Q-Bank Notes

University Endowment Mission

"A university endowment's mission is to maintain the purchasing power of the assets, while financing up to X% of the university's operating budgeting in perpetuity."

Trading Cost

(Sum all of the shares filled * their order prices = X X - (Arrival price * total number of shares)

Multiple on Invested Capital (M.O.I.C)

(Realized value + Unrealized value ) --------------------------------------- Total dollar amount invested

Bond total return formula

(-1Ending Effective Duration) [Ending YTM - Beginning YTM] + [Beginning YTM]

Trading Strategies (5)

1. Short-term alpha 2. Long-term alpha 3. Risk rebalance 4. Cash flow driven - client redemption 5. Cash flow driven - new client mandate

CME: Data Measurement Errors and Biases (3)

1. Transcription errors 2. Survivorship bias 3. Appraisal (smoothed) data

FFE rate implied by the futures contract price

100 - The current price for the fed funds futures contract expiring after the next FOMC meeting

(2) Common Analyst Biases (one emotional, one cognitive)

Confirmation - Cognitive Overconfidence - Emotional

4. Active Accumulators

4. Active Accumulator a. Basic type: Active b. Risk Tolerance: high c. Primary bias: emotional Entrepreneurial type, 1st gen wealth creation. Biases are overconfidence, self-control, illusion of control.

Five-Way Model (BB&K), Classifications: Straight arrow

5. Straight arrow a. Average investor (intersect point in middle) b. Neither overly confident or anxious c. Willing to take increased risk for increased exp. return

Correlation Formula

= Covariance/(std x * std y)

When do cash reserves increase for an endowment?

A foundation's cash reserve should include both anticipated and unanticipated needs for cash. If distribution amounts are known > less need for cash reserves If distribution amounts are unknown > more need for cash reserves

Z-Spread

A spread that when added to each spot rate on the default-free spot curve, makes the present value of a bond's cash flows equal to the bond's market price.

Added value (Trading formula)

Added value = Arrival Cost (bps) - Est. pre-trade cost (bps)

Allocation Effect Formula

Allocation = (wi - Wi)(Bi - B) B = the total return on the BENCHMARK

Homogenus in asset classes refers to:

Assets within an asset class should have similar attributes

Progressive tax system is _____________ for growth Increase in transfer payments is _______ for growth

BOTH ARE POSITIVE FOR GROWTH

Basis risk for equity indexs

Basis risk results from using a hedging instrument that is imperfectly matched to the investment being hedged. Basis risk can arise when the underlying securities pay dividends, because the futures contract tracks only the price of the underlying index.

The notional principals on a cross currency basis swap are most likely exchanged:

Both at inception and at maturity.

Marginal Contribution to Total risk is used by:

Bottom up manager with an absolute return target

A member candidate can invest freely, however...

But the client can't be disadvantaged by it

A two-bond hypothetical portfolio's immunization goal is to lock in a rate of return equal to:

CASH FLOW YIELD

Civil law and Common law

Civil law - Judges apply general, abstract rules or concepts to particular cases (Deductive reasoning) Common law - Draw abstract rules from specific cases (Inductive reasoning)

A. Knowledge of the Law

Code and standards always, unless more strict is the answer

Remember to discuss cognitive vs emotional errors

Cognitive errors result from faulty reasoning and analysis. The individual may be attempting to follow a rational decision-making process but fails to do so because of cognitive errors Emotional biases, which stem from impulse or intuition, may be considered to result from reasoning influenced by feelings. These biases are difficult to correct.

Capital Contribution in year (t) formula

Ct = RCt * (CC - PICt) RCt =rate of contribution CC = committed capital PICt = Paid in capital

Spread risk

Decline in the price of a bond relative to a risk free bond, due to spreads widening Increase in spreads > Prices declining (inverse relationship)

Bank main factors effected: Liquidity of portfolio investments

Decreases Asset STD

Situational Profiling PWM (3)

Determine investor source of wealth Measure of perceived wealth vs needs Stage of life (These help frame risk tolerance/return objectives)

CME: Limitations with misinterpretations of correlations

Doesn't take into account nonlinear relationships or changing correlations among variables

BPVp

Duration * 0.0001 * MVp

Fair does not mean equal, it means...

EQUITABLE

effective beta or ex post beta

Effective beta = % change in value of portfolio / % change in value of index

Effective fed funds rate

Effective fed funds rate ; blend between the high and low estimate for the FED ex. The current federal funds rate target range is set between 2.50% and 2.75%.

What do excess and less kurtosis imply?

Excess kurtosis > greater downside risk Less kurtosis > less downside risk

5 Constraints to consider in PWM

First emphasis on: 1. Return 2. Risk THEN CONSTRAINTS: 1. Legal 2. Liquidity 3. Tax 4. Time 5. Unique

Fundamental law of active management

IC [(IB)^0.5] TC * STD IR = IC * (N)^0.5

Variance of domestic-currency returns

If no weights are given, just do equal to 1

Implementation shortfall

Implementation Shortfall BPS = [Implementation Shortfall ($)] ------------------------------- * 10000 bps [Total order share * decision price] Implantation Shortfall ($) = +Execution Cost (Trading costs and delay cost) + Opportunity Cost + Explicit Fee Cost

Define Financial Capital

Includes tangible and intangible assets (outside of human capital)

Short sale against the box

Involves shorting a security that is held long. Beta = 0 Riskless asset, earn a money market rate of return Least expensive way to mitigate concentrated asset risk

Marginal vs average tax rate

Marginal - the tax rate on the NEXT dollar Average - average of all the different progressive tax brackets

Portfolio value equation Style equation Portfolio equation Alpha Equation

P = M + S + A S = ( B-M) P = B + A A = P - B

Bayes Formula

P(A|B) = [P(B|A) / P(B) ] * P(A) How the rational decision maker update their beliefs

Variance Swap value at time T

PV(T) is the present value of at time t of $1 received at maturity T Squaring percents as normal numbers > 20% > 20^2 Example interest rate annual at 2.5% at halfway point PV(T) = 1 / 1 + (2.5% * 180/360)

Dollar Duration Rebalancing Ratio Cash Requirement

Portfolio Value * Duration * 0.01 = DD Rebalancing Ratio = Target value / DD Cash Requirement = (Rebalancing Ratio - 1 ) * market value of total portfolio

What do positive skewness and negative skewness imply?

Positive skewness > Smaller downside risk Negative skewness > Larger downside risk

Minimum Variance Hedge Ratio

Regression of changes in the value of the portfolio to the past value of the hedging instrument to minimize tracking error. Used to optimize foreign currency return and minimize volatility of domestic

PWM : Soft Skills

Soft skills involve interpersonal relationships and include 1. communication skills, 2. social skills, 3. education and coaching skills, 4. and business development and sales skills.

Source Taxation Resident Taxation

Source tax system: A jurisdiction that imposes tax on an individual's income that is sourced in the jurisdiction. Residence tax system: A jurisdiction that imposes a tax on an individual's income based on residency whereby all income (domestic and foreign sourced) is subject to taxation.

Who would pay more in a private equity situation (to reduce concentrated position in an asset), strategic or financial buyers?

Strategic Investors will typically pay more, because they perceive a strong synergistic effect from the purchase.

Holdings based approaches are not appropriate for...

Strategies with high portfolio turnover

Future accumulated value with multiple tax distributions (Capital gains, interest, and dividends) T*

T* = TCG * (1 - pd - pi - pcg) / (1 - pdtd - piti - pcgtcg)

When calculating estate taxes, statutory allowances are...

TAKEN FROM THE TOTAL BEFORE SPLITTING THE MONEY OR DOING ESTATE TAXES

Intraday Benchmarks (2)

TWAP VWAP

(5) constraints to consider when doing an IPS question

Tax Time Liquidity Legal Unique

Relative value of a tax free gift

Te is estate text if bequeathed at death

Current account surplus impact on exchange rate

The country with the LARGER current account surplus should see their currency INCREASE

Zero Replication

The interest rate risk has been immunized, which is known as zero replication.

Exemption Method

The tax liability under the exemption method is simply the tax imposed at the foreign source, SO THE SOURCE RATE PREVAILS

Key difference between portfolio reporting and portfolio review is that...

The wealth manager is more heavily involved in the portfolio review

G-Spread

The yield spread in basis points over an actual or interpolated government bond.

Transfer payments

These payments are considered a redistribution of wealth from the well-compensated to the poorly compensated. They are made both for humanitarian reasons and, at times of economic distress, to help stimulate the economy by putting more money into people's hands.

Money weighted return

Think IRR calculation, need to discount

Which has more investment options, universal or whole life insurance policies?

UNIVERSAL typically has more options for investing the cash value than do whole life policies.

Expected Utility Theory

Um = E(Rm) - 0.005λσ^2 MAKE SURE TO KEEP ALL IN PERCENTS WHEN SQUARING

CME: Limitations to account for conditioning information

Unconditional forecasts, which dilute this information by averaging over environments, can lead to misperception of prospective risk and return

Credit method

Under this method the tax liability equals the greater of the tax liability due in either the residence or source country. SOURCE ALWAYS GETS FULL

Capture Ratio

Up Capture / Down Capture

Implied forward rate

Use YTM for the R

Smart order router, when to use?

Used when a portfolio manager wishes to execute a small order by routing the order into the market as either a marketable or nonmarketable (limit) order.

Security Lending transfers the....

VOTING RIGHTS NOT THE DIVIDEND PAYMENTS

Value of a Variance Swap

Variance Notional * (Realized Variance - Strike Variance)

Accounting Defeance

Way of extinguishing a debt obligation by setting aside sufficient high-quality securities, such as US treasury notes, to repay the liability

When is an asset allocation optimal from a risk-budgeting perspective

When the ratio of excess return (over risk free rate) to MCTR is the same for all assets

Herfindahl-Hirschman Index (HHI) Effective Number of Stocks

Wi^2 for all stocks added 1/HHI

Number of future contracts needed (equity using beta)

[((Beta T) - (Beta P)) / (Beta F) ] * ( portfolio market value/index value)

Formula for Notional Principle in a swap

[(MDURt - MDURp) / MDURs ] * (MVp)

Econometric Model ; Pros (3) / Cons (5)

a macroeconomic model that uses algebraic equations to describe how the economy behaves Pro: 1. Model can be robust, many factors 2. New data collected quickly and consistently 3. Provides quantitative estimates of impact of changes in exogenous variables Con: 1. Complex and time consuming to formulate 2. Data inputs not easy to forecast 3. Relationship not static 4. May give false sense of precision 5. Rarely forecasts turning points well

Goals based investing is typically optimized based on :

a stated maximum level of volatility and/or to a specified probability of success

The three requirements for an index to become the basis for an equity investment strategy are

a) rules based, (b) transparent, and (c) investable.

Do all trade errors need to be disclosed to. clients?

as part of a suitable policy for the treatment of trade errors, those errors and any resulting gains/losses need to be disclosed to a compliance department and documented in a trade error log. The priority is to ensure errors are resolved in a way that prevents adverse impact for the client, AS SUCH WE DO NOT NEED TO DISCLOSE EVERY TRADE ERROR TO CLIENTS

Riding the yield curve

benefit from coupon income as well as capital gains over a particular horizon. This strategy pays off in an upward-sloping, static yield curve scenario. As time passes, bonds in the portfolio will roll down and can be sold at a lower yield than when they were purchased. "Riding the yield curve is a strategy based on the premise that, as a bond ages, it will decline in yield if the yield curve is upward sloping."

convertible arbitrage strategies go long _______________ and short the ______________

convertible arbitrage strategy, the fund buys the convertible bond and takes a short position in the underlying security.

Status Quo Bias what is it and cons and how to combat

emotional bias in which people do nothing instead of making a change cons Unknowingly maintain portfolios with risk characteristics that are inappropriate for them fail to explore other opportunities Combat this though education, FMPs should quantify the risk-reducing a return-enhancing advantages of diversification and proper asset allocation

When advising emotionally biased investors, advisers should focus on explaining how the investment program being created affects such issues as

financial security, retirement, or future generations RATHER THAN focusing on quantitative details.

Deemed dispositions

means that at death and transfer there is no tax on transfer but all unrecognized gains and losses become realized and are taxed themselves.

Appraisal Ratio

measures a managers stock selection ability by dividing the portfolio alpha by the specific risk ( unsystematic risk ) of those securities STDe - Standard error of regression Jensen's alpha / ( non-systematic risk )^0.5

Jensen's alpha

measures investment performance as the raw portfolio return less the return predicted by the capital asset pricing model Return on market - CAPM for market

Explain what packeting and buffering is in index portfolios

packeting involves splitting stock positions into multiple parts. For example, if a mid-cap stock's capitalization increases and breaches the breakpoint between the mid-cap and large-cap indexes, a portion of the total holding is transferred to the large-cap index but the rest stays in the mid-cap index. Buffering involves establishing ranges around breakpoints that define whether a stock belongs in one index or another. As long as stocks remain within the buffer zone, they stay in the current index, and as a result, the holdings of the fund may exceed the holdings of the index.

