Portfolio Management Pathway (11.17.24) Flashcards
(212 cards)
1
Q
Overlay
A
A derivative position(s) used to adjust a pre-existing portfolio closer to its objectives
2
Q
Completion overlay
A
A type of overlay that addresses an indexed portfolio that has diverged from its proper exposure
3
Q
Rebalancing overlay
A
A type of overlay that addresses a portfolio’s need to sell certain constituent securities and buy others
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
5
Q
Program trading
A
A strategy of buying or selling many stocks simultaneously
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)
7
Q
Excess return
A
Tell the investor how the manager performed relative to the benchmark
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
9
Q
Cash drag
A
Tracking error caused by temporarily uninvested cash
10
Q
What could make net expenses negative in low cost index portfolio
A
Securities lending
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
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
13
Q
Portfolio overlay
A
An array of derivative positions managed separately from the securities portfolio to achieve overall intended portfolio characteristics
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
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
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
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
18
Q
Categories of data used in quantitative investing
A
1) Company mapping
2) Company fundamentals
3) Survey data
4) Unconventional data
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)
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
21
Q
Unconventional data
A
Also known as unstructured data
Include satellite images, measures of news sentiment, customer-supplier chain metrics, and corporate events
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
23
Q
Spearman rank IC
A
Pearson correlation coefficient between the ranked factor scores and the ranked forward returns
24
Q
Implicit vs Explicit trading costs
A
Explicit is commissions, fees, and taxes
Implicit is bid-ask spread and market impact
25
Two types of active equity management approaches
1) Fundamental
2) Quantitative
26
Two approaches to style analysis
1) Returns-based
2) Holdings-based
27
Holdings based approach
Aggregates the style scores of individual holdings
28
Returns based approach
Analyzes the investment style of portfolio managers by comparing the returns of the strategy to those of a set of style indexes
29
4 main building blocks of portfolio construction
1) Factor weightings
2) Alpha skills
3) Position sizing
4) Breadth of expertise
30
Three factors that describe the sources of manager's active returns
1) Exposure of rewarded risks
2) Timing of exposures to rewarded and unrewarded risks
3) Position sizing and its implications for idiosyncratic risk
31
Information coefficient
Correlation between forecast return and actual return
32
What does information coefficient measure
Effectiveness of investment insight
33
Breadth
The number of truly independent decisions made each year
34
Transfer coefficient
The ability to translate portfolio insights into investment decisions without constraint
35
Expected active portfolio return formula
IC * Sq(BR) * manager's active risk * TC
36
Active share
A measure of how similar a portfolio is to its benchmark
A manager who precisely replicates the benchmark will have active share of zero
37
Active risk
The standard deviation of active returns
38
Absolute approach objective
maximize sharpe ratio
39
relative approach objective
maximize information ratio
40
Risk budgeting
Process by which the total risk appetite of the portfolio is allocated among the various components of portfolio choice
41
Incremental VAR (IVAR)
Change in portfolio VaR when adding a new position to a portfolio, thereby reducing the position size of current positions
42
Marginal VAR (MVAR)
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
43
3 Rules of thumb for slippage
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
44
2 Inherent limitations of market neutral strategies
1) Difficult to maintain zero beta, as correlations between exposures are continually shifting
2) Limited upside in a bull market unless they equitized
45
Benefits of long/short strategies
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
46
Inherent risk of a short strategy
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
47
Systematic vs. discretionary approach
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
48
How much of global financial assets by market value does fixed income make up
75%
49
Immunization
An asset/liability management approach that structures investments in bonds to match (offset) liabilities' weighted-average duration; a type of dedication strategy
50
Expected fixed-income portfolio returns
Coupon income +/- rolldown return +/- expected change in price due to investor's view of:
1) benchmark yields +/-
2) yield spreads +/-
3) currency value changes
51
Primary factors that affect yield curve and how much they account for changes in yield curve
1) Level (parallel "shift") - 82%
2) Slope (flattening or steeping "twist") - 12%
3) Shape or curvature ("Butterfly movement") - 4%
52
Butterfly spread
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
53
Bullet portfolio
a fixed-income investment strategy that focuses on the intermediate term (or "belly") of the yield curve
54
Barbell portfolio
A fixed income strategy combining short and long-term bond positions
55
When is convexity a valuable metric
when interest rate volatility is expected to rise
56
Two basic ways a manager may actively position a bond portfolio versus a benchmark index to generate excess return from a static yield curve
increase risk by adding either duration or leverage to the portfolio
