BIG REVIEW

Question 1

Taylor Rule

Answer 1

r = policy neutral rate + 0.5(exp - trend GDP growth) + 0.5(exp - acceptable inflation)

Question 2

H-Model

Answer 2

for emerging economies

Question 3

Fed Model

Answer 3

• EY > treasury yield, ratio > 1 - undervalued
• EY < treasury yield, ratio < 1 - overvalued

CONS: ignores ERP, ignores earnings growth, compares real variable (EY) to nominal value (treasury yield)

Question 4

Yardeni Model

Answer 4

compares theoretical EY to acutal EY

• EY > fair value yield - undervalued
• EY < fair value yield - overvalued

CONS: assumed r, d varies over time, earnings estimates can be wrong

Question 5

Q Models

Answer 5

MV/ replacement cost

q > 1 - overvalued

q < 1 - undervalued

Question 6

CAPE

Answer 6

cyclically adjusted P/E ratio

CAPE > historical avg - overvalued

CAPE < historical avg - undervalued

10 yr avg earnings captures effects of business cycle and inflation

Question 7

Credit Risk

Answer 7

risk counterparty will default; based on changes in spread

• %Δ value = - D (Δs)
• currency swap CR highest closet to maturity
• int rate or eqty swap CR highest in middle of life

Question 8

HHI

Answer 8

HHI = Σ market share²

effective # stocks = 1/ HHI

Question 9

Mean Variance Optimization

Answer 9

optimizer to set AA, min tracking error, max returns; identify corner portfolios

+: considers correlations

-: doesn’t consider BM variance (need to factor into constraints); based on hist values

Question 10

M²

Answer 10

r_f + σ_mkt * SR

Question 11

Myopic Loss Aversion

Answer 11

overemphasizing ST potential losses, underemphasizing LT potential gains > risk premium too high

Question 12

Life Insurance

Answer 12

• bond like HK, insure against mortality risk
• not needed for equity like HK b/c higher risk HK

Question 13

Corner Portfolios

Answer 13

1. on efficient frontier
2. move weight from 0% to X% or X% to 0%
3. GMVP is starting port (doesn’t always follow 2)

Question 14

Hedging Foreign Markets

Answer 14

• hedge foreign market risk only: earn Rf_for + R_FX
• hedge FX risk only: earn Rf_dom - Rf_for

Question 15

Effective Beta

Answer 15

%Δ value of portfolio / %Δ value of index

Question 16

FV of Portfolio AT

Answer 16

Question 17

Expected Annual Return

Answer 17

D/P - Δs + i + g + ΔP/E

Question 18

Strategic AA

Answer 18

• portfolio’s general AA, under “normal” conditions
• based on capital market exp and inv obj/ constraints
• LT time horizon
• neg: GIGO

Question 19

Tactical AA

Answer 19

• exploit perceived capital market arbitrage opp
• based on ST cap market exp
• temporarily deviating from a portfolio’s LT SAA
• neg = volates linear reg assumptions

Question 20

Return on Leverage

Answer 20

R_lev + borrowed/ equity * (R_lev - R_bor)

Question 21

Return

Answer 21

1. coupon yield
2. %Δ price
3. manager exp → -DΔy + 1/2C(Δy)²
4. credit loss
5. curr g/l

Question 22

Immunization

Answer 22

• PVA = PVL
• min structural risk
• single liab = min convexity
• multiple liab = C_A > C_L

Question 23

Duration Gap

Answer 23

• gap = BPV_A - BPV_L
  
  • BPV = D * V * 0.0001
• # contracts = gap/ BPV
  • BPV_fut = BPV/ CF
  • BPV_swap = BPV_rec - BPVpaid

Question 24

Active Return

Answer 24

IC * √BR * σ_Ra * TC

IC = corr btwn factor and HPR

TC = degree of constraints

Question 25

Duration Matching

Answer 25

balance price and reinvestment risk * inc yield = ↓ price, ↑ reinv value * dec yield = ↑ price, ↓ reinv value

Question 26

Portfolio Construction

Answer 26

1. full replication = dec tracking error (need fewer sec) 2. optimization = dec tracking error, high turnover 3. stratified samping = dec turnover, high tracking error

Question 27

Active Share

Answer 27

diff btwn portfolio and benchmark; want higher active share b/c paying for active management 0.5 Σ |W_p - W_b|

Question 28

Active Risk

Answer 28

tracking error b/c factor exposure and idiosyncratic risk √ [( Σ R_A² )/ ( T - 1 )]

Question 29

Variance in Portfolio from Asset

Answer 29

* contribution of asset to portfolio var * Σ w_i w_j cov_ij * _​contribution of asset to portfolio var (considering index) * ( w_p - w_b ) cov

Question 30

β

Answer 30

systematic risk; value equity and FI sec ρ_i,m σ_i / σ_m

Question 31

Covariance | (Econ)

Answer 31

β₁ \* β₂ \* σ²

Question 32

ERP | (Econ)

Answer 32

σ_p \* SR_M \* corr + premiums

Question 33

Information Ratio

Answer 33

Active Return/ Active Risk

Question 34

Asset Class Characteristics

Answer 34

1. homogeneous 2. mutually exclusive 3. diversifying 4. contain most of the inv universe 5. liquid

Question 35

Monte Carlo Simulation

Answer 35

* multi-period - incorporate changes (rebalancing, distributions, taxes) * include path dependency * visualization of potential outcomes * doesn't follow normal distribution

Question 36

Convexity

Answer 36

* stable curve = sell convexity * long callable/ putable bonds * long MBS * short call/ put options

Question 37

Benchmark Characteristics

Answer 37

1. specified in advance 2. appropriate 3. measurable 4. unambiguous 5. relective of manager's style 6. accountable 7. investable