Accrual equivalent tax rate

r(1 - TAE) = RAE NEED TO FIND THE ACCRUAL RETURN FIRST

Future accumulated value with multiple tax distributions (Capital gains, interest, and dividends) r*

r* = r(1 - pdtd - piti - pcgtcg)

PEG Ratio

ratio of P/E multiple to earnings growth rate

Tobin's q

ratio of market value of the firm to replacement cost

Non-systematic risk formula

risk that can be eliminated by diversification (STDp^2) - [(beta^2)*(STDm^2)] Or (1-R2) * (STDp^2)

Index Cost

side×(Index VWAP − Index arrival price ) -------------------------------------------- * 10000 Index arrival price

Effective spread

the difference between the price of the actual transaction and the amount halfway between the quoted spread

Certainty Equivalent

the guaranteed income level at which an individual would receive the same expected utility level as from an uncertain income

The decision to moderate or adapt to a client's behavioral biases depends on two factors:

the standard of living risk / level of wealth (high or low) (High standard, more likely to moderate) (Low standard, more likely to adapt) and the type of bias (emotional or cognitive). (Cognitive, more likely to moderate) (Emotional, more likely to adapt)

Neuroeconomics

the study of brain mechanisms at work during economic decision making Cons: Critics believe the impact is unlikely to have direct influence into economic theory

Link between current account and capital account

| Current Account | = | Capital Account |

2 types of private credit

1. Direct-lending 2. Distressed debt

Interaction Effect Formula

Interaction Effect = (Wi - Wi)(Ri - Bi)

Morningstar classifications

Morningstar 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 strongly positive net score leads to a growth classification, and a strongly negative score leads to a value classification. A score relatively close to zero indicates a core classification. To achieve a blend classification, the portfolio must have a balanced exposure to stocks classified as value and growth, a dominant exposure to stocks classified as core, or a combination of both.

Most people reject a gamble with even chances to win and lose unless the possible win is at least ..... (prospect theory)

Most people reject a gamble with even chances to win and lose unless the possible win is at least twice the size of the possible loss.

Executing a pairs trade

Must achieve equal weighted beta position. 1. Long stock A you want at target $ exposure 2. Short stock B at equal beta (BetaB / BetaA) * the amount being longed on A

Relative value of a taxable gift

NEED TO HAVE +TgTe IF DONOR PAYS TAX

When credit spreads widen, how to bonds of different quality types perform?

Narrow spreads = lower quality outperforms Widening spreads = Higher quality outperforms

# of futures contracts needed (Using BPV for fixed income) Futures BPV calculation

Nf = (Liability portfolio BPV - asset portfolio BPV) / Futures BPV Futures BPV = BPV(ctd) / CF(ctd)

D. Misconduct

No act that reflects poorly on professional reputation, integrity, competence

B. Independence / Objectivity

No gift/benefit/compensation (offer, solicit, accept) that could reasonably compromise I/O $50 okay, $500 not okay

Normative / Descriptive / Prescriptive

Normative - How you should rationally act Descriptive - How people actually act Prescriptive - How people should act when incorporating rationality (considering for bounded rationality)

Determining number of contracts through PVBP

Number of contracts = Required additional PVBP ----------------------------------- PVBP of the futures contract

Mismatch in character

Occurs when the gain or loss in the concentrated position and the offsetting loss or gain in hedge are subject to different tax treatments (ordinary income vs capital gain for example)

What they mean when the say a "10" delta call option

On an individual option the delta represents the probability that the option will expire in the money. A positive or negative 10 delta option has a 10% chance of finishing in the money. This can be helpful in considering which options to buy or sell. Higher delta option = more expensive premium

Opportunity Cost

Opportunity cost is based on the number of shares left unexecuted in the order and reflects the cost of not being able to execute all shares at the decision price THE DECISION PRICE IS THE PRICE OF THE SECURITY WHEN THE PORTFOLIO MANAGER MADE THE DECISION TO PURCHASE

According to prospect theory, when are individuals risk seeking ?

People are risk-seeking when there is a LOW probability of GAINS or a HIGH probability of LOSSES. Deviations in decision making result in overweighting low-probability outcomes.

Illusion of Control Bias what is it and cons and how to combat

People believe they can control or influence outcomes when they in fact, cannot Cons: Trade more than is prudent Lead investors to inadequately diversify their portfolio Combat this by having investors recognize that successful investing is a probabilistic activity Seek contrary viewpoints Critical to keep records

Representativeness Bias what is it and cons and how to combat

People tend to clasify new information based on past experiences and classifications Base rate neglect (ignoring porbability of the categorization) and sample size neglect (assuming sample sizes are reflective of population) Cons: OVERWEIGHT NEW INFORMATION Update beliefs using simple classifications rather than deal with mental stress of updating with complex data analysts need to be aware of statistical mistakes, ask themselves if they are overlooking the reality of the investment situation

Confirmation Bias what is it and cons and how to combat

People tend to look for and notice what confirms their beliefs, while ignoring or undervaluing what contradicts them Cons Consider only positive information develop screening criteria to ignore data that refutes the validity of their screening UNDER DIVERSIFY THEIR PORTFOLIOS hold too much company stock Combat this bias by getting corroborating support for an investment decision

Loss Aversion Bias what is it and cons and how to combat

People tend to strongly prefer avoiding losses as opposed to achieving gains Cons People tend to hold onto losers that they may have little or no chance of going back up Selling investments too soon to lock in gains Trade excessively as a result of selling winners Combated by having a disciplined approach to investment based on fundamental analysis

Describe the 3 buckets of goals based investing:

Personal - Protection from poverty or decrease in lifestyle (CDs, personal residence) Market - Maintain the current standard of living (Stocks and bonds) Aspirational - The opportunity to increase wealth substantially (Concentrated stock, real estate, privately owned businesses) Allows the advisor to incorporate psychological considerations into the asset allocation process.

Real Estate cap rates are positively correlated with _____________ and negatively correlated with ________

Positively correlated: Interest rates and credit spreads Negatively correlated: Credit availability

Alternative Trading Systems Provide:

Post-trade transparency only Alternative trading systems, such as dark pool trading venues, are available only to select clients and provide far less transparency, reporting only post-trade transactions and quantities.

c. Misrepresentation

Practice, credentials, qualifications, performance record, intended use of 3rd party managers

Predicted Bond Price Change with PVBP and curve shift

Predicted change = Portfolio par amount × Partial PVBP × (-Curve shift)

Primary Capital

Primary capital is the sum of assets that fall into the personal and market risk buckets. It includes the residence, municipal bond portfolio, global equity fund, and cash equivalents. Does not include concentrated positions; these would be considered aspirational

Principal Invoice Amount for CTD

Principle Invoice amount = (Future settlement price / 100) * CF * 100

CME Forecasting - D.C.F

Pro - Consistent process, Says that the intrinsic value of an asset is equal to the PV of its future cash flows; uses future expected cash flows Con - Doesn't take into account supply and demand in the market place

CME Forecasting - Risk Premium Approach

Pro - Determines discount by starting with a risk-free rate, add in premiums for risk investor is assuming Con - Subjective

CME Forecasting - Statistical Method pro/con

Pro - Sample stats use well known data from the past to forecast; data is easy to get Con - Considered to be the most imprecise since past is not indicative

Pros / Cons of the Risk-Based Approach to asset allocation (2)

Pro: 1. Common risk factor identification 2. Integrated risk framework Con: 1. Sensitivity to the historical look-back period 2. Implementation hurdles

Pros / Cons of the Traditional Approach to asset allocation (2)

Pro: 1. Easy to communicate 2. Relevance for liquidity management and operational considerations Con: 1. Over-estimation of portfolio diversification 2. Obscured primary drivers of risk

Impact that progressive tax systems have on an economy

Progressive income taxation may result in a more equitable income distribution, higher revenues, less financial and economic volatility, and faster growth. Progressive taxation can also indirectly affect stability by impacting trends that are associated with less volatility, such as more equal income distribution.

Checklist Approach (2) pros / cons

Pros: 1. A subjective approach, analysis will think of a series of questions (making it customizable) 2. Less complex than other approachesCons:1. Subjectivity can also be a negative2. Very manual process and time consuming

Separately Managed Accounts (2 Pros/Cons)

Pros: 1. Greater transparency 2. Greater control of flows Cons: 1. Not available or appropriate for many alternative strategies 2. A manager cannot invest alongside the client in the client's SMA

Economic Indicator Approach (2) pros / cons

Pros: 1. Indicators are very simple and intuitive, the data used is often reliable 2. Can often be tailored to specific needs Cons: 1. Results have often been inconsistent, with many models providing false signals 2. Indicators are often revised, creating look back issues

Separately managed accounts (pro 4) and (con 3)

Pros: 1. Ownership 2. Customization 3. Tax efficiency 4. Transparency Cons: 1. Cost 2. Tracking risk 3. Investor behavior

Prospect Theory

Prospect theory considers how alternatives are perceived based on their FRAMING, how gains and losses are evaluated, and how uncertain outcomes are weighted.

What asset class offers the least supportive flow (or holding) to a currency?

Public debt is less supportive because it has to be serviced and must be either repaid or refinanced, potentially triggering a crisis. Some types of flows and holdings are considered to be more or less supportive of the currency. Investments in private equity represent long-term capital committed to the market and are most supportive of the currency. Public equity would likely be considered the next most supportive of the currency. Debt investments are the least supportive of the currency.

Seagull Spread

Put spread combined with selling a call (ex. buy 35-delta put, sell a 25-delta put and sell a 35-delta call). Same downside protection as Put Spread but lower cost and less upside potential.

Singer and Terhaar approach

REMEMBER AT THE END TO ADD IN THE RFR ALWAYS THE STD OF THE NON MARKET SHARPE RATIO OF THE MARKET

Calculating "Real Risk Free Rate" when given nominal RFR and inflation (for PWM questions on capitalized value of core capital needs)

Real Risk Free Rate = (1 + Nominal Risk Free Rate) {------------------------------------} - 1 (1 + inflation rate)

For swaptions, who receives the premium and who pays it?

Receiver Swaption > Receives Fixed > Increased duration > Paying premium for that Payer Swaption > Pays Fixed > Decreases duration > receives premium for that

Relative to broad-market-cap-weighting, passive factor-based strategies tend to _______________ risk exposures

Relative to broad-market-cap-weighting, passive factor-based strategies tend to CONCENTRATE risk exposures Passive factor-based strategies tend to be transparent in terms of factor selection, weighting, and rebalancing. The strategies can be easily replicated by other investors which can produce overcrowding and reduce the realized advantages of a strategy.

Formula for relating the geometric average return over period N to the arithmetic average return and its volatiliy

Rg = r - [0.5 * STD^2]

Portfolio Return (Using leverage Fixed Income)

Ri + [(VB/VE)*(Ri-Br) MAKE SURE TO SUBTRACT VB FROM TOTAL ASSETS (IF THEY GIVE YOU ASSETS INSTEAD OF VALUE OF EQUITY)

Utility function of wealth: Risk Averse Risk Neutral Risk Seeking WHAT DO THESE MAKE UP ?

Risk Averse - CONCAVE Risk Neutral - Linear upward sloping Risk Seeking - CONVEX THESE MAKE UP THE INDIFFERENCE CURVE

Structural Risk

Risk arises from portfolio design, particularly the choice of the portfolio allocations. Structural risk is reduced by minimizing the dispersion of the bonds positions, going from a barbell design to more of a bullet portfolio.

A criticism of Resampled Efficient Frontiers are that risker asset allocations are....

Risker asset allocations are over-diversified, not under-diversified.

PWM: (4) Client segments / adviser types

Robo-Adviser (part of the mass affluent client segment) Mass Affluent Segment "Private Client" Range of High-Net-Worth Segment Ultra-High-Net-Worth Segment

Availability Bias what is it and cons and how to combat

Rule of thumb or mental shortcut to estimating probability based on what comes most easily to their minds Various sources: retrievability, categorization, resonance Cons Choosing an investment based on advertising Limit investment opportunity set Fail to diversify Fail to achieve an appropriate asset allocation combat this by having a disciplined approach to prevent the investor from overemphasizing the most recent financial events DEVELOPE AN IPS

VWAP Cost (BPS) and TWAP Cost (BPS) and MOC Cost (BPS)

SIDE * (Average price - VWAP)/VWAP * 10,000 SIDE * (Average price - TWAP)/TWAP * 10,000 SIDE * (Average price - MOC)/MOC * 10,000

For the three types of sovereign wealth funds, what does their asset allocation look like: Savings Fund Reserve Funds Budget Stabilization Fund

Savings Fund - Invest in risk and illiquid assets, including equities and a wide range of alternative investments Reserve Funds - Generally invest in a diversified portfolio with significant exposure to equities and other high-yielding alternative investments Budget Stabilization Fund - Mainly government bonds and other debt securities - short-term basis for risk mangement

Scheduled Algorithms

Scheduled algorithms are appropriate for orders in which portfolio managers or traders do not have expectations for adverse price movement during the trade horizon. TWAP AND VWAP These algorithms are also used by portfolio managers and traders who have greater risk tolerance for longer execution time periods and are more concerned with minimizing market impact. Scheduled algorithms are often appropriate when the order size is relatively small (e.g., no more than 5%-10% of expected volume), the security is relatively liquid, or the orders are part of a risk-balanced basket and trading all orders at a similar pace will maintain the risk balance.

Selection Effect Formula

Selection = (Wi)*(Ri - Bi)

Difference in using the taylor rule in the short term vs. the long term?

Short term - Must consider the path of short term rates Long term - use r neutral

If yield curves lose curvature, how does that impact short, mid, and long term rares?

Short term rates - Potentially rise Mid term - Potentially fall Long-term Potentially rise "Positive butterfly twist"

Determining if effective fed funds rate projected will be higher or lower

Take the current effective fed funds rate (ex. 2.5-2.75), and then compare that to the "FFE rate implied by the futures contract price" if the "FFE rate implied by the futures contract price" is higher than the current range, use an upward estimation. If lower, use a decreased value.

How are Hedge Funds (generally) considered in regards to tax efficiency?

