A

A common yield curve shape strategy that combines a long or short bullet position with a barbell portfolio in the opposite direction to capitalize on expected yield curve shape changes

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64
Q

Negative butterfly

A

An increase in the butterfly spread due to lower short and long-term yields-to-maturity and a higher intermediate yield-to-maturity

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65
Q

Positive butterfly

A

A decrease in the butterfly spread due to higher short and long-term yields-to-maturity and a lower intermediate yield-to-maturity

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66
Q

Effective Duration formula

A

((PV-) - (PV+)) / (2 * delta curve * PV0)

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67
Q

Effective convexity formula

A

((PV-) + (PV+) - 2*PV0) / (delta curve^2 * PV0)

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68
Q

Swaption

A

An instrument that grants a party the right, but not the obligation, to enter into an interest rate swap at a pre-determined strike (fixed swap rate) on a future date in exchange for an upfront premium

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69
Q

Uncovered interest rate parity

A

The proposition that the expected return on an uncovered (unhedged) foreign currency (risk-free) investment should equal the return on a comparable domestic currency investment

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70
Q

Forward rate bias

A

An empirically observed divergence from interest rate parity conditions that active investors seek to benefit from by borrowing in a lower-yield currency and investing in a higher-yield currency

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71
Q

What does the yield curve slope measure

A

Difference between the yield-to-maturity on a long-maturity bond and the yield-to-maturity on a shorter-maturity bond

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72
Q

What are stand-alone interest rate put and call options generally based on

A

Bond’s price, not yield-to-maturity

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73
Q

What strategy is commonly used to capitalize on expected yield curve shape changes

A

Butterfly strategy

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74
Q

Credit valuation adjustment (CVA)

A

The present value of credit risk for a loan, bond, or derivative obligation

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75
Q

Credit loss rate

A

the realized percentage of par value lost to default for a group of bonds equal to the bonds’ default rate multiplied by the loss severity

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76
Q

Empirical duration

A

Estimation of the price-yield relationship using historical bond market data in statistical models

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77
Q

I-spread

A

Interpolated spread

Yield spread measure using swaps or constant maturity Treasury YTMs as a benchmark

78
Q

Asset swaps

A

Convert a bond’s fixed coupon to MRR plus (or minus) a spread

79
Q

Asset swap spread (ASW)

A

The spread over MRR on an interest rate swap for the remaining life of the bond that is equivalent to the bond’s fixed coupon

80
Q

Z-spread

A

Zero-volatility spread

A constant spread which is estimated using the market prices of comparable bonds for issuers of similar credit quality of a bond over the benchmark rate

81
Q

Quoted Margin (QM)

A

Specified spread of a floating rate instrument over a market reference rate or benchmark

82
Q

Discount margin (DM)

A

The discount (or required) margin is the yield spread versus the MRR such that the FRN is priced at par on a rate reset date

83
Q

Zero-discount margin (Z-DM)

A

A yield spread calculation for FRNs that incorporates forward MRR

84
Q

Spread duration

A

The change in bond price for a given change in yield spread

Also referred to as OAS duration when the OAS is the yield measure used

85
Q

Duration Times Spread (DTS)

A

Weighting of spread duration by credit spread to incorporate the empirical observation that spread changes for lower-rated bonds tend to be consistent on a percentage rather than absolute basis

DTS = (Effective spread duration) * (spread)

86
Q

Excess spread

A

Surplus difference of yield remaining after payments to bondholders are made after expenses are made and losses are covered

Excess spread = spread(0)/periods - (effective spread duration * delta spread)

87
Q

Expected excess spread return

A

spread(0) - (Effective spread duration * delta spread) - (POD * LGD)

88
Q

Effective Rate Duration of FRN

A

((PV-) - (PV+) / (2 * delta MRR * PV0)

89
Q

Effective Spread Duration of FRN

A

((PV-) - (PV+) / (2 * delta DM * PV0)

90
Q

Portfolio manager’s motivations to trade

A

1) Profit seeking

2) Risk management / hedging needs

3) Cash flow needs

4) Corporate actions / index reconstitutions / margin calls

91
Q

Trade urgency

A

a reference to how quickly or slowly an order is executed over the trading time horizon

92
Q

Alpha decay

A

In trading context, alpha decay is the erosion or deterioration in short term alpha after the investment decision has been made

93
Q

Arrival price

A

price at the time the order was released to the market for execution

94
Q

Principal trades

A

A trade in which the market maker or dealer becomes a disclosed counterparty and assume risk for the trade by transacting the security for their own account

Broker risk trades

95
Q

Agency trades

A

A trade in which the broker is engaged to find the other side of the trade, acting as an agent; the broker does not assume any risk for the trade

