Risk and Risk Mgt.

Question 1

Active return

Answer 1

The deviation from the asset’s return from its benchmark

Question 2

Fund style index

Answer 2

performance index based on the collection of fund managers operating a similar strategy

Question 3

Bailey criteria

Answer 3

Seven characteristics a benchmark should have to be a useful gauge. 
US MAORI
1. Unambiguous
2.  Specified in advance 
3. Measurable
4. Appropriate
5. Owned
6. Reflective of current investment opinion
7. Investable

Question 4

Hughen and Eckrich (2015) describe liquid alternatives are hard to benchmark why?

Answer 4

Low correlation of liquid alternatives to typical long only benchmarks. Solution is to create benchmarks for the underlying asset classes.

Question 5

Three considerations in benchmarking

Answer 5

1. Is the benchmark appropriate (similar return drivers)
2. Was outperformance statistically/economicaly significant.
3. Why did the fund outperform its benchmark

Question 6

What do the empirical tests indicate if the CAPM describe returns perfectly?

Answer 6

(1) Intercept is statistically equal to zero
(2) Slope is statistically equal to the asset’s true beta
(3) Residual = idiosyncratic asset specific risks

Question 7

Omission of systematic risk factors in an up market will result in

Answer 7

Overestimation of the risk-adjusted performance of assets positively exposed to the omitted risk factors

Question 8

Four reasons not to apply CAPM to alternatives

Answer 8

1. Multi-period issues (CAPM = single period)
2. Non-Normality
3. Illiquidity of Returns
4. Investor specific assets or liabilities

Question 9

Value-based index (60% equity/40% bonds)

Answer 9

fixed component weights expressed as percentage of value of the index

Question 10

Quantity-based index (S&P 500)

Answer 10

fixed number of contracts for each commodity (index weights change daily)

Question 11

Input variables to determine commodity weights

Answer 11

1. World production (S&P GSCI)
2. Liquidity (BCOM)
3. Open interest (nominal value of open futures)

Question 12

Total return index

Answer 12

Fully collateralized investment strategy whereby you include collateral yield (from T-bills)

Question 13

Excess return index

Answer 13

Provides returns over cash and is linked to a basket of commodity futures contracts

Question 14

Roll method choices

Answer 14

1. Futures curve positioning (determine time to expiration)

2. Roll procedure (when to close/open positions)

Question 15

Three generations of commodity indices

Answer 15

1st generation -> Heavily weighted in energy with long-only position in front-month contracts.
2nd generation -> Attempt to enhance returns through forward curve positioning.
3rd generation -> includes active commodity selection.

Question 16

Private Equity Benchmarks: PME and LN PME method

Answer 16

• PME only contains 2 cashflows

- LN PME focuses on computing two IRRs

Question 17

Cap rate spread

Answer 17

Cap rate - 10Y Default free bond

Question 18

2 ways of benchmarking core real estate

Answer 18

Cap rates, Risk premium formula E(Ri)=RF+RP

Question 19

Three approaches to benchmark non-core real estate

Answer 19

1. Cap rates,
2. Risk premium approach
3. Use of absolute hurdle rates

Question 20

CTA three describing levels of value

Answer 20

1. Trading Level
2. Funding Level (total amount of collateral posted)
3. Notional Funding (exposure above trading level)

Trading Level = Funding Level + Notional

Question 21

Capital At Risk

Answer 21

total loss if each asset hits its stop-loss on that day

Question 22

Critical assumption VaR method

Answer 22

Normal distribution of daily returns

Question 23

Omega Ratio

Answer 23

General measure of risk that takes into account the entire return distribution

Question 24

Interpret Omega Ratio

Answer 24

If the Omega Ratio is less than one the asset failed to earn a summed return that exceeds the target level

Question 25

Primary culprits as to why returns can’t be unsmoothed by arbitrageurs

Answer 25

1. No true trading opportunities

2. Transaction costs

Question 26

Portable alpha

Answer 26

Exploit alpha by investing in an alpha-producing strategy while simultaneously maintaining a target beta exposure

Question 27

Rebalancing when a stock follows a random walk

Answer 27

Does not change the expected value only the risk

Question 28

Rebalancing when a stock mean-reverts

Answer 28

increases expected value vs. a buy-and-hold strategy and alters the risk

Question 29

Six activities of monitoring private partnerships

Answer 29

1. Planned vs. implemented strategy
2. Review FS, valuation, divestment information
3. Analyze impact of market trends
4. Assess individual investments and portfolio
5. Measure performance against benchmark
6. Verify each partnership’s legal/compliance/tax

Question 30

Three substantial benefits from monitoring

Answer 30

1. greater options to liquidate investment
2. greater ability to exert control over management
3. larger implication for portfolio’s other assets

Question 31

Forms of active involvement inside and outside funds governance process

Answer 31

Inside: Renegotiation of fees; Termination with cause
Outside: Not-commit to follow-up funds; LP Default

Question 32

Three ways to create value through monitoring

Answer 32

1. Evaluate follow-on investments
2. Enhanced awareness of other investment opport.
3. Better liquidity management

Question 33

Five components of risk management

Answer 33

1. Investment Position (Where)
2. Frequency of Data Collection (When)
3. Aggregation and System Development (How)
4. Dimensions of Risk (What)
5. Risk reporting (Whom)

Question 34

Categories of Quantitative Information

Answer 34

Historical returns, Historical risk mgt. reviews, Asset allocations and capital balances

Question 35

Categories of Qualitative Information

Answer 35

Descriptive information, Key information, Activities log