57
Futures Basis point value (BPV)
BPV (CTD) / CF (CTD)
CF = conversion factor
CTD = cheapest to deliver
58
Swap BPV
ModDur (Swap) * Swap Notional/10,000
59
Bull Steepening
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
60
Bear Steepeing
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
61
Bear flattening
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
62
Bull flattening
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
63
Butterfly strategy
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
64
Negative butterfly
An increase in the butterfly spread due to lower short and long-term yields-to-maturity and a higher intermediate yield-to-maturity
65
Positive butterfly
A decrease in the butterfly spread due to higher short and long-term yields-to-maturity and a lower intermediate yield-to-maturity
66
Effective Duration formula
((PV-) - (PV+)) / (2 * delta curve * PV0)
67
Effective convexity formula
((PV-) + (PV+) - 2*PV0) / (delta curve^2 * PV0)
68
Swaption
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
69
Uncovered interest rate parity
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
70
Forward rate bias
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
71
What does the yield curve slope measure
Difference between the yield-to-maturity on a long-maturity bond and the yield-to-maturity on a shorter-maturity bond
72
What are stand-alone interest rate put and call options generally based on
Bond's price, not yield-to-maturity
73
What strategy is commonly used to capitalize on expected yield curve shape changes
Butterfly strategy
74
Credit valuation adjustment (CVA)
The present value of credit risk for a loan, bond, or derivative obligation
75
Credit loss rate
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
76
Empirical duration
Estimation of the price-yield relationship using historical bond market data in statistical models
77
I-spread
Interpolated spread
Yield spread measure using swaps or constant maturity Treasury YTMs as a benchmark
It is an estimate of the spread over MRR for an new par bond from the bank issuer, with the difference largely reflecting the premium or discount of the outstanding bond price
78
Asset swaps
Convert a bond's fixed coupon to MRR plus (or minus) a spread
79
Asset swap spread (ASW)
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
It is an estimate of the spread over MRR vs. the bond's original coupon rate to maturity
80
Z-spread
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
more accurate than the other spreads but more complex to calculate
81
Quoted Margin (QM)
Specified spread of a floating rate instrument over a market reference rate or benchmark
82
Discount margin (DM)
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
Zero-discount margin (Z-DM)
A yield spread calculation for FRNs that incorporates forward MRR
84
Spread duration
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
Duration Times Spread (DTS)
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
Excess spread
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)
spread(0) is the initial yield spread, changes to spread(0)/periods per year for holding periods of less than a year
87
Expected excess spread return
spread(0) - (Effective spread duration * delta spread) - (POD * LGD)
88
Effective Rate Duration of FRN
((PV-) - (PV+) / (2 * delta MRR * PV0)
89
Effective Spread Duration of FRN
((PV-) - (PV+) / (2 * delta DM * PV0)
90
Portfolio manager's motivations to trade
1) Profit seeking
2) Risk management / hedging needs
3) Cash flow needs
4) Corporate actions / index reconstitutions / margin calls
91
Trade urgency
a reference to how quickly or slowly an order is executed over the trading time horizon
92
Alpha decay
In trading context, alpha decay is the erosion or deterioration in short term alpha after the investment decision has been made
93
Arrival price
price at the time the order was released to the market for execution
94
Principal trades
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
Agency trades
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
Scheduled algorithmic trading types
1) Percentage of volume (POV)
2) Volume-weighted average price (VWAP)
3) Time-weighted average price (TWAP)
97
Multilateral trading facilities
European dark pool
98
Systematic Internalisers (SI)
Single-dealer liquidity pools in Europe
99
Alternative trading system
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
Implementation Shortfall (IS)
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
Execution cost
The difference between the (trading related) cost of the real portfolio and the paper portfolio, based on shares and prices transacted
102
Arrival cost (bps)
Side * (average execution price - arrival price) / arrival price * 10^4 bps
side = 1 for buy; -1 for sell
103
VWAP cost (bps)
Side * (average execution price - VWAP) / VWAP * 10^4 bps
side = 1 for buy and -1 for sell
104
TWAP cost (bps)
Side * (average execution price - TWAP) / TWAP * 10^4 bps
side = 1 for buy and -1 for sell
105
Index cost (bps)
Side * (index VWAP - index arrival price) / index arrival price * 10^4
106
Market-adjusted cost (Bps)
Arrival cost (bps) - stock's beta * index cost (bps)
107
Aspects included in trade policy
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
The most common way to immunize the interest rate risk on a single liability
buy a zero coupon bond that matures on the obligation's due date
109
Immunized portfolio convexity formula
(MacDur^2 + MacDur + Dispersion) / (1+ Cash flow yield)^2
110
Structural risk
risk that arises from portfolio design, particularly the choice of the portfolio allocations
111
Accounting Defeasement
A way of extinguishing a debt obligation by setting aside sufficient high-quality securities to repay the liability
In-substance defeasance