96
Q

Scheduled algorithmic trading types

A

1) Percentage of volume (POV)
2) Volume-weighted average price (VWAP)
3) Time-weighted average price (TWAP)

97
Q

Multilateral trading facilities

A

European dark pool

98
Q

Systematic Internalisers (SI)

A

Single-dealer liquidity pools in Europe

99
Q

Alternative trading system

A

trading venues in the US that function like exchanges but do not exercise regulatory authority over their subscribers except with respect to the conduct of the subscribers’ trading

must be approved by the SEC

100
Q

Implementation Shortfall (IS)

A

The difference between the return for a notional or paper portfolio, where all transactions are assumed to take place at the manager’s decision price, and the portfolio’s actual return, which reflects realized transactions, including fees and costs

Paper return - actual return

101
Q

Execution cost

A

The difference between the (trading related) cost of the real portfolio and the paper portfolio, based on shares and prices transacted

102
Q

Arrival cost (bps)

A

Side * (average execution price - arrival price) / arrival price * 10^4 bps

side = 1 for buy; -1 for sell

103
Q

VWAP cost (bps)

A

Side * (average execution price - VWAP) / VWAP * 10^4 bps

side = 1 for buy and -1 for sell

104
Q

TWAP cost (bps)

A

Side * (average execution price - TWAP) / TWAP * 10^4 bps

side = 1 for buy and -1 for sell

105
Q

Index cost (bps)

A

Side * (index VWAP - index arrival price) / index arrival price * 10^4

106
Q

Market-adjusted cost (Bps)

A

Arrival cost (bps) - stock’s beta * index cost (bps)

107
Q

Aspects included in trade policy

A

1) Meaning of best execution
2) Factors determining the optimal order execution approach
3) Listing of eligible brokers and execution venues
4) Process to monitor execution arrangements

108
Q

The most common way to immunize the interest rate risk on a single liability

A

buy a zero coupon bond that matures on the obligation’s due date

109
Q

Immunized portfolio convexity formula

A

(MacDur^2 + MacDur + Dispersion) / (1+ Cash flow yield)^2

110
Q

Structural risk

A

risk that arises from portfolio design, particularly the choice of the portfolio allocations

111
Q

Accounting Defeasement

A

A way of extinguishing a debt obligation by setting aside sufficient high-quality securities to repay the liability

In-substance defeasance

112
Q

Contingent immunization

A

Hybrid approach that combines immunization with an active management approach when the asset portfolio’s value exceeds the present value of the liability portfolio

113
Q

Relationship for full interest rate hedging

A

Asset BPV * change in asset yields + Hedge BPV * change in hedge yields = liability BPV * change in liability yields

114
Q

Enhanced indexing

A

matching market index but purchasing fewer securities than the full set of index constituents, but matches primary risk factors

115
Q

Key rate duration

A

(Partial duration), measure of bond’s sensitivity to a change in the benchmark yield at a specific maturity

116
Q

Present value of distribution of cash flows methodology

A

Method used to address a portfolio’s sensitivity to rate changes along the yield curve

Seeks to approximate and match the yield curve risk of an index over discrete time periods

117
Q

Risk to immunization

A

As the yield curve shifts and twists, the cash flow yield on the bond portfolio does not match the change in the yield on the zero-coupon bond that provide for perfrect immunization

118
Q

Conditions to immunize multiple liabilities

A

1) Market value of assets is greater than or equal to the market value of the liabilities

2) Asset basis point value (BPV) equals the liability BPV

3) Dispersion of cash flows and the convexity of assets are greater than those of the liabilities

119
Q

Reduced form credit models

A

Credit models that solve for default probability over a specific time period using observable company-specific variables such as financial ratios and macroeconomic variables

120
Q

Structural credit models

A

Credit models that apply market-based variables to estimate the value of an issuer’s assets and the volatility of asset value

121
Q

Default intensity

A

POD over a specified time period in a reduced form credit model

122
Q

Authorized participants

A

A special group of institutional investors who are authorized by the ETF issuer to participate in the creation/redemption process

Large broker dealers, often market makers

123
Q

Hazard rate

A

the probability that an event will occur, given that it has not already occurred

124
Q

CDS price at contract inception

A

1 + ((fixed coupon - cds spread) * effective spread duration of the CDS)

125
Q

percentage of excess return

A

(return difference due to factor weighting) / (factor weighting return difference + security weighting return difference)

126
Q

how does lipper methodology determine classification

A

it sums the z-score of six portfolio characteristics over several years to determine an overall z-score that determines either a value, core, or growth classification