Tax inefficiency is seen frequently with many hedge fund strategies, especially those funds and fund companies where tax-exempt investors dominate the client base. The fund manager may be insensitive to tax considerations for a taxable investor

Deduction Method Example ; which country gets which>

Tax paid= (tax residence + tax source) - (Tax residence * tax source) SOURCE GETS FULL

Relative value of a taxable gift (gift tax paid by recipient)

Tg is the tax on gifting

Annuity Puzzle

The "annuity puzzle" describes the phenomenon that retirees tend to avoid annuity investments, which may be appropriate to best help them reach their financial goals.

Mortality / Longevity risks of a DC vs. DB plan

The DB plan pools mortality risk such that those in the pool who die prematurely leave assets that help fund benefit payments for those who live longer than expected. The individual bears the risk of outliving her savings with the DC plan

The Norway Model

The Norway model passively invests in publicly traded securities subject to environmental, social, and governance concerns.

Implementation Shortfall algorithm

The implementation shortfall algorithm is a frontloaded strategy that can be adjusted to aggressively execute an order when the order has a high urgency.

Gamma is largest when....

The largest gamma occurs when options are trading at the money or near expiration, when the deltas of such options move quickly toward 1.0 or 0.0. Under these conditions, the gammas tend to be largest and delta hedges are hardest to maintain.

The characteristic of securities lending that makes it different from a repurchase agreement is:

The lender can recall the loan at any time Both repurchase agreements and securities lending make use of securities as collateral and fees paid by the borrower. However, repurchase agreements are for a specified contractual period of time whereas securities lending is open-ended. The borrower can return the securities at any time and the lender can demand their return at any time

It is okay to solicit clients after leaving an employer as long as:

The names do not come from a list, and there is no agreement in place restricting that

When back-testing a factor-based strategy for a new fund, the calculated information coefficient should be based on:

The purpose of back-testing is to identify correlations between the CURRENT period's factor scores, FS(t), and the NEXT period's holding period strategy returns, SR(t + 1).

Domestic currency return

The rate of return expressed in the investor's home currency For the Rfx component, try to make sure the home domestic currency is in the numerator Also for the Rfx calculation, just do the later value, over the original value (T2 / T1)

Option Adjusted Spread

The spread to the Treasury spot curve that the bond would have if it were option-free

Semi-Standard Deviation

The square root of the semi-variance.

non-forfeiture clause (what type of policy is this associated with)?

The whole life insurance policy feature described is a non-forfeiture clause, whereby there is the option to receive some portion of the benefits if premium payments are missed (i.e., before the policy lapses).

I-Spread

The yield spread of a specific bond over the standard swap rate in that currency of the same tenor. Smoother then G-spread However, these securities are not credit risk free; so not the same as the G-spread

Difference between time-series momentum and cross-sectional momentum

Time series momentum - Momentum trading strategies (long what is going up, short what is going down). Can go net long or net short. Cross sectional momentum - Implemented with a cross section of assets by going long those that are rising in price the most and shorting those that are falling the most; usually market neutral

The goal of an immunized portfolio is to

To earn the portfolios internal rate of return

Relative value of a charitable gift

Toi = tax rate on ordinary income

Factor's marginal contributions to total risk and specific risk should be used by:

Top-down managers with an absolute return target

Liability Noise

Two components: Model Uncertainty Plan demographic experience differing from the actuary's model Less participants = more liability noise Statistical methods are used to estimate this component of the mode; more participants means it is more likely that the plan's population will track closely with the model

A decision-making investor is most likely to worry more about making a Type I error than a Type II error because:

Type I errors are more easily measured than Type II errors. In addition, Type I errors may be linked to the compensation of the decision maker. Type I errors are errors of commission, whereas Type II are errors in omission. Firing a skilled manager is less transparent to the investor.

4. Legal and Regulatory (IPS)

Typically relate to tax relief and wealth transfer Most common for L3 are trusts and foundations - Revocable trust: grantor retains rights and is responsible for taxes - Irrevocable trust: ownership of assets conferred to professional trustee who manages. Assets considered immediately transferred and can be subject to wealth tax. For exam - If client says wants a trust, ensure PM follows the trust document - Do not go outside bounds of what is taught; not a trust/legal expert

Preservation of confidentiality

UNLESS: 1. illegal activity on the part of the client 2. required by law 3. client permits it

Downside Capture Ratio Up Capture Ratio Geometric mean

Use geometric average return for both upcapture and down capture Geometric Mean (G)G=(X1*X2*X3)^(1/3)

Completeness Fund Approach

Used when holdings concentrated. Completeness fund adds holdings (funds or securities) to diversify and adjust risk to the desired level. Need cash available for completeness. Must be rebalanced frequently. Advantages Active return from the managers can be maintained (eg as in core satellite approach) while active risk is minimized. Disadvantages May result in reducing active returns from misfit risk (EG differences between manager's normal portfolio and broader asset class benchmark.)

Opportunistic Algo (liquidity seeking)

Used when trading volume is a large percentage of total volume Used for large orders that the portfolio manager would like to execute quickly without having a substantial impact on security price. Want to minimize information leakage.

Subtle advantage of tax harvesting is that....

When exercised often, it can lead to having a larger investable base (compared to if it were unrealized) ; resulting in the opportunity for more compounding growth f "Amount of net-of-tax money available for investment"

When projecting expected returns, the order of returns from highest to lowest is typically regarded as:

When projecting expected returns, the order of returns from highest to lowest is typically regarded as 1. private equities, 2. hedge funds, 3. Public equity 4. bonds.

Convexity formula (using Duration)

[(Macaulay Duration^2 + Macaulay Duration + Dispersion] -------------------------------------------------- (1+Cash Flow Yield)^2

Satisfice

accepting solutions that are "good enough" "Satisfy" and "Suffice"

The three main building blocks of portfolio construction are

alpha skills, position sizing, and rewarded factor weightings.

advanced life deferred annuity's (ALDA's)

an advanced life deferred annuity's (ALDA's) payments begin later in life—for example, when the individual turns 80 or 85. An ALDA would provide the greatest supplemental level income relative to the cost because the payments are made far in the future, life expectancy is shorter when the payments begin, and some policyholders will die without receiving payments.

a factor-based VCV matrix approach may result in some portfolios that erroneously appear to be riskless if....

any asset returns can be completely determined by the common factors or some of the factors are redundant.

Individual IPS : PWM (Investment Objective Breakdown)

break down goal prioritization and quantification (primary and secondary) Investment Objectives: 1.Purpose: Support Patel's lifestyle in retirement (higher priority), provide for family's needs (higher priority), fund philanthropic activities (lower priority), provide inheritance for children (lower priority) 2. Anticipated annual need: "€200,000, with annual increases for inflation" 3. Annual need met with: "Income from small business (approx. €120,000), pension (€50,000 with annual inflation increases), portfolio distributions 4. Additional purchases: Intent to purchase of €1.4 million vacation home in three years" 5 Additional information (Quantify): "Zik should assist in quantifying philanthropic and bequest goals and determining how to fund the vacation home purchase."

When deciding whether to use market value or spread duration as the portfolio sizing metric, a key factor is the relative importance of ___________

default loss risk versus credit spread risk. If default losses > Market value > risk metric for high yield If Credit spread > think spread duration > risk metric for investment grade

Small currency trades are usually implemented using_____________

direct market access (DMA). Buy-side traders generally use DMA for exchange-traded derivatives, particularly for smaller trades.

Suppose that the results of a style analysis for an investment manager are not consistent with the stated philosophy of the manager and the manager's stated investment process. These facts suggest the:

investment process may not be repeatable.

after tax wealth accumulation for deferred capital gains formula (with split tax rate occurring annually and at end)

r* = r(1 - pcgtcg) T* = tcg(1 - pcg)/(1 - pcgtcg) FVIFTaxable = (1 + r*)n(1 - T*) + T* - (1 - B)tcg, B = 1

cost of carry model

specifies a relationship between two positions that must exist if the only difference between the positions involves the expense of maintaining the positions.

For a VCV matrix, how many observations should you have for any given number of asset classes?

the rule of thumb suggests there should be at least 10 times the number of observations per each asset class. example: 200 observations for 20 asset classes

Hyperbolic discounting

the tendency for people to increasingly choose a smaller-sooner reward over a larger-later reward as the delay occurs sooner rather than later in time

Life Insurance Company Mission

"The core mission of the general account is twofold: 1. Provide liquidity for the payment of policy holder claims in the normal course of insurance operations" 2. Grow the company's surplus over the long-term"

Life Insurance Company Investment Objective

"The investment objective must follow prudent investing practices and achieve an appropriate balance between maintaining short-term liquidity and contributing to long-term asset growth"

DB Risk Objective in IPS example

"The risk objective is to invest so that to minimize the probability of asset values falling below X% of PBO"

University Investment Objective

"The university's investment objective, consistent with the mission, is to produce a total rate of return over the stated inflation index of at least 5% with a reasonable level of risk the volatility of returns should not exceed at least 15% annually" MAY NEED TO INCLUDE TIME FRAME, DEPENDING ON HOW OFTEN THE IPS IS REVISED REAL RETURN RELEVANT INFLATION TARGET WITH A REASONABLE LEVEL OF RISK PURCHASING POWER INTO PERP

(e) changes due to yield

(-Duration * Change in yield)+(1/2 * Convexity * change in yield ^2)

Correlation between percentage value changes of assets and liability claims

(A/E)^2 * STD^2(Assets) + [(A/E)-1] * STD^2(Liabilities) - 2 * (A/E) * (A/E - 1 ) * Correlation * STD(Assets) * STD(Liabilities)

Delay Cost

(Arrival Price - Decision Price) * (# of total shares filled) ARRIVAL PRICE IS THE PRICE WHEN TRADING BEGINS (or when the orders are able to begin)

BPV Swap Formula

(BPVa) + (Notional Amount * (BPV Swap / 100) = (BPVl)

Basis Point Value Hedge Ratio

(BPVt - BPVp) ---------------- * CF (BPVctd)

Probability of a rate hike fed funds

(Contract price implied by futures) - Effective fed funds rate ---------------------------------------- (Effective rate if increased / decreased 0.25) - Effective fed funds rate

Active Return

(Difference in weight versus bm) * return on stock

Taylor Rule

(Forecast - Trend) Common criticism is that it doesn't account well for jolts in the economy.

Expected Real Estate Return Formula

(NOI / P) + (NOIg) - (Change in Cap Rate %) Make sure the change in cap rate % is the PERCENTAGE OF CHANGE ( X2 - X1) / X1 Make sure to include inflation too for NOIg Note: As the cap rate is expected to decrease, property values are expected to increase, hence the cap rate change contributions to the expected return

Butterfly spread formula

(Short-term yield) + (Long term yield) - (2 * Medium-term yield)

Total contribution to the return caused by active factor weighting formula

(Underweighting of the Growth factor + Overweighting of the Quality factor) ÷ Total effect

Balance of payments formula

(X-M) = (S-I) + (T-G) Net exports = savings - investments + taxes - government expenditure

Ratio of excess return to MCTR (Formula)

(expected return - FRF) --------------------------- MCTR

Risk Objective

- Address both willingness and ability to take risk Ability to take risk: ability to sustain losses and still meet goals Two things that affect this the most - Time horizon - Expenditure relative to the portfolio Willingness to take risk Subjective; determined through psychological profile

Capital allocation line and tangency portfolio

- CAL - straight line drawn from the Rf rate to the tangency portfolio. Tangency portfolio - corner portfolio with the highest sharpe ratio If required return is lower than Er on the tangency portfolio, investor will invest a portion of funds in a Rf asset and the remainder in the tangency portfolio If Rr is higher than Er, investor will use margin to lever up on the return

2 forms of property rights: Community and Separate

- Community property rights Spouse entitled to one half of estate earned during marriage. Gifts/inheritance received before/during marriage held separate from marital assets Assets not distributed under community property rights distributed via will - Separate property rights regime Common in civil law countries Each spouse owns and controls his/her property separate from each other Barring forced heirship rules, may distribute as they wish*** When country has both community property rights and forced heirship, spouse entitled to greater of two amounts.

Delta Hedging

- Delta hedging: combining option position with a position in the underlying asset to limit short term changes in underlying asset. value of portfolio should grow at RF rate given dynamically hedged - Most common is to delta hedge naked call by owning the underlying asset in amount that will make value of change in underlying immune. - Symbol for delta = ∆

how to est. hedge effectiveness (3 sources of hedging error)

- Evaluating hedging effectiveness. 3 sources of hedging error... 1. Forecast of the basis at the time the hedge is lifted 2. Estimated durations 3. Estimated yield beta

strategies concentrated positions in real estate

- Mortgage financing Borrower effectively has put option on property. If property value falls below loan amount, borrower can default on the loan, keep loan proceeds and put property to lender. - Donor advised fund or charitable trust Allow owner to take tax deduction, gift money to charity and influence the use of that donation.Gains and depreciation recapture never taxed on gifts to charity - Sale and leaseback Sell to financial buyer then leaseback property for use (often with warehouse)Rental payments on lease deductible as a business expense

Prospect theory....(2 phases) Difference between Utility Theory and Prospect Theory

- Prospect theory: Framing decisions as gains or losses and weighting outcomes Utility theory = assume risk aversion Prospect theory = assume loss aversion - 2 phases of prospect theory 1) editing phase 2) evaluation phase

yield beta (for foreign countries)

- Yield beta: measures the change in one set of rates (foreign) and another set (domestic). change yield foreign = B * (yield change domestic) * D

Roy's safety-first criterion

- measure of downside risk - calculates excess return to risk

Empirical Duration

-Duration determined by regression analysis of the historical relationship between security prices and yields Bonds of different credit quality WILL have different empirical durations Therefore if your index has the same EFFECTIVE duration but different credit qualities, there may be a difference in the EMPIRICAL durations

An efficient, well-constructed portfolio should have (2)

1) risk exposures that align with investor expectations 2) low idiosyncratic (unexplained) risk relative to total risk.