112
Contingent immunization
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
Relationship for full interest rate hedging
Asset BPV * change in asset yields + Hedge BPV * change in hedge yields = liability BPV * change in liability yields
114
Enhanced indexing
matching market index but purchasing fewer securities than the full set of index constituents, but matches primary risk factors
115
Key rate duration
(Partial duration), measure of bond's sensitivity to a change in the benchmark yield at a specific maturity
116
Present value of distribution of cash flows methodology
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
Risk to immunization
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
Conditions to immunize multiple liabilities
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
Reduced form credit models
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
Structural credit models
Credit models that apply market-based variables to estimate the value of an issuer's assets and the volatility of asset value
121
Default intensity
POD over a specified time period in a reduced form credit model
122
Authorized participants
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
Hazard rate
the probability that an event will occur, given that it has not already occurred
124
CDS price at contract inception
1 + ((fixed coupon - cds spread) * effective spread duration of the CDS)
125
percentage of excess return
(return difference due to factor weighting) / (factor weighting return difference + security weighting return difference)
126
how does lipper methodology determine classification
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
how does morningstar determine classification
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
what bias is reduced when both adjusted and raw data are incorporated into a model
look-ahead bias
129
what is the risk management method used to offset the primary risk of pairs trading strategy
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
rebalancing under quantitative vs fundamental approach
rebalancing more frequent under quantitative
131
evaluation of risk under quantitive vs fundamental approach
quantitive - risk at the portfolio level
fundamental - risk at the company level
132
number of stocks held under quantitive vs fundamental approach
quantitative - more stocks held
fundamental - less stocks held
133
what should the characteristics of pairs trading be
1) current price ratio differs from long-term average
2) shows historical mean reversion
3) stocks are highly correlated
134
impact on classification if using RSA or HBA when new factor is introduced but the investment universe stays the same
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
when looking at benchmarks which style analysis is most accurate (one you should use)
Holdings-based anaylsis
136
how to pick a fund that minimizes active risk
the one with the highest covariance because active risk represents volatility of difference of returns
137
% of risk explain by one of the factors
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
active share and active risk under closet indexing
low active share and low active risk
139
what does high active share represent
manager's holdings differ substantially from the benchmark
140
what does low active risk represent
low idiosyncratic risk resulting from diversification
141
proportion of variance explained by one investment (in 3 asset portfolio)
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
characteristics of well constructed portfolio
1) low idiosyncratic risk (low unexplained risk)
2) low absolute volatility
3) low active risk
143
gross exposure of long-short portfolio
100%
144
investment capacity of long-only vs long-short approach
long-only provides greater investment capacity
145
how to reduce structural risk of bonds
minimizing dispersion of cash flows, going from barbell to bullet portfolio
146
what do with duration when interest rates are expected to increase and what do with when liabilities have longer duration than assets
increase duration, so assets duration matches liabilities
147
formula for how many contracts to remove duration gap between assets and liabilities
(BVP liabilities - BVP assets) / (BVP contract to purchase
148
value weighted index of credit issuers
weighted by the value of debt, so credit deterioration risk is heightened with the use of value weighted index
149
Equity vs. Fixed Income; which portfolio is easier to value
equity because it trades more frequently
150
objective convexity when trying to mimic zero coupon bond
minimize convexity
151
which fixed income metric does immunization attempt to match
cash flow yield (internal rate of return)
152
in case of single liability, how is immunization achieved
match Macauley duration with investment horizon
153
how often should a benchmark be valued for it to be consistent with an investable, transparent benchmark
daily
154
how to take advantage of positive butterfly spread
purchase the bullet, sell the barbell
155
appropriate duration to use for commercial and residual MBS
effective duration
156
for investment grade bonds, what is the correlation between risk free rate and credit spreads
negative
157
primary risk for investment grade bonds
credit migration
158
primary risk for high yield bonds
loss severity
159
formula for excess return on bond (calculating relative value)
EXR = (s*t) - (change in s * SD) - (t*p*L)
s = z-spread
t = holding period
SD = spread duration
p = probability of default
L = loss severity
160
investment grade vs. HY, which is more sensitive to interest rate changes
investment grade
161
when are scheduled algorithms appropriate
when traders do not have expectations for adverse price movements during the trade horizon and shares are relatively liquid