127
Q

how does morningstar determine classification

A

it calculates a score for value and growth on a scale of 0 to 100 using five proxy measures for each. the value score is subtracted from the growth score, a strong positive net score leads to a growth classification

128
Q

what bias is reduced when both adjusted and raw data are incorporated into a model

A

look-ahead bias

129
Q

what is the risk management method used to offset the primary risk of pairs trading strategy

A

frequent use of stop-loss order rules

pairs trading risk comes when the observed price divergence that occasionally happens, is not temporary and could be due to structural reasons

130
Q

rebalancing under quantitative vs fundamental approach

A

rebalancing more frequent under quantitative

131
Q

evaluation of risk under quantitive vs fundamental approach

A

quantitive - risk at the portfolio level
fundamental - risk at the company level

132
Q

number of stocks held under quantitive vs fundamental approach

A

quantitative - more stocks held
fundamental - less stocks held

133
Q

what should the characteristics of pairs trading be

A

1) current price ratio differs from long-term average

2) shows historical mean reversion

3) stocks are highly correlated

134
Q

impact on classification if using RSA or HBA when new factor is introduced but the investment universe stays the same

A

classification would change under both because correlations of returns to the factors would change, so RSA would change

also, holdings would likely change, leading to HBA changing

135
Q

when looking at benchmarks which style analysis is most accurate (one you should use)

A

Holdings-based anaylsis

136
Q

how to pick a fund that minimizes active risk

A

the one with the highest covariance because active risk represents volatility of difference of returns

137
Q

% of risk explain by one of the factors

A

sum of (risk coefficient * variance of that factor with other factor * risk coefficient(~)) / StD^2

risk coefficient(~) = risk coefficient of each of the factors

138
Q

active share and active risk under closet indexing

A

low active share and low active risk

139
Q

what does high active share represent

A

manager’s holdings differ substantially from the benchmark

140
Q

what does low active risk represent

A

low idiosyncratic risk resulting from diversification

141
Q

proportion of variance explained by one investment (in 3 asset portfolio)

A

weight of asset 1 * weight of asset 1 * cov(1,1)

weight of asset 1 * weight of asset 2 * cov(1,2)

weight of asset 1 * weight of asset 3 * cov(1,3)

  • sum of those 3 is asset 1’s contribution to portfolio variance

(can also do weight of asset 1 * covariance with portfolio)

  • portfolio variance = portfolio StD^2
  • asset 1 total variance / portfolio variance
142
Q

characteristics of well constructed portfolio

A

1) low idiosyncratic risk (low unexplained risk)

2) low absolute volatility

3) low active risk

143
Q

gross exposure of long-short portfolio

A

100%

144
Q

investment capacity of long-only vs long-short approach

A

long-only provides greater investment capacity

145
Q

how to reduce structural risk of bonds

A

minimizing dispersion of cash flows, going from barbell to bullet portfolio

146
Q

what do with duration when interest rates are expected to increase and what do with when liabilities have longer duration than assets

A

increase duration, so assets duration matches liabilities

147
Q

formula for how many contracts to remove duration gap between assets and liabilities

A

(BVP liabilities - BVP assets) / (BVP contract to purchase

148
Q

value weighted index of credit issuers

A

weighted by the value of debt, so credit deterioration risk is heightened with the use of value weighted index

149
Q

Equity vs. Fixed Income; which portfolio is easier to value

A

equity because it trades more frequently

150
Q

objective convexity when trying to mimic zero coupon bond

A

minimize convexity

151
Q

which fixed income metric does immunization attempt to match

A

cash flow yield (internal rate of return)

152
Q

in case of single liability, how is immunization achieved

A

match Macauley duration with investment horizon

153
Q

how often should a benchmark be valued for it to be consistent with an investable, transparent benchmark

A

daily

154
Q

how to take advantage of positive butterfly spread

A

purchase the bullet, sell the barbell

155
Q

appropriate duration to use for commercial and residual MBS

A

effective duration

156
Q

for investment grade bonds, what is the correlation between risk free rate and credit spreads

A

negative

157
Q

primary risk for investment grade bonds

A

credit migration

158
Q

primary risk for high yield bonds

A

loss severity

159
Q

formula for excess return on bond (calculating relative value)

A

EXR = (st) - (change in s * SD) - (tp*L)

s = z-spread
t = holding period
SD = spread duration
p = probability of default
L = loss severity

160
Q

investment grade vs. HY, which is more sensitive to interest rate changes

A

investment grade

161
Q

when are scheduled algorithms appropriate

A

when traders do not have expectations for adverse price movements during the trade horizon and shares are relatively liquid