Excess Return and expected excess return on credit securities

1. (ST) - (Change in spread * Spread duration) 2.(ST) - (Change in spread * Spread duration)-(Lpt)

Things to include in annual portfolio monitoring / performance reporting

1. A transaction details report showing contributions, withdrawals, interest and dividends, and capital appreciation for the current period 2.A purchase and sale report for the current period 3.Currency exposure report detailing the effects of exchange rate fluctuations 4. A benchmark report that shows the performance of Patel's equity and bond portfolios relative to their respective benchmarks and the overall portfolio performance relative to a blended benchmark (based on weights that are appropriate for Patel's holdings) 5. An accompanying letter that provides market commentary, investment context, education, and other advice

Different types of benchmarks (7)

1. Absolute return 2. Broad market 3. Style 4. Factor-model based 5. Returns-based 6. Manager universes 7. Custom security-based

Success of an investment program involves (3)

1. Achieving client goals 2. Following a consistent process 3. Realizing favorable portfolio performance

Five-Way Model (BB&K), Classifications

1. Adventurer 2. Celebrity 3. Individualist 4. Guardian 5. Straight arrow

Five-Way Model (BB&K), Classifications: Adventurer

1. Adventurer a. Confident NE quadrant) b. Might hold highly concentrated portfolio c. Makes own decisions d. Unwilling to take advice e. Advisers find difficult to work with

A country cannot do these 3 things at once (in regards to exchange rate linkages)

1. Allow unrestricted capital flows 2. Maintain a fixed rate 3. Pursue independent monetary policy

CME: (6) psychological biases

1. Anchoring Bias 2. Availability Bias 3. Overconfidence Bias 4. Confirmation Bias 5. Prudence Bias 6. Status Quo Bias

Steps to effective investment governance (6)

1. Articulate long and short-term short objectives 2. Allocate roles and responsibilities to appropriate individuals 3. Set the investment IPS 4. Set the strategic asset allocation 5. Create a reporting framework 6. Review periodically (annually)

MVO Limitations (6)

1. Asset allocation are highly sensitive to small changes in input variables 2. Garbage in, garbage out 3. Only focuses on the mean and variance of returns(not considering liabilities) 4. Sources of risk may not be well diversified 5. Single period framework and ignores trading / rebalancing costs and taxes 6. Doesn't account for non-normal distributions

Describe Fixed Income Arbitrage

1. Attractiveness of returns is a function of the correlations between different securities, the yield spread pick-up available, and the high number and wide diversity of debt securities. 2. Liquid trades in the US, but fewer mispricing opportunities 3. Liquidity decreases in other sovereign markets 4. High leverage usage RELATIVE VALUE STRATEGY

Factors impacting the decision to invest passively or active (6)

1. Available investments 2. Scalability of active strategies being considered 3. The feasibility of investing passively while incorporating client-specific constraints 4. Beliefs concerning market informational efficiency 5. The trade-off of expected incremental benefits relative to incremental costs and risks of active choices 6. Tax status

Main biases for alternative investments (2)

1. Backfill bias 2. Survivorship bias

Parts of an individuals IPS (6)

1. Background and investment objectives 2. Investment parameters 3. Portfolio asset allocation 4. Portfolio management 5. Duties and responsibilities - (wealth manager responsibilities) 6. IPS Appendix

If a client is offering a MC additional compensation, how do potential conflicts of interest differ: 1. Before performance is achieved 2. After performance is achieved

1. Before performance > must receive written permission before engaging (yes conflict of interest, could impact judgement) 2. After performance > must have notification / disclosure (no conflict of interest, gift can't change existing performance)

2 types of factors for comparing portfolio construction

1. Bottom up or top down 2. Discretionary versus non-discretionary

Considerations for an manager's investment philosophy (4)

1. Can the manager clearly and consistently articulate their investment philosophy 2. Are the assumptions credible and consistent 3. How has the philosophy developed over time 4. Are the return sources linked to credible and consistent inefficiencies

Types of super class assets (3)

1. Capital assets - Stocks / bonds 2. Consumable / transformable assets - commodities 3. Store of value - currencies, art

2 Disadvantages to covered call strategy

1. Capped upside 2. Unlimited downside

Describe Volatility Trading strategy

1. Capture relative timing and strike pricing opportunities due to changes in the term structure of volatility. 2. Try to capture volatility skew / smile using various types of option spreads 3. Will use OTC options, VIX futures, volatility swaps, and variance swaps 4. Focus is on generating uncorrelated, attractive risk adjusted returns SPECIALIST STRATEGY

Strategies under a stable yield curve (4)

1. Carry trade 2. Ride the yield curve 3. Sell convexity 4. buy and hold

6 operations in the editing process of Prospect theory

1. Codification - People perceive outcomes as gains and losses rather than final states of wealth or welfare 2. Combination - Prospects are simplified by combining the probabilities associated with identical gains or losses 3. Segregation - The risk less component of any prospect is separated from its risky component 4. Cancellation - Cancellation involves discarding common outcome probability pairs between choices 5. Simplification - Prospects are likely to be rounded off 6. Detection of Dominance - Outcomes are strictly denominated and scanned and rejected without further evaluation During the editing phase, a decision maker organizes and reformulates the available options to simplify the choice

Different types of tax regimes (7)

1. Common progressive 2. Heavy dividend tax 3. Heavy capital gains tax 4. Heavy interest tax 5. Light capital gains tax 6. Flat and light 7. Flat and heavy

(4) types of soft skills for PWM

1. Communication skills 2. Social skills 3. Education and coaching skills 4. Business development and sales skills

4 axioms of traditional finance (utility)

1. Completeness: assumes that an individual has well-defined preferences and can decide between any two alternatives 2. Transitivity assumes individuals consistently apply their completeness rankings. 3. Independence assumes rankings are also additive and proportional. 4. Continuity assumes utility indifference curves are continuous, meaning that unlimited combinations of weightings are possible.

Emotional biases commonly associated with concentrated positions

1. Conservatism 2. Confirmation 3. Illusion of control 4. Anchoring and adjustment 5. Availability heuristic

Factors to consider when writing institutional IPS objective statement (2)

1. Consider if it is considering for inflation or not 2. "A reasonable level of risk" should be incorporated

Advantages of a Trust (3)

1. Control 2. Asset Protection 3. Tax Reduction

2 Disadvantages to the protective put strategy

1. Cost of options 2. Counter party risk for OTC options (significantly less if exchange traded)

Disadvantages swaps (4)

1. Counter party risk 2. Liquidity 3. Interest rate 4. Tax policy risks

Process for marking to market a forward position (4)

1. Create an equal and offsetting forward position to the original forward position 2. Determine the appropriate all-in forward rate for this new, offsetting position 3. Calculate the cash flow at settlement date 4. Calculate the present value of this cash flow at the future settlement date

Potential risks to using swaptions (3)

1. Credit risk if the swaption is not collateralized 2. "Collateral exhaustion risk" 3. Spread risk between swap fixed rates and the corporation's cost of funds

Factors that complicate translation of business cycle information (3)

1. Cycles can vary in length 2. Not easy to distinguish between cyclical and secular forces 3. How, when, and by how much the market responds to the business cycle is unpredictable

CME: Limitations with biases in analyst methods (2)

1. Data mining bias 2. Time period bias

Deflation damages the economy due to it undermining (2)

1. Debt financed investments 2. The power of the central bank

pre-trade benchmarks

1. Decision Price 2. Previous Close 3. Opening Price 4. Arrival Price A pre-trade benchmark is often specified by portfolio managers who are buying or selling securities on the basis of decision prices.

Asset location for taxes can be approached with the following (3) methods:

1. Deferral 2. Avoidance 3. Reduction

Factors to consider when reviewing EM bonds 1. Deficit to GDP ratio 2. Debt to GDP ratio 3. Investors should expect "Real" growth 4. Current Account deficit relative to GDP GDP 5. Foreign debt levels relative to GDP 6. Debt levels relative to current levels 7. Foreign exchange reserves less than______ of short-term debt

1. Deficit to GDP ratio > Above 4% means greater risk 2. Debt to GDP ratio > Above 70/80% = greater risk 3. Investors should expect "Real" growth > 4% 4. Current Account deficit that is greater than 4% above GDP > Higher risk 5. Any foreign debt levels > 50% of GDP = higher risk 6. Any debt levels greater than 200% of current levels = higher risk 7. Foreign exchange reserves less than 100% of short-term debt = higher risk

The steps to developing a fundamental active investment process (7)

1. Define the investment universe and the market opportunity—the perceived opportunity to earn a positive risk-adjusted return to active investing, net of costs—in accordance with the investment mandate. The market opportunity is also known as the investment thesis. 2. Prescreen the investment universe to obtain a manageable set of securities for further, more detailed analysis. 3. Understand the industry and business for this screened set by performing industry and competitive analysis and analyzing financial reports. 4. Forecast company performance, most commonly in terms of cash flows or earnings. 5. Convert 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.

Key considerations in forecasting exchange rate results: capital flows

1. Degree of capital mobility 2. Relative short-term interest rates, term, credit, equity and liquidity premiums 3. Hot money flows

How to use mean variance to determine if an asset class should be added to a portfolio

1. Determine sharpe ratio of current portfolio and the new asset class. 2. Multiply the current portfolio sharpe ratio by the correlation of the new asset class to the portfolio 3. If the multiplied value is smaller than the new asset class sharpe ratio, ADD

7 Steps to CME

1. Determine the specific CME that are needed according to (A. Investor's allowable asset classes, B. Investor's Time Horizon) 2. Explore an asset classes historical performance to determine factors of past performance. 3. Identify the valuation model (FCFF, FCFE, Dividend Discount) 4. Collect best data possible 5. Use experience and judgement to understand current investment condition outcomes 6. Formulate CME (M.V.O, Black Litterman, Monte Carlo) 7. Monitor performance, refine the model or processes as needed

(2) methods for evaluating capital sufficiency

1. Deterministic forecasting - (Straight line forecasting) 2. Monte Carlo simulation

Subcomponents of Wealth manager responsibilities on an individuals IPS (11)

1. Developing an appropriate asset allocation 2. Recommending or selecting investment options 3. Monitoring the asset allocation and rebalancing 4. Using derivatives, leverage, short sales, and repurchase agreements (repos) 5. Monitoring the costs associated with implementing the investment strategy 6. Monitoring the activities of third-party service providers 7. drafting and maintaining the IPS 8. Reporting or performance, including an indication of the base currency 9. Reporting of taxes and financial statements 10. voting proxies 11. Assisting with the preparation of agreements associated with private fund offerings

Subcomponents of Portfolio asset allocation on an individuals IPS (4)

1. Discretionary authority 2. Rebalancing 3. Tactical changes 4. Implementation

Roles of fixed income in a portfolio (3)

1. Diversification 2. Income 3. Possible inflation hedge

When adding fixed income to a portfolio, consider the following (4) factors when evaluating changes

1. Diversification benefits 2. Liquidity benefits 3. Cash Flow benefits 4. Inflation hedging benefits

Considerations for capacity of an inefficiency (3)

1. Does the inefficiency provide a sufficient frequency of opportunity and level of return to cover transaction cost and fees? 2. Does the inefficiency provide a repeatable source of return? 3. Is the inefficiency sustainable?

Questions to ask about investment personnel (5)

1. Does the investment team have sufficient expertise and experience to effectively execute the investment process? 2. Does the investment team have sufficient depth to effectively execute the investment process? 3. What is the level of key person risk? 4. What kinds of agreements and incentives exist to retain and attract key employees to join and stay at the firm? 5. What has been the turnover of firm personnel?

2 Issues with analyzing real estate historical returns

1. Each property is unique, so the investments are heterogenous (not homogeneous) 2. Smoothing of returns (appraisal data)

Risks to human and financial capital (6)

1. Earnings risk 2. Premature death 3. Longevity risk 4. Property risk 5. Liability risk 6. Health risk

Tactical strategies for managing currencies (4)

1. Economic fundamental analysis - In the long-term, currencies should revert to their long-term averages (relative PPP) 2. Technical Analysis > Past price can predict future price movements ; Past price patterns tend to repeat > Doesn't matter what a currency "should" be worth 3. Carry Trade - Makes assumption that markets are stable. Typically can make money in the short-term > suffers once volatility increases 4. Volatility Trading - Typically uses either a straddle or strangle trading method

Categories of hedge funds (6)

1. Equity 2. Event driven 3. Relative value 4. Opportunistic 5. Specialist 6. Multi-manager

Options for implementing a relative value arbitrage strategy

1. Exchange traded options 2. OTC options 3. Vix futures 4. OTC volatility swap

Common methods of fixed income attribution (3)

1. Exposure decomposition - Top down approach, decomposes risk and return through interest rate risk 2. Yield Curve Decomposition - Duration based - Top down or bottom up, uses duration and YTM (more data required than exposure decomposition) 3. Yield Curve Decomposition - Full Repricing based - securities are repriced using spot rates for zero coupon type securities. Most accurate but most expensive.

