Chap 15 - Macro and Managed Futures Funds

Question 1

What is counterparty risk ?

Answer 1

Counterparty risk is the
uncertainty associated with the economic outcomes of one party to a contract due to
potential failure of the other side of the contract to fulfill its obligations, presumably
due to insolvency or illiquidity.

Question 2

What is discretionary fund trading ?

Answer 2

Discretionary fund trading occurs when the decisions of the investment process are made according to the judgment of human traders. The trader may rely on computers for calculations and other data analysis, but in discretionary trading, the trader
must do more than simply mechanically implement the instructions of a computer
program.

Question 3

What is Systematic fund trading ?

Answer 3

Systematic fund trading, often referred to as black-box model trading because the details are hidden in complex software, occurs when the ongoing trading decisions of the investment process are automatically generated by computer programs. Although
these computer programs are designed with human judgment, the ongoing application of the program does not involve substantial human judgment.

Question 4

What is Thematic investing ?

Answer 4

Thematic investing is a trading strategy that is not based on a particular instrument or market; rather, it is based on secular and long-term changes in some fundamental
economic variables or relationships—for example, trends in population, the need for alternative sources of energy, or changes in a particular region of the world economy.

Question 5

What is market risk ?

Answer 5

Market risk refers to exposure to directional moves in general market price levels.

Question 6

Macro funds typically do not focus on equity markets, as equities can be highly influenced by microeconomic factors, such as company-specific events. However, macro funds can take substantial and concentrated risks in currency, commodity, and
sovereign debt markets, especially when it is believed that changes in governmental policies will lead to large moves in the underlying markets.

Answer 6

True.
Example of China’s economy and society expansion needing a lot of ressources (commodities) to build the cities so a hedge fund manager with a macro strategy can place his trades based on information like this.

Question 7

What is event risk ?

Answer 7

Event risk refers to sudden and unexpected changes in market conditions resulting from a specific event (e.g., Lehman Brothers bankruptcy). Macro funds attempt
to benefit from particular events.

Question 8

What is leverage ?

Answer 8

Leverage refers to the use of financing to acquire and maintain market positions larger than the assets under management (AUM) of the fund. Leverage is typically established through borrowing or derivatives positions and poses risks. Funds with
leverage may be forced to deploy additional capital if they experience losses, and if they are unable to do so, they may be forced to liquidate positions at the least opportune time.

Question 9

What does it mean managed futures ?

Answer 9

The term managed futures refers to the active trading of futures and forward contracts on physical commodities, financial assets, and exchange rates.

Question 10

However, cash positions can have numerous disadvantages, such as storage costs, financing costs, higher transaction costs, inconvenience, and restrictions on short selling. Market participants with short-term trading horizons often prefer futures
and forward contracts. Futures and forward contracts usually offer lower transaction costs, higher liquidity, more observable pricing, and more flexibility to short sell.

Answer 10

Some advantages of futures contracts.

Question 11

A managed account (or separately managed account) is created when money is placed directly with a CTA in an individual account rather than being pooled with other investors. When large enough to be cost-effective, managed accounts offer
numerous advantages over pooled arrangements. These separate accounts have the advantage of representing narrowly defined and specific investment objectives tailored to the investor’s preferences.

Question 12

What is systematic trading ?

Answer 12

Systematic trading is usually quantitative in nature and often referred to as computerbased, model-based, or black-box trading. Systematic trading in this context refers
to the automation of the investment process, not to systematic risk. Systematic trading models apply a fixed set of trading rules in determining when to enter and exit
positions. Deviation from the system’s rules is generally not permitted.

Question 13

What is slippage ?

Answer 13

Slippage is the unfavorable difference between assumed entry and exit prices
and the entry and exit prices experienced in practice. Thus, an analyst observing a long history of daily closing prices should assume that an actual trading strategy is likely to generate less favorable price executions due to the tendency of buy orders to push prices up, or be executed at an offer price, and of sell orders to push prices down, or be executed at a bid price.

Question 14

what are three useful questions to ask when evaluating an individual trading
strategy ?

Answer 14

1. What is the trading system, and how was it developed?
2. Why and when does the trading system work, and why and when might it not work?
3. How is the trading system implemented?

Question 15

The key to systematic trading systems is to differentiate spurious results from
results that will persist. In other words, at what point should a trading system be abandoned or modified if the system worked very well in
the past but has generated poor results recently?

Answer 15

True

Question 16

What is the validation of a trading rule ?

Answer 16

Validation of a trading rule refers
to the use of new data or new methodologies to test a trading rule developed on
another set of data or with another methodology. For example, a trading rule developed analyzing data during five calendar years should be tested first in subperiods
of those five years to see if the results are robust across data sets and sub-intervals.