162
when is DMA (direct market access) used for trades
for small currency trades and small exchange traded derivatives
163
opportunity cost of execution
(Shares not purchased) * (closing price - decision price)
164
when are dark aggregators used
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
when are arrival price algorithms to be used
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
when are time-weighted algos to be used
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
expanded implementation shortfall
delay cost + trading cost + opportunity cost + fees
168
delay cost
(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
trading cost
(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
Equitization
temproarily investing cash using futures or ETFs to gain the desired equity exposure before investing in the underlying securities longer term
171
when would equitization be required
if large inflows into a portfolio are expected and there is a lack of liquidity in the underlying securities
172
when would liquidity-seeking algorithms be used
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
pre-trade benchmark
reference price that is known before the start of the period over which trading will take place
174
which type of bonds is spread duration a more useful measure of risk for
investment-grade bonds because they are more sensitive to changes in interest rates
175
which phase of the credit cycle involves a decline in the number of issuer defaults
late expansion
176
the appropriate action to take with CDS's when an economic contraction is expected
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
3 Types of Cash-Based Static Yield Curve Strategies
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
2 Types of Derivatives-Based Static Yield Curve Strategies
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
key inputs for trade strategy
1) order characteristics
2) security characteristics
3) market conditions
4) individual risk aversion
180
execution risk
risk of adverse price movement occurring over trading horizon either due to change in fundamental value or due to volatility
181
correlation between high risk aversion and trade urgency
high risk aversion - high trade urgency to avoid market impacts
182
trader's dilemma
trading too fast results in too much market impact, but trading too slow results in too much market risk
183
reference price / price benchmark
specified prices, price-based calculations, or price targets used to select and execute a strategy
184
decision price
security price at the time the PM made the decision to buy or sell
185
when would a PM select an intraday benchmark
when they do not expect and short-term price volatility
intraday benchmark is either VWAP or TWAP
186
when would a PM commonly use VWAP
when they are rebalancing and have excess cash from sales that they need to reinvest
187
when would a PM commonly use TWAP
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
when would a PM use a post-trade benchmark
when they are tracking an index that adjusts based on closing price and they want to minimize tracking risk
189
most common post-trade benchmark
closing price
190
disadvantage of using post-trade benchmark
do not know trade price until after the trade is done
191
added value from trading
arrival cost (bps) - estimated pre-trade cost (bps)
192
4 Key aspects that need to be included in trade policy
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
193
difference between yield spread and g spread
yield spread is difference between the bond you're analyzing and the ~nearest~ government bond
g spread requires you to linearly interpolate the g spread rate
194
calculate g spread when not given exact government bond
(maturity on longest g bond - corporate bond) / (maturity on longest g bond - other closest g bond maturity) = weight allocation to lower maturity g bond yield
1 - ^ = weight allocation to higher maturity g bond yield
195
downside to i spread
limited to option-free bonds as a credit risk measure
196
asset swap spread rate when bond is priced close to par
~= bond's credit risk over the MRR
197
credit default swap basis
difference between the z spread on a specific bond and cds spread of the same (or interpolated) maturity for the same issuer
198
cds curve
plot of cds spreads across maturities for a single reference entity or index
199
3 factors that complicate translation of business cycle information into capital market expectations
1) cycles vary in length and amplitude
2) not always easy to distinguish between cyclical forces and secular forces
3) how, when, and by how much the markets respond to the business cycle is uncertain
200
over what range is business cycle information likely to be most reliable in setting capital market expectations
within the range of likely expansion and contract phases
transitory developments over short-term and long-term anything is unreliable
201
when in the business cycle is the greatest risk of monetary policy
at the top of the cycle when the central bank may overestimate economy's momentum or underestimate the potency of restrictive policies
202
effectiveness of negative rate policy
unclear
203
effectiveness of quantitative easing
unclear
204
which part of the credit cycle do credit spreads peak
contraction
205
which part of the credit cycle to corporate defaults peak
early expansion
206
yield spread
difference between bond's YTM and the YTM of an on-the-run government bond of a similar maturity
207
main drawback of OAS
highly dependent on volatility and other model assumptions
208
QM vs DM when FRN priced at discount
DM > QM
209
QM vs DM when FRN priced at premium
QM > DM
210
disadvantages of QM
does not capture changes in credit risk over time
211
disadvantages of DM
assume flat MRR zero curve
212