Describe Convertible Arbitrage

1. Extract "underpriced" implied volatility from long convertible bond holdings 2. Works best in periods of high convertible issuance, moderate volatility, and reasonable market liquidity 3. Typically 300% long and 200% short 4. Complexities may arise from less liquidity for convertible bonds and complications towards short selling RELATIVE VALUE STRATEGY

Personal factors to consider learning about a client in PWM (7)

1. Family situation 2. Identification (license or passport) 3. Career information 4. Investment background 5. More details on financial goals and risk tolerance 6. Liquidity needs / risk tolerance 7. Investment preferences (unique)

3 risks faced by individual investors

1. Financial market risk 2. Longevity risk 3. Spending uncertainty risk

(4) types of portfolio restraints

1. Fixed Allocation Restraint 2. Asset Allocation Range Restraint 3. Upper Limit Restraint 4. Liability relative restraint

Relative Value hedge funds (2)

1. Fixed income arbitrage 2. Convertible bond arbitrage

Describe Global Macro Strategy

1. Focus on correctly discerning and capitalizing on trends in global financial markets 2. Delivers diversification in periods of market stress, heterogenous outcomes 3. Discretionary implementation approach 4. Highly liquid, high leverage OPPORTUNISTIC STRATEGY

Describe Distressed Securities

1. Focus on firms in bankruptcy or under financial stress 2. In liquidation, the firm's assets are sold off and securities holders are paid sequentially based on priority of their claims 3. In reorganization, a firm's capital structure is re-organized and terms for current claims are negotiated and revised 4. Usually long biased, high levels of illiquidity, moderate to low leverage 5. Higher end return profile, but more discrete and cyclical EVENT DRIVEN STRATEGY

Describe Managed Futures strategy

1. Focus on investments using mainly futures and options 2. Implemented with a systematic approach 3. Highly liquid, high leverage 4. Exhibit positive right tail skewness during market stress OFFER AN UNCORRELATED SOURCE OF ALPHA OPPORTUNISTIC STRATEGY

Approaches to forecasting (3)

1. Formal tools 2. Surveys 3. Judgement

Approaches to constructing an indexed portfolio (3)

1. Full replication - minimal tracking risk, more expensive 2. Stratified Sampling - Retains basic characteristics of index without costs associated with buying all the stocks 3. Optimization - Seeks to match portfolio's risk exposures (including covariances) to those of the index ; but can be misspecified if historical risk relationships change over time

Methods of leverage for FI (5)

1. Futures contracts 2. Repurchase agreements 3. Swap Agreements 4. Structured Financial instruments 5. Securities Lending

Key points for GIPS (7)

1. GIPs requires you say what currency everything is in 2. GIPs requires you to disclose gross or net of fees 3. In disclosure, must say, "Not verified, verified, or verified and performance examination" 4. Need to include composite inception date 5. Only assets managed by the firm can go in a composite 6. Simulated results may not be included 7. Must include BM

Opportunistic hedge funds (2)

1. Global macro 2. Managed futures

Wealth managers should assist their clients with:

1. Goal quantification 2. Goal prioritization 3. Goal changes

Reasons to use a linear risk factor framework for a hedge fund strategy (3)

1. Hedge funds may have dynamic trading strategies. 2. Hedge funds may have unexpected exposures to systemic risks. 3. Hedge funds are likely to experience multicollinearity, which factor models can attempt to address.

Challenges to bond market indexes as benchmarks

1. Heterogeneous and illiquid Lots of differences between types of bonds, maturity, seniority, and other features (call, put) vs stocks are typically uniform Liquidity varies drastically 2. Vendor indexes vary drastically 3. Risks change over time in index 4. Cap weighted indexes more exposed to credit downgrades 5. Difficult to find index matching investor risk profile

Rebalancing considerations for wider / narrower 1. Higher transaction costs 2. More risk averse investor 3. Less correlated assets 4. Beliefs in momentum 5. Belief in mean reversion 6. Illiquid investments 7. Increased volatility 8. Taxes - discourage rebalancing, therefore, wider

1. Higher transaction costs - Wider 2. More risk averse investor - Narrower 3. Less correlated assets - Narrower 4. Beliefs in momentum - Wider 5. Belief in mean reversion - Narrower 6. Illiquid investments - Wider (most of the time for cost) 7. Increased volatility - Narrower (if risk control) or wider (if cost control) 8. Taxes - discourage rebalancing, therefore, wider a. For Liquid asset: The higher the volatility, the narrower the band b. For Illiquid asset: The higher the volatility, the wider the band. Rebalancing ranges are determined through a balance of risk and cost

5 step process for managing concentrated position

1. Identify and establish objectives and constraints 2. Identify tools/strategies that can satisfy these objectives 3. Compare tax advantages and disadvantages 4. Compare non-tax advantages and disadvantages 5. Formulate and document an overall strategy

Pompian behavioral model: Top Down Behavioral Alpha Process, steps

1. Identify risk tolerance 2. Plot the investor 3. Test for behavioral biases 4. Determine behavioral investor type (BIT)

Reasons why gifting can be preferred over leaving money to be bequeathed at death (2)

1. If it is under the annual amount, can avoid gift tax 2. Lowers the total taxable estate upon death

4 Considerations for concentrated positions

1. Illiquidity 2. Triggering taxable gains on sale 3. Restrictions on amount and timing of sales 4. Emotional and cognitive biases

Decomposing Fixed Income Returns (5)

1. Income Return (current yield) 2. Roll Return 3. (e) changes due to yield 4. (e) changes due to credit 5. (e) changes due to currency

When probability of success falls below an acceptable range for capital sufficiency analysis, potential solutions include (4)

1. Increasing contribution amount 2. Reducing goal amount 3. Increasing time horizon / delaying goal 4. Adopting an investment strategy with higher expected returns (albeit within the client's acceptable risk tolerance and risk capacity levels).

5 Phases of the Business Cycle

1. Initial Recovery - short-term rates and bond yields low, stock market may begin to rise 2. Early Upswing - short term rates are moving up, stocks are trending up 3. Late Upswing - interest rates rise across curve, with yields flattening. Stock market may still rise, but with increased volatility, inflation hedges outperform 4. Slowdown - Short-term rates are at or nearing a peak. Government bond yields peak and may then decline sharply. Stocks may fall, quality outperforms 5. Recession - Interest rates and bond yields drop, yield curve steepens. Credit spreads widen. Stock market drops, but recovers quickly before recovery begins.

CME: 2 subcomponents of model uncertainty

1. Input uncertainty 2. Parameter uncertainty (Potentially the most serious issues because the wrong model may lead an analyst to fundamentally flawed conclusions)

Qualitative risks that can arise from alternative investments (7)

1. Key Person risk 2. Style drift of chosen investment style 3. Risk complexity / management 4. Service providers 5. Client / asset turnover 6. Client profile (are you invested with similar investors?) 7. Alignment of interests

9 Problems in forecasting CME

1. Limitations associated with historical data 2. Data measurement biases and errors 3. Limitations associated with historical estimates 4. Use of ex-post risk & return measures to determine ex-ante 5. Non-repeating data patterns 6. Failing to account for conditioning information 7. Misinterpretation of correlations 8. Psychological Biases 9. Model Uncertainty

Spread Curve Considerations (5)

1. Liquidity 2. Date of Issuance 3. Pending new supply 4. Seniority incase of bankruptcy 5. Size of issue and total issuance by issuer

6 Factors for a Life Insurance Company to take into consideration for its risk tolerance and constraints section of IPS

1. Liquidity 2. Interest Rate Risk 3. Credit Risk 4. Foreign Exchange Risk 5. Regulatory Requirements 6. Tax Considerations

(4) strategies for managing portfolio liquidity

1. Liquidity profiling and time-to-cash tables 2. Rebalancing and commitment strategies 3. Stress testing analyses 4. Derivatives

Equity hedge funds (3)

1. Long/short equity 2. Dedicated short bias 3. Equity market neutral

Behavioral finance assumptions (3)

1. Loss aversion 2. Biased expectations 3. Asset segregation i. Asset prices reflect underlying economics and investor subjective feelings ii. Portfolio construction segmented in layers; each layer reflect priority of its goals to investor.

2 Benefits of direct investment in Real Assets (Timber)

1. Low correlation with public equities, and thus can be used as a portfolio diversifier 2. Provides high long-term returns and can fulfill the functional role of capital growth.

Methods to reduce tracking error in a fixed income portfolio (4)

1. Lower cost enhancements 2. Issue selection enhancements 3. Yield curve enhancements 4. Sector/quality enhancements

6 approaches to optimizing asset allocation

1. MVO 2. resampled efficient frontier 3.Black Litterman 4. Monte Carlo 5. Asset liability management 6. Experience based

Compare and contrast MVO and reverse optimization approach

1. MVO - Expected returns of asset classes are inputs to the optimization, with the expected returns generally estimated using historical data 2. Reverse - The expected returns of asset classes are the outputs of optimization with the market capitalization weights, covariances, and the risk aversion coefficient used as inputs ALLOCATIONS FOR REVERSE IS THE MARKET CAP / GLOBAL PORTFOLIO ALLOCATION ; BASED ON MARKET PORTFOLIO Reverse uses the CAPM approach Return on asset class = RFR + Beta * market risk premium

risks of leverage (3)

1. Magnified losses 2. Higher risks 3. Forced liquidations

3 Factors of Adaptive Market Hypothesis

1. Magnitude of profits available 2. # of market participants 3. Adaptability of participants

Total active return and risk: 1. Managers true active return 2.Managers misfit active return

1. Managers true active return (MTAr) = Managers return - managers normal bm 2.Managers misfit active return (MMAr)= Managers normal benchmark - investor's bm Total active risk = ((MMAr^2)+(MTAr^2))^0.5

Describe dedicated short / short biased sellers

1. May moderate short beta by holding cash 2. Generally dedicated short have 60%-120% net short, while short bias have 30%-60% net short 3. Uses little leverage (due to implicit volatility of shorting strategy 4. Typically lower return goals, but offer negative correlation EQUITY STRATEGY

A trade policy needs to incorporate these key aspects (5)

1. Meaning of best execution 2. Factors determining the optimal order execution approach 3. Handling trading errors 4. Listing of eligible brokers and execution venues 5. process to monitor execution arrangements

Event-Driven hedge funds (2)

1. Merger arbitrage 2. Distressed securities

Risks associated with managing a portfolio against a liability structure (7)

1. Model Risk 2. Measurement error 3. Assuming that change in yields are equal for A, H, & L 4. Spread risk 5. Counterparty credit risk 6. Collateralization risk 7. Asset liquidity risk

Subcomponents of IPS appendix on an individuals IPS (2)

1. Modeled portfolio behavior 2. Capital market expectations

Asset allocation approaches (3)

1. Monte Carlo Simulation 2. Optimization techniques (mean-cvar approach) 3. Risk factor-based approaches

Approaches to retirement planning (3)

1. Mortality Tables - A mortality table allows for estimating the present value of retirement spending needs by associating each outflow with a probability based on life expectancy. 2. Annuity Method - The calculated price of an annuity equals the present value of a series of future fixed outflows during retirement. 3. Monte Carlo Simulation - Monte Carlo simulation yields an overall probability of meeting retirement needs by aggregating the results of many trials of probability-based estimates of key variables, and it is a flexible approach for exploring different retirement scenarios.

3 most relevant elements of life insurance pricing

1. Mortality expectations - insurer is concerned about the probability that the insured will die within the term of the policy 2. Discount rate - Applied to the expected outflow 3. Loading - Upward adjustment onto premium to allow for expenses and profit

Multimanager Hedge Funds (2)

1. Multi-strategy 2. Fund-of-funds

Monte Carlo simulation and scenario analysis (4)

1. Multiple period framework 2. Provides a realistic picture of distribution of potential future outcomes 3. Can incorporate trading/rebalancing costs and taxes 4. can model non normal distributions, serial and cross sectional correlations, evolving asset allocations, path dependent decisions, non traditional investments, human capital

Advantages of a laddered portfolio (3)

1. Natural liquidity 2. Diversification 3. More convexity than bullet portfolio

Key considerations in forecasting exchange rate results: trade in goods and services (3)

1. Net trade flows 2. PPP (Inflation differentials) 3. Current account imbalances ( Difference between national saving and investment)

Limitations of expected return decomposition (3)

1. Only duration and convexity are used to summarize price yield relationship 2. Model implicitly assumes all intermediate cashflows are reinvested at the YTM; results in different coupon rates 3. Ignores local richness / cheapness ; which are deviations of individual maturity segments from the fitted yield curve

(3) broad types of tools to be used to mitigate risks of a concentrated position

1. Outright sale - triggers tax liability 2. Monetization strategies - no tax event triggered. Create risk free position, and then borrow against that position 3. Hedging the value of the concentrated asset

6 Psychological Biases associated with CME

1. Overconfidence Bias 2. Status Quo Bias 3. Confirmation Bias 4. Availability Bias 5. Prudence Bias 6. Anchoring Bias

Cognitive biases commonly associated with concentrated positions (5)

1. Overconfidence and familiarity 2. Status quo bias 3. Naive extrapolation of past returns 4. Endowment effect 5. Loyalty effects

4 BITs

1. Passive Preservers 2. Friendly Followers 3. Independent Individualists 4. Active Accumulators

Methods of currency management (4)

1. Passive hedging 2. Discretionary hedging 3. Active Currency Management 4. Currency Overlay

3 Limitations for REM

1. Perfect Information 2. Perfect Rationality 3. Perfect Self-Interest

Explanation of: 1. Performance Measurement 2. Performance Attribution 3. Performance Appraisal

1. Performance Measurement - What was the portfolio's performance 2. Performance Attribution - How was the performance achieved 3. Performance Appraisal - Was the performance achieved through manager skill or luck

6 exogenous shocks to growth

1. Policy Changes 2. New products and technology 3. Geopolitics 4. Natural disasters 5. Natural resources / critical inputs 6. Financial Crises

Risks that arise from investing in emerging and frontier markets

1. Poor fiscal discipline 2. Rely on foreign borrowing 3. Less diverse tax base 4. Significant dependence on specific industries

Primary Fixed Income Risk Factors (6)

1. Portfolio modified adjusted duration 2. Key Rate Duration 3. % in sector & credit quality' 4. Sector & credit quality spread duration contribution 5. Sector / Coupon / Maturity cell weights 6. Issuer exposure

Example for each type of liability type 1. 2. 3. 4.