Question 17

What is robustness ?

Answer 17

Robustness refers to the reliability with which a model or system developed for a
particular application or with a particular data set can be successfully extended into
other applications or data sets.

Question 18

What is out-of-sample data ?

Answer 18

Out-of-sample data are observations that were not directly used to develop a trading rule or even indirectly used as a basis for knowledge in the research. For example, the trading rule should be validated on the most recent data, which, of course, should not have been used explicitly or implicitly in the model’s development

Question 19

What is in-sample data ?

Answer 19

In-sample data are those observations directly used
in the backtesting process.

Question 20

Out-of-sample data should be used to test the profitability of a
trading strategy beyond the period covered by the backtest. The goal is to avoid data
dredging and to ensure that a trading rule generates persistent performance.
Further, it is vital to know how many trading rules were tested, how many were
subjected to validation, and how many were rejected in the validation process.

Answer 20

True

Question 21

What are the 3 groups for systematic trading ?

Answer 21

Systematic trading strategies are generally categorized into three groups: trendfollowing, non-trend-following, and relative va

Question 22

What is Whipsawing ?

Answer 22

Whipsawing is when a trader alternates between establishing long positions immediately before price declines and establishing short positions immediately
before price increases and, in so doing, experiences a sequence of losses. In trendfollowing strategies, whipsawing results from a sideways market.

Question 23

The primary challenge of implementing a moving average strategy is forecasting when markets are likely to trend, meaning the strategy should be applied,
and forecasting when markets are likely to be random or to mean-revert, meaning the strategy should not be applied. Thus, implementation of moving average
strategies focuses on developing methods of determining when to apply the strategy in addition to specifying which particular moving average strategy to apply.
There has been considerable academic debate over the viability of trend-following
strategies.

Question 24

What is a Breakout strategies ?

Answer 24

Breakout strategies focus on identifying the commencement of a new trend by observing the range of recent market prices (e.g., looking back at the range of prices over a
specific time period).

Question 25

What is a Countertrend strategies ?

Answer 25

Countertrend strategies use various
statistical measures, such as price oscillation or a relative strength index, to identify range-trading opportunities rather than price-trending opportunities.

Question 26

What is the relative strength index (RSI) ?

Answer 26

The relative strength index (RSI), sometimes called the relative strength indicator, is a signal
that examines average up and down price changes and is designed to identify trading
signals such as the price level at which a trend reverses

Question 27

Relative value strategies attempt to capture inefficient short-term price divergences between two empirically or theoretically correlated prices or rates. Technical strategies commonly applied to prices and rates can also be applied to spreads or ratios
between prices and rates in relative value strategies.

Answer 27

In managed futures, relative value strategies focus on short time frames (e.g., measured in seconds to days) or long time frames (e.g., measured in months). Relative value strategies analyze the correlation structure between two or more futures
contracts and attempt to exploit deviations in prices as individual futures contracts respond differently to new information or to liquidity imbalances.

Question 28

What are the 4 core decisions that compose the typical futures trading system ?

Answer 28

The typical futures trading system is composed of the following four core decisions:
1. Entry: When to enter a position
2. Position sizing: How large a position to take on
3. Exit: When to get out of a position
4. Market allocation: How much risk or capital to allocate to different sectors and markets

Question 29

What are the 4 components that are integrated into portfolio construction ?

Answer 29

There are several components that are integrated into portfolio construction: (1) data processing, (2) position sizing, (3) market allocation, and (4) trading execution.

Question 30

Position sizing must take into account the volatility of a particular
market. One approach to this is volatility targeting, where the size of the position is determined by the trader’s conviction in the signal, the volatility of the particular
futures market, and a volatility target that is determined by the trader.

Question 31

Notice that risk loading is multiplied by the amount of equity in the portfolio. The risk loading times the equity or capital is sometimes termed the capital at risk. For example, if $1 million is the available equity or capital, and the risk loading is 0.02, then $20,000 is the capital at risk.

Question 32

What is the point value ?

Answer 32

The point value is the gain or loss in the contract from a one-point change (e.g., $1) in the futures prices.

Question 33

What is Equal dollar risk allocation ?

Answer 33

Equal dollar risk allocation is a strategy that allocates the same amount of dollar risk to each market. This approach does not consider the correlation between markets and is similar to the 1/N approach.

Question 34

What is equal risk contribution ?

Answer 34

Equal risk contribution is a strategy that allocates risk based on the risk contribution of each market, taking correlation into account. This approach is similar
to risk parity.

Question 35

What is market capacity weighting ?