162
Q

when is DMA (direct market access) used for trades

A

for small currency trades and small exchange traded derivatives

163
Q

opportunity cost of execution

A

(Shares not purchased) * (closing price - decision price)

164
Q

when are dark aggregators used

A

when the concern is that information leakage may occur
from posting limit orders
+
the order size is large relative to the market (% of expected volume)
+
trades do not need to be executed in its entirety

165
Q

when are arrival price algorithms to be used

A

when the trader believes prices are likely to move unfavorably during the trade horizon, like the market is not pricing in bad news enough into a stock’s price

166
Q

when are time-weighted algos to be used

A

when traders to not have expectations of adverse price movements during the trade horizon
+
traders who have a greater risk tolerance for longer execution time periods

167
Q

expanded implementation shortfall

A

delay cost + trading cost + opportunity cost + fees

168
Q

delay cost

A

(number of shares sold * arrival price) - (number of shares sold - decision price)

value of shares sold at arrival price - value of shares sold at decision price

169
Q

trading cost

A

(total shares sold * execution price) - (number of shares sold * arrival price)

value of shares sold at execution price - value of shares sold at arrival price

170
Q

Equitization

A

temproarily investing cash using futures or ETFs to gain the desired equity exposure before investing in the underlying securities longer term

171
Q

when would equitization be required

A

if large inflows into a portfolio are expected and there is a lack of liquidity in the underlying securities

172
Q

when would liquidity-seeking algorithms be used

A

to execute quickly without having substantial impact on the security price
+
when displaying sizable liquidity via limit orders could lead to unwanted information leakage and adverse price movements

173
Q

pre-trade benchmark

A

reference price that is known before the start of the period over which trading will take place

174
Q

which type of bonds is spread duration a more useful measure of risk for

A

investment-grade bonds because they are more sensitive to changes in interest rates

175
Q

which phase of the credit cycle involves a decline in the number of issuer defaults

A

late expansion

176
Q

the appropriate action to take with CDS’s when an economic contraction is expected

A

buy protection on short term high yield and sell protection on short term investment grade

  • economic contraction is associated with a sharp rise in shorter-term high yield spreads and spread curve flattening in investment grade and inversion in high yield
177
Q

3 Types of Cash-Based Static Yield Curve Strategies

A

1) buy-and-hold: add duration beyond target given static yield curve view

2) Rolling down the yield curve: add duration and increased return if future short-term yields are below current yield-to-maturities

3) Repo carry trade: generate repo carry return if coupon plus rolldown exceeds financing cost

178
Q

2 Types of Derivatives-Based Static Yield Curve Strategies

A

1) Long futures position: synthetically increase duration (up-front margin and daily mark-to-market valuation)

2) Synthetically increase portfolio duration (up-front / mark-to-market collateral) +/ swap carry

179
Q

key inputs for trade strategy

A

1) order characteristics

2) security characteristics

3) market conditions

4) individual risk aversion

180
Q

execution risk

A

risk of adverse price movement occurring over trading horizon either due to change in fundamental value or due to volatility

181
Q

correlation between high risk aversion and trade urgency

A

high risk aversion - high trade urgency to avoid market impacts

182
Q

trader’s dilemma

A

trading too fast results in too much market impact, but trading too slow results in too much market risk

183
Q

reference price / price benchmark

A

specified prices, price-based calculations, or price targets used to select and execute a strategy

184
Q

decision price

A

security price at the time the PM made the decision to buy or sell

185
Q

when would a PM select an intraday benchmark

A

when they do not expect and short-term price volatility

intraday benchmark is either VWAP or TWAP

186
Q

when would a PM commonly use VWAP

A

when they are rebalancing and have excess cash from sales that they need to reinvest

187
Q

when would a PM commonly use TWAP

A

when they wish to evaluate fair and reasonable prices in market environments with uncertain volatility or for securities that could spike in trading volume

it basically excludes trade outliers which the PM may not be able to participate in for their trade

188
Q

when would a PM use a post-trade benchmark

A

when they are tracking an index that adjusts based on closing price and they want to minimize tracking risk

189
Q

most common post-trade benchmark

A

closing price

190
Q

disadvantage of using post-trade benchmark

A

do not know trade price until after the trade is done

191
Q

added value from trading

A

arrival cost (bps) - estimated pre-trade cost (bps)

192
Q

4 Key aspects that need to be included in trade policy

A

1) meaning of best execution (not necessarily best price)

2) factors determining the optimal order executing approach (may differ by asset class, security liquidity, and security trading mechanism

3) listing of eligible brokers and execution venues

4) process to monitor execution arrangements

CFA L3 (7 decks)

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