1. Principal repayment 2. Life Insurance 3. Floating rate annuity payout 4. Health care benefits / post retirement

Motivation for a portfolio manager to trade (4)

1. Profit seeking 2. Risk management 3. Cash flow needs 4. Corporate actions / index reconstitution / margin calls

Advantages of bond immunization (3)

1. Protects against interest rate risk 2. Can potentially enhance returns (you can find a combination of bonds with same duration but higher higher yield) 3. An immunized portfolio can be used as a benchmark which an actively managed portfolio can be compared

Quantitative and qualitative factors to consider when choosing broker or execution venues (7)

1. Quality of service 2. Financial stability 3. Reputation 4. Settlement capabilities 5. Speed of execution 6. Cost competitiveness 7. Willingness to commit capital

2 methods to improve trading execution performance

1. Reduce the delay time in between the decision price and the arrival price 2. Determine what the proper order size should be (to reduce opportunity cost)

Primary objectives to discuss with clients regarding their concentrated positions (3)

1. Reducing the concentrated position for risk reduction 2. Generating liquidity from the concentrated positions 3. Achieving tax efficiency in the first two objectives

CME: Limitations of historical estimates (2)

1. Regime changes 2. Historical data may not be indicative of future performance

Key features distinguishing Alternative Investments from traditional investments (7)

1. Regulatory and legal constraints lower 2. Larger investment universe 3. Greater flexibility with shorting and derivative investments 4. Take more aggressive investment exposure potential 5. Constraints with liquidity 6. Lack of transparency 7. Higher cost structure

Describe Merger Arbitrage

1. Relatively liquid 2. Occasional left tail risk when merger deals unexpectedly fail 3. M&A vertical deals involving vertical integration face antitrust scrutiny 4. Higher return option with insurance like payoff, moderate-high leverage EVENT DRIVEN STRATEGY

Describe Equity L/S strategies

1. Rely heavily on stock picking 2. Generally net long 3. Generate average annual returns same as long only, but with 50% lower STD EQUITY STRATEGY

AN endowments primary, secondary and tertiary investment objectives might be:

1. Required Return 2. Outperform relative to a benchmark 3. Outperform a set of pre-defined peers

Price inefficiencies on the short side (4) (Equities)

1. Restrictions to short selling 2. Management's tendency to deliberately overstate profits 3. Sell-side analysts issue fewer sell recommendations 4. Sell-side analysts are reluctant to issue negative opinions

4 Objectives of concentrated positions

1. Risk Reduction 2. Monetization 3. Tax Optimization 4. Control

(traditional vs behavioral) 3 assumptions of traditional finance

1. Risk aversion:a. Minimize risk for given level of return or maximize return for level of risk.b. Measured by volatility 2. Rational expectations a. Investor forecasts are unbiased and accurately reflect all relevant information 3. Asset integration a. Investors consider correlation of potential investment with their existing portfolios.

4 methods to manage risk

1. Risk avoidance 2. Risk reduction 3. Risk transfer 4. Risk retention

(3) levels of private client risk measurement

1. Risk tolerance 2. Risk capacity 3. Rick perception

Subcomponents of Investment Parameters on an individuals IPS (6)

1. Risk tolerance 2. Time horizon 3. Asset class preferences 4. Other investment preferences (ESG) 5. Liquidity preferences 6. Constraints

Security Characteristics (4)

1. Security Type 2. Security Liquidity 3. Time horizon 4. Short term alpha

Steps to creating the asset allocation process (9)

1. Set objectives, liabilities, and goals 2. Set risk tolerance 3. Set the time horizon 4. Understand tax considerations 5. Set asset allocation approach 6. Determine available asset classes and CME 7. Develop asset allocation hypotheticals 8. Simulate asset allocation returns 9. Determine Asset Allocation portfolio

Hedging for Monetization Strategies (4)

1. Short sale against the box 2. Total Return equity swap 3. Short forward or futures contract 4. Synthetic short forward (long put and short call)

Building block approach to fixed income returns (4)

1. Short-term default free rate 2. Term premium 3. Credit premium 4. Liquidity premium

Investment decision making process 4 elements

1. Signal creation 2. Signal capture 3. Portfolio construction 4. Portfolio monitoring

Order Characteristics (3)

1. Size of order 2. Side of order 3. Relative Size (% of ADV)

Primary considerations to include for adding an alternative asset allocation to a portfolio (4)

1. Size of the AI allocation 2. Team's expertise with AI 3. available internal resources for AI 4. Cash flow needs and anticipated liquidity factors

Choosing a benchmark (7)

1. Specified in advance 2. Accountable 3. Measurable 4. Unambiguous 5. Reflective of current investment options 6. Appropriate 7. Investable

Investment Objective IPS endowment guideline (4 points)

1. State the mission 2. "Maintain purchasing power into perpetuity" 3. State targeted real return (after inflation) 4. "With a reasonable level of risk"

Formal tools for CME forecasting (3)

1. Statistical Methods 2. DCF 3. Risk Premium Approach

Exit strategies for concentrated positions (9)

1. Strategic buyers 2. Financial buyers 3. Leveraged Recapitalization 4. Management buyout 5. Divesture of noncore assets 6. Sale or gift to family members 7. Personal line of credit secured by company shares 8. IPO 9.Employee share ownership plan

Issues discussed during shareholder engagement (5)

1. Strategy 2. Allocation of capital 3. Corporate governance 4. Remuneration 5. Composition of the board of directors

Describe Life settlement strategies

1. Strategy involves analyzing pools of life insurance contracts offered by 3rd party brokers, and effectively become the beneficiary. 2. Looks for policies with: low surrender cost, ongoing premium payments low, high statistical probability of insured dying sooner than predicted by standard actuarial methods 3. Focus is on generating uncorrelated, attractive risk adjusted returns SPECIALIST STRATEGY

Inefficiencies can be categorized as

1. Structural 2. Behavioral

Disadvantages of bond immunization (3)

1. Structural risks (twists or steepening of the yield curve) still exist for the portfolio 2. Need to rebalance can create complexities and increased costs 3. While it does protect from interest rate risk, it does not protect against other types of risk (call risk, default risk, etc.) 4. Idiosyncratic risk is still present, which can create major rebalancing events and may cause the portfolio to fail its goal

Describe equity market neutral strategies

1. Take advantage of idiosyncratic short-term mispricing between securities 2. Does not accept beta risk, making it attractive in periods of market stress / non-trending markets 3. Generally accept high levels of leverage 4. Generally modest return profiles, high levels of diversification and liquidity with lower STD 5. Think mean reversion EQUITY STRATEGY

Currency related issues addressed in the IPS (5)

1. Target proportion of currency exposure to be passively hedged 2. Latitude for active currency management around this target 3. Frequency of hedge rebalancing 4. Currency hedge performance benchmark to be used 5. Hedging tools permitted (types of forward and option contacts)

Categories of real investments (5)

1. Timber 2. Commodities 3. Farmland 4. Energy 5. Infrastructure All have a high degree of correlation with inflation broadly or with a sub component of inflation TIE FC

IPS constraints (detailed) 1. Time horizon

1. Time horizon EITHER SINGLE STAGE OR MULTI STAGE, MAKE SURE TO SPECIFY. ALSO SPECIFY THE LENGTH OF THE PERIOD AND CURRENT AGE. ( LONG TERM OR SHORT TERM) - State number of stages in time horizon, main objective of each stage and number years in each stage - Watch out for stages defined by people other than client; EG expected large inheritance - Can also be multi-generational : leave $$ for heirs

CME: Limitations of economic data (2)

1. Time lag 2. Data revisions

(3) methods of dealing with the effects of fat tails in asset allocation

1. Time-varying models 2. Regime-switching models 3. Extreme value theory

Cons of shareholder engagement (4)

1. Timely and costly for both the company and shareholders 2. Pressure on company to meet near term price targets might come at the expense of long term corporate decisions 3. Engagement can lead to selective disclosures for the company 4. Conflicts of interest can arise

2 Types of costs associated with hedging

1. Trading costs - dealing with bid/ask spread of dealers, upfront payment for options, overhead costs for trading infrastructure 2. Opportunity costs - loss of upside that comes with deciding to hedge

Two primary approaches to constructing a client portfolio:

1. Traditional approach 2. Goals-Based investing approach

3 types of FX risk

1. Transaction exposure Cash flow in a foreign currency to be received at future date Can hedge this, if received, sell it forward. If it will be paid, buy it forward 2. Economic exposure When changes in currency value effect business competition Exporter selling goods in foreign markets. If domestic currency ↑ products become less competitive internationally (because more expensive) Same with purchasing internationally. If domestic currency ↓, imports become more expensive for buyers. 3. Translation exposure Converting foreign back to domestic currency and translation G/L risk.

Risk governance must be (4 characteristics)

1. Transparent 2. Establish clear accountability 3. Cost efficient in use of resources 4. Effective in achieving desired outcomes

2 Disadvantages of Leveraged recapitilization

1. Typically the buyer is a financial buyer, so they will pay less than a strategic buyer 2. The owner typically relinquishes control of the company

Generally good forecasts for CME are (3)

1. Unbiased, objective, and well researched 2. Efficient 3. Internally consistent Standard rule of thumb in statistics is you need 30 observations to meaningfully test a hypothesis

Problems with modeling the yield curve (4)

1. Unsynchronized observations of various maturities on the curve 2. Gaps in maturities that require interpolating/smoothing 3. Observations that seem inconsistent with neighboring values 4. Differences in accounting or regulating treatment of certain bonds that may make them look like others

Approaches to improve quality of MVO asset allocation (3)

1. Use reverse optimization to compute implied returns and improve quality of inputs (I.e. Blacklitterman) 2. Adding constraints to incorporate short-selling and other real-world restrictions into optimization 3. Resampled MVO technique combining MVO and Monte Carlo approaches to seek the most efficient and consistent optimization

Specialist hedge funds (2)

1. Volatility strategies 2. Reinsurance strategies

Identify risks faced by investors in emerging market equities over and above those that are faced by fixed income investors in such markets.

1. Weaker corporate governance 2. Weaker accounting standards 3. Weaker disclosure rules Generally less integrated, local factors exhibit stronger influence on risk and return

Yield Enhancement Strategy (2)

1. Write covered calls to generate income; Does not reduce downside risk 2. Can also do securities lending(lender still receives dividends)

initial recovery phase of the business cycle - 1. Output Gap 2. Money Market Rates 3. Improving Confidence 4. Stimulative Monetary Policy

1. large output gap, 2. low money market rates, 3. improving confidence, and 4. stimulative monetary policy.

Individuals can attempt to reduce or avoid forced heirship by: (3)

1. moving assets into an offshore trust governed by a different jurisdiction; 2. gifting or donating assets to others during their lifetime to reduce the value of the final estate upon death; or 3. purchasing life insurance, which can move assets outside of realm of forced heirship provisions.

5 parts of manager questionnaire

1. organization and staff 2. investment philosophy and process 3. Resources 4. performance (benchmarks, alpha, risk sources) 5. Fee schedules - ad valorem = fee based on aum - performance fee

Limitations of BIT Classifications (5)

1.Investor possesses both cognitive and emotional biases. 2.Investors may display multiple characteristics of different personality types. 3.Investors may exhibit changes of different personality types as they age. 4.Investors must be treated as unique individuals even if they are in the same BIT classification. 5.Investors may be irrational and unpredictable from time to time.

Cyclically adjusted P/E (CAPE)

10-Year moving average CAPE ratio controls for business cycle effects and is mean reverting If calculated CAPE is larger than the long term average, than market is OVERVALUED Use REAL values BUSINESS CYCLES DON'T IMPACT IT, REGIME CHANGES DO

Five-Way Model (BB&K), Classifications: Celebrity

2. Celebrity a. Anxious and impetuous (SE quadrant) b. Have opinions but realize limitations c. Seeks and takes advice - advisors like

2. Friendly Followers

2. Friendly follower a. Basic type: passive b. Risk Tolerance: low to medium c. Primary bias: cognitive Decisions influcened by availability, hindsight and framing biases.

2. Tax considerations (IPS)

2. Tax considerations Income tax Capital gains tax Wealth transfer tax Personal property tax - Strategies used to reduced tax bill Tax deferral: - Paying taxes at the end of the investment holding period. - LT cap gains, low turnover, loss harvesting Tax avoidance - Invest in tax free securities; munis Tax reduction - Invest in securities that require less direct payment Wealth transfer taxes - Can minimize taxes by planning transfer of wealth to others without utilizing a sale

3. Independent Individualists

3. Independent Individualist (II) a. Basic type: Active b. Risk Tolerance: medium to high c. Primary bias: cognitiveII's most contrarian. Biases are conservatism availability, confirmation and representativeness.