Answer 35

Market capacity weighting is an approach in which capital is allocated as a function of individual market capacity. In futures markets, a market capacity weighting will depend on the market size, as measured by both daily volume and price volatility.

Question 36

What is alpha decay ?

Answer 36

Alpha decay is the speed with which performance degrades as execution is delayed. In the long-term perspective, alpha decay is much less important
for trend following than it is for many shorter-term futures strategies. As a result, the more important consideration related to execution for trend-following systems is cost rather than execution speed.

Question 37

Access to multiple markets :
The fundamental law of active management states that the information ratio of an investment increases as the breadth of the investment strategy increases
(holding other variables constant). This means that CTAs have the potential to
provide performance with a superior risk-return profile.

Question 38

Explain why Futures contracts give very low foreign exchange risk

Answer 38

A futures contract has no net liquidating value. This means a futures position in a foreign-currency-denominated asset is similar to a cash position in the same asset with investment financed through
borrowing in the same foreign currency. As a result, currency fluctuations will have equal effects on assets and liabilities of the investors, with zero net effect. For instance,
from a Japanese investor’s viewpoint, a position in Euro Stoxx futures makes or loses money only when the index rises or falls. A change in the yen price of the euro would, by itself, produce neither a gain nor a loss, because the investor has no cash position in euros.

Question 39

During periods of increased uncertainty in global markets, currency volatility may contribute as much to the risk of a fully funded position as does the volatility of the underlying asset.

Answer 39

True

Question 40

What is model risk ?

Answer 40

Model risk is economic dispersion caused by the failure of models to perform as intended.

Question 41

What is transparency ?

Answer 41

Transparency is the
ability to understand the detail within an investment strategy or portfolio.

Question 42

What is transparency risk ?

Answer 42

Transparency risk is the dispersion in economic outcomes caused by the lack of detailed information regarding an investment portfolio or strategy.

Question 43

What is capacity risk ?

Answer 43

Capacity risk arises when a managed futures trader concentrates trades in a market that lacks sufficient depth (i.e., liquidity).

Question 44

What is a managed account ?

Answer 44

A managed account is a brokerage account held by a brokerage firm that is also registered as a futures commission merchant, in which investment discretion has been
assigned to the managed futures fund manager.

The investor is responsible for opening and maintaining the account, reconciling brokerage statements, and maintaining cash controls, as well as negotiating contracts with managers, including investment management agreements and powers of attorney.

Question 45

What are some advantages of a managed account ?

Answer 45

The money is within the investor’s
control, not the fund manager’s, at all times. The accounts offer complete transparency. The investor can see the positions, trades, and details at any time. Managed accounts, then, virtually eliminate the risk of fraud, as the transparency and security of these accounts prevent the manager from misstating leverage, manipulating
returns, or stealing the investor’s assets. The investor controls the terms of the power of attorney,
including the right to revoke trading privileges.

Question 46

Do managed accounts have limited liability ?

Answer 46

Managed accounts, however, do not automatically have a limited liability
structure. Especially in futures markets, where the required margin is much smaller than the notional value of contracts, investor losses in high margin-to-equity investments can be larger than the amount of contributed capital. Therefore, managed
accounts must be carefully designed with a legal structure that ensures that limited liability is obtained.

Question 47

What does a investor do to protect himself from the lack of limited liability ?

Answer 47

In most cases, the investor uses the SPV to open an account at a brokerage firm where the managed futures funds manager has trading authority. The investor gives the manager the authority to trade in the account.

Question 48

What are some of the functions a Managed futures managers can fulfill ?

Answer 48

Managed futures managers may fulfill the following functions: (1) they allow other participants to hedge a position and therefore reduce their risks, (2) they provide liquidity so that other participants satisfy their need for liquidity, and (3) they take offsetting positions for rebalancing and other demands from other market
participants.

Question 49

Key observations on the returns to systematic diversified funds that are consistent
with economic reasoning are an essential component of knowledge and include the
following:

1. The historic return distribution of systematic diversified funds resembled that
   of a normal distribution, with no indication of a pronounced skew or fat tails
   (excess kurtosis).
2. Volatility of returns was moderately low relative to world equities.
3. Returns exhibited little or no autocorrelation.
4. Maximum drawdown was much better than observed for global equities.

Question 50

Key observations on the returns to macro funds that are consistent with economic reasoning are an essential component of knowledge and include the following:

1. The historic return distribution of Macro (Total) resembled that of a normal distribution, with no indication of a pronounced skew or fat tails (excess kurtosis).
2. Volatility of returns was low relative to world equities.
3. Returns exhibited little or no autocorrelation.
4. Maximum drawdown was much better than observed for global equities.