Five-Way Model (BB&K), Classifications: Individualist

3. Individualist a. Confident and careful (NW quadrant) b. Likes to make own decisions only after careful analysis c. Advisors like - listen and process info rationally

Five-Way Model (BB&K), Classifications: Guardian

4. Guardian a. Anxious and careful (SW quadrant) b. Concerned with the future and protecting assets c. May look to others who they view as smarter for advice

Expected risk of the domestic currency return

= (1 + rFC)σ(rFX)

Equity Q

= Market Value of Equities / (Assets at market value or replacement costs - liabilities)Less than 1 means under valued

PV of Joint Spending Needs

= {P(SurvivalJ) * (SpendingJ)} / [(1+r)^n]

Negative delta of a combined options position results in:

A SHORT POSITION

When are bullet portfolios preferred?

A bullet performs well when the yield curve is expected to steepen.

Interpreting a capture ratio: Convex Concave Symmetrical

A capture ratio greater than 1 indicates positive asymmetry, or a convex return profile. A capture ratio less than 1 indicates negative asymmetry, or a concave return profile. The capture ratio measures the asymmetry of return. A capture ratio equal to 1 would describe a symmetric return profile, whereas a ratio greater than or less than 1 indicates an asymmetric profile.

A flattening of a futures curve for the Fed Funds rate on its own would indicate: (the impact on rates)

A greater likelihood of unchanged short-term rates

Health maintenance organization plan

A health maintenance organization plan is a type of medical insurance that allows office visits at no, or very little, cost. Encourages individuals to seek help for small medical problems before they become more serious

Laddered portfolio vs. bullet portfolio impact on cash flow reinvestment risk

A laddered portfolio will have MORE reinvestment risk than a bullet portfolio. (exposure to the higher ends of the curve)

Leveraged recapitalization strategy explained

A leveraged recapitalization is a strategy that involves retooling a company's balance sheet in partnership with a private equity firm. A recapitalization strategy is a "STAGED" exit strategy, The private equity firm generally invests equity capital and arranges debt with senior or subordinated lenders. The owner transfers his/her stock for cash and an ownership interest in the newly capitalized entity. This allows the owner to monetize a significant portion of his/her business equity (typically 60% to 80%) and retain significant upside potential with the remaining ownership (typically 20% to 40%). The after-tax proceeds the investor receives could be deployed into other asset classes to help build a diversified portfolio. Additionally, the retained stake motivates the owner to grow the business.

How does life insurance provide liquidity in the event of a family member passing?

A life insurance policy can provide liquidity without the delay involved in the legal process of settling the estate. This liquidity can be particularly valuable if the estate contains illiquid assets or assets that are difficult to separate and distribute equitably among heirs.

Unvested pension benefits are typically contingent on future work and are thus considered to be________________________

A part of human capital.

A rising current account deficit will

A rising current account deficit will tend to put upward pressure on REAL REQUIRED RETURNS so as to encourage a higher saving rate in the deficit country and to attract the increased flow of capital from outside the country needed to fund the deficit. RISING CURRENT ACCOUNT DEFICIT = HIGHER REAL RETURNS, MORE ATTRACTIVE

A call option on the USD / EURO (ex. at 1.22) trading pair protects against what risk?

A risk of the BASE currency increasing in value The option allows you to lock a price of 1.22, where if the base increases in value, that number will rise to 1.30. This then lets you lock in the exchange rate of BUYING the base at 1.22

Estate Tax Freeze

A strategy to transfer future appreciation and tax liability to future generations. Typically done by Partnership or Corporate Structure. Owners transfer a junior equity interest to the children that will receive most or all of the future appreciation of the enterprise

Symmetrical fee structure

A symmetrical fee structure is one in which the fees are affected by both positive and negative performance.

Leverage factor for banks is equal to Equity capital ratio

A/E If they give you equity capital ratio, make sure to invert

3. Liquidity (IPS)

Ability to meet anticipated and unanticipated needs Clients ownership of home is illiquid asset; not typically noted here For exam.... - START WITH THE IMMEDIATE LIQUIDITY NEEDS - The need for ongoing distributions should be disclosed and noted - One time / couple times liquidity distribution should be noted - Holding of illiquid assets that are restricted from sale should be noted here - Emergency cash reserves NOT listed here unless small or specifically told to

Accrual Equivalent Annual Return

Accrual Equivalent Annual Return % = 100% × [(Ending Value/Beginning Value)1/12 − 1]

Window dressing

Action taken by the client shortly before the balance sheet date to improve the financial picture presented in the financial statements. (single period observation risk, holdings based analysis is subjected to this)

Difference between active risk and active share

Active risk = tracking error. It's the difference in the standard deviation of returns on the portfolio vs. that of the benchmark (think tracking error) Active share = the number of active decisions made by the manager to overweight/underweight securities Managers can control active share, can't control active risk.

Active Risk

Active risk, which is driven by the differences between the security weights in the portfolio and the security weights in the benchmark, increases when a portfolio becomes more uncorrelated with its benchmark. A concentrated portfolio tends to have high active risk (typically 8-12% or higher).

Additional Compensation (ethics)

Additional compensation from employer is okay From clients, any compensation that might reasonably create a conflict of interest should be disclosed

All else being equal, the Singer-Terhaar model implies that when a market becomes more globally integrated (segmented), its required return should _______________. How should you position towards portfolios that are increased in integration? Where should allocation be decreased?

All else being equal, the Singer-Terhaar model implies that when a market becomes more globally integrated (segmented), its required return should DECLINE (RISE). As prices adjust to a lower (higher) required return, the market should deliver an even higher (lower) return than was previously expected or required by the market. Therefore, the allocation to markets that are moving toward integration should be increased. If a market is moving toward integration, its increased allocation will come at the EXPENSE OF MARKETS THAT ARE ALREADY HIGHLY INTEGRATED This will typically entail a shift from developed markets to emerging markets.

Box Spread

An option strategy that combines a bull spread and a bear spread having two different exercise prices, which produces a risk-free payoff of the difference in the exercise prices.

(3) responsibilities of DC plan providers

Appropriate investment of plan assets Suitable investment options Selecting administrative providers

Grossman-Stiglits Paradox

Arguement that prices must offer a return to information acquisition, otherwise information will not be gathered and processed. If information is not gathered and processed, the market cannot be efficient.

"Bums" Problem

Arises as a result of a market-cap-weighted portfolio increasing the weight of a particular issuer or sector that has increasing borrowings.

Arrival Cost Formula

Arrival cost (bp) = Side × [ (Average price −P0) / P0 ] × 10000 P0 = execution price

Added value formula (For trading)

Arrival cost - estimated pre-trade cost

When to use an arrival price trading strategy?

Arrival price strategies are used when a portfolio manager believes prices are likely to move unfavorably during the trade horizon.

Managers using an active fundamental investment process usually rebalance.....

At any time, in response to changes in company-specific information.

How to Incentive Fees impact a portfolios net return volatility? How do management fees?

Because incentive fees are fees charged as a percentage of returns (reducing net gains in positive months and reducing net losses in negative months), its use lowers the standard deviation of realized returns. Charging a management fee (a fixed percentage based on assets) lowers the level of realized return without affecting the standard deviation of the return series.

Overconfidence Bias what is it and cons and how to combat

Bias in which people demonstrate unwarranted faith in their own intuitive reasoning, judgements, and/or cognitive abilities Prediction and certainty overconfidence Cons Underestimate risks and overestimate expected returns Hold poorly diversified portfolios Trade excessively Experience lower returns than those of the market Combated by reviewing reading records, identifying winners and losers, and calculating portfolio performance (compared against a bm)

Self Control Bias what is it and cons and how to combat

Bias in which people fail to act in pursuit of their long-term overarching goals because of a lack of self-discipline Cons Save insufficiently for the future Accept too much risk in their portfolios in an attempt to generate higher returns cause asset allocation problems Combat this by adhering to a savings plan and an appropriate asset allocation strategy are critical to long-term financial success

Mental Accounting Bias what is it and cons and how to combat

Bias in which people treat one sum of money differently from another equal-sized sum based on which mental account the money is assigned to Cons: Neglect opportunities to reduce risk by combining assets with low correlations Combat this by focusing on total return instead of segmenting the return into capital appreciation and income return

Hindsight Bias what is it and cons and how to combat

Bias with selective perception and retention aspects; people may see past events as having been predictable and reasonable to expect cons Causes an overestimate the degree to which they predicted an investment outcome, thus giving them a false sense of confidence. Also can lead to unfairly assessing money managers or security performance To combat this, FMPs need to carefully record and examine their investment decisions, both good and bad, to avoid repeating past investment mistakes

For Fixed income bottom up, focus on.... For fixed income top down, focus on...

Bottom up - Spread duration and market value allocation Top down - Interest rate changes, inflation changes in GDP

Marginal contribution to tracking risk is used by:

Bottom up manager with a relative return target

Bounded Rationality

Bounded rationality describes the phenomenon whereby people gather some (but not all) available information.

How would large, urgent trades be handled typically?

Broker risk trade via the RFQ (Request for quote) process

5. Unique circumstances (IPS)

Catch all for anything that can affect management of assets not covered in prior constraints - Special investment concerns - Restrictions on assets or asset classes to be invested in - Assets held outside the portfolio For exam - Don't leave blank. Say "none" o list anything important that doesn't fit - Can include large amount of stock in a company founded by the client or relatives - Restricted asset classes EG tobacco/firearm

Describe human capital

Commonly defined as the MORTALITY-weighted net present value of an individual's future expected labor income

Utility Function of Risk-Averse Individual (graph)

Concave

How are conditional linear factor models used for hedge funds?

Conditional linear models are used for uncovering and analyzing hedge fund strategy risk exposures. The linear model can incorporate the factors specific to that hedge fund, and asses those factors in normal or stressed market conditions. Limitation: may not capture error terms, alpha, or omitted risk factors Ex. Equity risk, credit risk, currency risk, and volatility risk

Cognitive Bias Belief Preservation "C.RICH"

Confirmation Representativeness Illusion of control Confirmation Hindsight

Constant Mix

Constant mix (CM)Rebalancing portfolio within target weights (either periodic or within selected asset weights) Fits investor who's risk aversion increases and decrease proportionate with wealth Performs best in volatile mean reverting markets. Worst in trending markets

Utility Function of Risk-Seeking Individual

Convex

Corner Portfolio

Corner portfolios are efficient portfolios and represent a portfolio where an asset weight changes from zero to positive or positive to zero.

Minimum Variance Hedge Ratio (formula)

DC/FX

When comparing risk in the PWM make sure too...

DO TAX ADJUSTED RISK AND RETURN GOVERNMENT SHARES IN PARTS OF THE RETURN AND THE RISK

Bank main factors effected: Diversified Fixed Income Investments

Decreases Asset STD Debt securities less volatile than common equities, real estate, and other securities

Bank main factors effected: High-Quality bond/debt investments

Decreases Asset STD Overall, higher quality securities are less likely to be downgraded

Bank main factors effected: Derivatives transparency collateralization

Decreases Asset STD and Liability STD and increases correlation

Bank main factors effected: Diversifying insurances business

Decreases Liability STD

Bank main factors effected: Predictability of underwriting losses

Decreases Liability STD

Bank main factors effected: Surrender penalties

Decreases Liability STD

Deferred variable annuities pay when?

Deferred variable pay at the beginning of retirement

Expanded Implementation shortfall

Delay Cost + Trading cost + Opportunity cost + Fees

Formula for capitalized value of core capital spending needs

Discounted value= Real spending× ((1+Inflation)^t) × Joint probability ----------------------------------------------------- (1+Risk-free rate)^t

Diversifying income volatility risk

Diversify income volatility risk by appropriate financial capital. ex. if human capital is equity-like, financial capital should contain more bonds.

Criteria for an asset class (5)

Diversifying Homogenus Mutually Exclusive Scaleable Exhaustive of all investment options

1. Passive Preservers

Do not give these clients technical jargon 1. Passive Preserver a. Basic type: passive b. Risk Tolerance: low c. Primary bias: Emotional d. More receptive to "big picture"

modified duration of the bank's equity capital

D∗E=((A/E)*[Da]) − (([A/E]−1)*(Dl)*(ΔiΔy)) (A/E) = Equity capitalization ratio Da = Duration of assets L

Effective Interest Rate Calculation

Effective rate = ((Loan principal + Loan interest - Payoff from Call) / (Effective net loan proceeds))^(365/180) -1

Regret Aversion Bias what is it and cons and how to combat

Emotional bias in which people tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly. Two dimensions, actions people have taken, or actions people could have taken. Cons Be too conservative in their investment choices as a result of poor outcomes on risky investments in the past Engage in herding behavior Combat this by having FMPs quantify the risk-reducing and return enhancing advantages of diversification and proper asset allocation; understand LOSSES HAPPEN

Endowment Bias what is it and cons and how to combat

Emotional bias in which people value an asset more when they hold the rights to it Cons Fail to sell off certain assets and replace them with other assets maintain an inappropriate asset allocation continue to hold classes of assets with which they are familiar Effective way to combat the desire for familiarity is to start with a small purchase of an unfamiliar investment until a comfort level with them is achieved

Hedging for equities vs. fixed income

Equities have less of a need to be hedged, relatively speaking (due to their correlation with growth) Fixed income have more of a need to be hedged, due to their correlation with interest rates

How are equities used in liability portfolios for pensions?

Equities should be used to hedge the future real wage growth exposure for active employees until retirement. Real wage growth is linked with economic growth through labor's share of productivity increases, and there is a stable long term relationship between Real GDP growth and the stock market

Macaulay Duration

Estimate of a bond's interest rate sensitivity based on the time, in years, until promised cash flows will arrive. Not useful measure for bonds with embedded options.

Execution Cost

Execution cost is calculated as the difference between the cost of the real portfolio and the paper portfolio. It reflects the execution price(s) paid for the number of shares in the order that were actually filled or executed. PRICE OF THE SECURITY WHEN THE PORTFOLIO MANAGER MADE THE DECISION TO PURCHASE = DECISION PRICE

Hedge Fund Expected NAV Formula

Expected NAV = [Prior-year NAV × (1 + Growth rate) + Capital contributions - Distributions)] × (1 + Growth rate).

Hedge Fund Expected Distributions Formula

Expected distribution = [Prior-year NAV × (1 + Growth rate)] × (Distribution rate).

Future accumulated value with multiple tax distributions (Capital gains, interest, and dividends) Final Formula

FVIFTaxable = £1,000,000[((1 + r*)^n)(1 - T *) + T*] IF COST BASIS FVIFTaxable = £1,000,000[((1 + r*)^n)(1 - T*) + T* - ((1-B)*Tcg) MAKE SURE TO USE CG TAX FOR THE COST BASIS, NOT THE BLENDED

after tax wealth accumulation for deferred capital gains formula

FVIFcg = (1 + r)^n * (1 - tcg) + tcg

after tax wealth accumulation for deferred capital gains formula (with cost basis)

FVIFcg = (1 + r)n(1 - tcg) + tcg - (1 - B)tcg

Future Value (Capital Gains) Formula

FVcg = €400,000[(1 + r)n(1 - tcg) + tcg]

Performance presentation must be:

Fair Accurate Complete (CAN NOT GUARANTEE PERFORMANCE)

Relative value models (2)

Fed Model - Equity market undervalues if S&P 500 earnings yield > 10-Year treasury note yield (ignores equity risk premium and earnings growth) Yardeni Model - Equity markets undervalued if model's justified earnings yield < market's earnings yield

Assume (A/B) If currency B is a HIGH yield currency, then B is trading at a _____________________

Forward DISCOUNT. (Ra < Rb) ; (F A/B) < S (A/B) F(A/B) = S(A/B) * [(1+Rai) / (1 +Rbi)]

Assume (A/B) If currency B is a LOW yield currency, then B is trading at a _____________________

Forward PREMIUM. (Ra > Rb) ; (F A/B) > S (A/B) F(A/B) = S(A/B) * [(1+Rai) / (1 +Rbi)]

Investor Life Cycle (4 stages of life)

Foundation: wealth accumulation through jobs. LT horizon allows risk Accumulation: earnings/success rise. Assets accumulated Maintenance: nearing retirement. Preservation of wealth Distribution: assets exceed reasonable level of need

Cognitive Bias Information Processing "FAMA"

Framing Availability Bias Mental Accounting Anchoring and Adjustment

Conflicts of interest - Full Disclosure

Full disclosure of all matters that could reasonably be expected to impair independence / objectivity To both clients and employers

Active Share

Given the relatively small number of stocks (less than 60) held in the previous manager's portfolio and lack of diversification, the former manager exhibited characteristics of a concentrated stock picker. A concentrated portfolio tends to have high Active Share, typically above 0.90.

People with higher risk and potential volatility in income (human capital) should take on _________________risk in their investment portfolios.

HIGHER INCOME VOLATILITY = LOWER INVESTMENT RISK IN THEIR PORTFOLIOS

Canada Model

High AI exposure, insourcing, active management

Endowment Model

High AI exposure, outsourcing, active management

How to use risk reversals when hedging for a : 1. Long position 2. Short Position

Holders of a long position short a risk reversal by writing a call option and purchasing a put option. Holders of a short position go long a risk reversal by purchasing a call option and writing a put option.

Adequacy of Life Insurance

Human life value method - Estimates the PV of earnings that must be replaced Needs analysis method - Estimates financial needs of dependents

Steps for creating a quantitative strategy (4)

INVESTMENT THEORY The first step in creating a quantitative, active strategy is to define the market opportunity or investment thesis. ACQUIRE DATA Then, relevant data is acquired, processed, and transformed into a usable format. BACKTEST This step is followed by back-testing the strategy, which involves identifying the factors to include as well as their weights. TEST OUT OF SAMPLE Finally, the strategy performance should be evaluated using an out-of-sample back-test.

Defining the manager universe typically begins be:

Identifying the relevant benchmark that represents the manager's role in the portfolio. Typically, a search starts with a benchmark that represents the manager's role within the portfolio. The next step is to identify managers associated with that benchmark.

Describe a Price-Weighted Index

In a price-weighted index, the weight of each stock is its price per share divided by the sum of all the share prices in the index. As a result, a price-weighted index can be interpreted as a portfolio composed of one share of each constituent security.

How to avoid potential issues with the probate process: (4)

In some instances, probate can be avoided or its impact limited by holding assets in 1. joint ownership (e.g., joint tenancy with right of survivorship), 2. living trusts, 3. retirement plans, or 4. life insurance strategies. Through these structures, ownership transfers without the need for a will, and hence the probate process can be avoided.

For a profession with specific skills, the best definition of disability from the insured's perspective is:

Inability to perform the important duties of one's REGULAR OCCUPATION For disability, the lower the threshold for meeting the definition of disabled, the better the policy, but the more expensive it will be

Grinold-Kroner Subcomponents Income Return Nominal Earnings Growth Return Repricing Return

Income Return = D/P - ΔS Nominal Earnings Growth Return = i + g Repricing Return = ΔPE

Bank main factors effected: Common Stock Investments

Increases Asset STD, typically decreases correlation

Bank main factors effected: Catastrophic insurances risks

Increases Liability STD

Bank main factors effected: Maintaining reasonable balance between asset and liability durations, key rates durations, and sensitivity to embedded borrower and claimant options

Increases correlation

Bank main factors effected: Prepayment penalties on debt investments

Increases correlation

Bank main factors effected: Variable annuities

Increases correlation, and Asset STD / Liability STD decrease in relevance

Bank main factors effected: Switching from variable to fixed rate assets

Increases the duration of the bank's overall portfolio

Indemnity plans

Indemnity plans allow you to direct your own health care and visit almost any doctor or hospital you like. Insured must pay a specified percentage of "reasonable and customary" fees Indemnity plans are also referred to as "fee-for-service" plans.

Tax Optimized Strategies (2)

Index-tracking separately managed portfolio: designed to outperform benchmark on a tax adjusted perspective Completeness portfolio: Tracks index given concentrated portfolio characteristics and new investments

A traditional risk tolerance questionnaire is most likely to be effective as a diagnostic tool for:

Individuals who exhibit primarily cognitive rather than emotional biases. Although risk tolerance questionnaires may fail for emotionally biased individuals and work best for institutional investors, they are generally effective for cognitive-based individuals.

Which client is more likely to deviate from a mean variance optimized portfolio; emotional or cognitive biased based clients?

Individuals with cognitive based biases will be more likely to have a mean variance optimized portfolio, since these biases can be moderated. Emotional biases are typically accepted or incorporated into the asset allocation process, making it more likely that they will have portfolios that are not mean efficient.

Market Manipulation can be done in one of (2) factors

Information based Transaction based Needs to have the intent to mislead market participants Anything that distorts prices or volume

Framing Bias what is it and cons and how to combat

Information processing bias in which a person answers a question differently based on the way in which it is asked Cons Misidentify risk tolerances because of how questions about risk tolerance were framed Choose suboptimal investments Focus on short-term price fluctuations Combatted by asking "Is the decision the result of focusing on a net gain or net loss position"

Anchoring and Adjustment Bias what is it and cons and how to combat

Information processing bias in which the use of a psychological heuristic influences the way people estimate probabilities Cons: FMPs may stick too closely to their original estimates when new information is learned Do not rely on past prices or market levels to influence decisions. Observe changes in company fundamentals. Concentrate only on the future potential of the company to influence buy/sell decisions.

Business Cycle impact on yield curve: Initial recovery Early upswing Late upswing Slowdown Contraction

Initial recovery - steep Early upswing - Front steep, back flattening Late upswing - Flattening from long inwards Slowdown - Flat to inverted Contraction - Steepening

Explain how strong investment governance can contribute to the decision to have an allocation to alternative asset classes

Institutional investors usually operate under a formal governance framework. A well-structured governance framework includes an Investment Committee that is part of the board overseeing the endowment's investment portfolio. This framework also includes an Investment Office that implements the investment policy approved by the Investment Committee. The decision to invest in private real estate had to go through an approval process that is set and maintained by the governance structure in place.

Benefits of Integrated asset-liability portfolios vs. (surplus optimization and hedging / return seeking portfolios)

Integrated asset-liability portfolios do not require linear correlation assumption, can handle multiple time periods, capable of modeling transaction costs, turnover constraints, and other real-world constraints.

Effective Interest Rate when selling interest rate futures to lock in a bridge loan

Interest loan - [ (Hedge unwind amount - Hedge original) ]

Market conditions to consider when trading

Intraday trading volumes bid-ask spreads security and market volatility

What is more tax efficient? A tax-deferred account or a tax-exempt account?

It depends. Tax deferred are tax deductable and tax exempt are not. If current taxes are the same as future taxes, then there is no difference (401k). If current taxes are expected to be higher than future taxes, than a Tax-Deferred (roth IRA) account is better.

Is it appropriate to use the expected return of the assets used to fund their spending needs when calculating the capitalized value core capital spending needs? Why or why not?

It is not appropriate to use the expected return of the assets used to fund spending needs to calculate the capitalized value of their core capital needs, because the risk of the Pearsalls' spending needs is unrelated to the risk of the investment portfolio used to fund those needs. A RISK FREE RATE SHOULD BE USED ; uncertainty is unrelated to market risk factors that would be priced in a normal asset pricing model, making their beta equal to zero.

What is an indifference curve?

It's a curve that plots the desired expected return relative to risk. For risk neutral it's a straight line as these investors want the same return for any level of risk. For risk averse investors, it's concave as the higher the risk, the higher the return they desire (exponentially). For risk seeker investors, it's convex because the higher the risk, the lower the expected return they desire as they love risk.

Preferred Provider Organization (PPO)

Large network of physicians and other medical service providers that charge lower prices to individuals within the plan than to individuals who obtain care on their own.

Supervisors must make reasonable effort to detract or prevent violations of:

Laws, rules / regulations, code and standard Extends to anyone subject to supervision, whether they are a member candidate or not Delegation is no relief

Synthetic Long Forward Synthetic Short Forward

Long Call + Short Put Short Call + Long Put

Long Condor vs. Short Condor

Long condor - Seeks to profit from low volatility Short condor - seeks to profit from high volatility

Long butterfly spread options

Long the wings Double short the body

Long-term care insurance

Long-term care insurance is designed to cover a portion of the cost of home care, assisted living facilities, and/or nursing home expense.

CME: Limitations with ex post risk being used to measure ex ante risk

Looking backward, we are likely to overestimate returns and underestimate volatility

Emotional Biases "LOOSER"

Loss Aversion Overconfidence Self control bias Self attribution bias Endowment Bias Regret Aversion

Risk Management Techniques

Loss Characteristics - High/low severity High Frequency - Risk avoidance/risk reduction Low Frequency - Risk transfer/risk retention

When comparing two portfolios, the portfolio with the LOWER coupon will have _______________________ cash flow reinvestment risk

Lower cash flow = LOWER cash flow reinvestment risk

Duties to clients (3)

Loyalty, Prudence, and Care Always client > employer > yourself

Explicit Objective Function Formula

MAX( 1/3size + 1/3Value + 1/3 Momentum)

For immunization of bond portfolios WITHOUT options, use the ________duration

Macaulay Duration

Macaulay Duration is a measure of _______________ ModDur and EffDur are _______________

Macaulay Duration is a measure of TIME (think when someone says they want to "shorten") ModDur and EffDur are SENSITIVITIES

Conservatism Bias what is it and cons and how to combat

Maintain prior forecast, fail to incorporate new information Bayesian terms "Tend to overweight the base rates and underweight the new information" Cons: Opt to maintain prior belief Slow to update their views when new information comes When new information comes, ask "How has this new information change my forecast?"

Marital Estate Total Estate Forced Heirship

Marital Estate - Any assets that have been gathered during the marriage period (does not include inheritance received during the marriage) (Surviving partner gets 50% of Marital estate) Total Estate - Inheritances + Marital estate Forced Heirship - Children have a right to part of a parents total estate (1/3rd of the TOTAL estate)

difference between market neutral and short extension

Market neutral = equal betas and positions sizes in long and short positions for zero beta and NO systematic risk exposure Short extension = typically beta around 1.0, but manager can adjust higher or lower.

Market-adjusted cost (bps)

Market-adjusted cost (bps)= Arrival cost (bps)−β×Index cost (bps)

Insurable Interest

Means that the policy owner must derive some type of benefit from the continued survival of the insured that would be negatively affected should the insured pass away

Diffusion index

Measures how many economic indicators are pointing up and how many are pointing down

Present value of distribution of cash flows methodology

Method for fixed income managers to reduce tracking error Attempts to approximate and match the yield curve risk of an index over discrete time periods referred to as cash flow vertices. By doing so, better aligns the contribution of portfolio duration that comes from each market, sector, and issuer type based on credit quality.

Positive butterfly twist

Mid rates go down Bullet outperforms barbell

Negative butterfly twist

Mid rates go up Barbell outperforms bullet

Return Objective (IPS)

Might be: - req. rate of return - may be difference in required and desired components.... - Another way to distinguish for PM's is between income and growth.