Chapter 17 Flashcards by Toby Hill

Two components of return

Income (dividends or coupons)

Capital gains

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What is the terminal value of of a dividend reinvested equation

Terminal value = dividend x (1+r)^n

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Excess returns can be broken into 4 sub components

Asset allocation effect l
Currency effect
Security selection affect
Interaction effect

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How can bond returns be decomposed

Credit quality, sector and maturity

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What is it called when changes in interest rates change the yield curve

Yield curve twists

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What is the income effect for bond returns

Return an investor would receive if th shield curve was unchanged

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What does interest rate effect measure for bonds

What happens if yield curve shifts

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That is the residual effect formula

Total return - YTM effect - I rate effect - sector/quality effect = residual

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What does a large residual effect mean for bond managers

Superior bond selection

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Excess returns for stocks driven by

Stock/sector selection

Market timing

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What does total excess return relative to benchmark equal

Total asset allocation effect + stock selection effect + total interaction effect

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Money weighted rat Eid return, what does it do and what is it

Takes into account cash inflows and cash outflows

IRR of a portfolio

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How do inflows affect the result of the money weighted rate of return

Give overstated return when fund does well

Understated return when fund does poorly ( negative return)

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Limitation of money weighted rate of return

Places greater emphasis on performance in periods where account size is higher

Hence being money weighted

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What does time weighted rate of return do

Gives equal weight to the returns achieved in each portion of the particular period of interest

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Why is time weighted rate of return preferred to money weighted rate of return

Bc money weighted rate of return inflates fund manager performance

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What is key when picking bench mark

Overall performance ace goals and tolerance for risk

Liquidity for investor and bench mark should be similar

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Criteria for constructing a benchmark

Specified in advance - so investor cannot pick an underperforming benchmark after period
Appropriate risk
Measurable
Transparent with names of underlying securities
Investable
Historical data
Low turnover of securities

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Broad market indices examples

S and p 500
MSCI world

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Limitation of broad benchmarks

Too broad for some managers

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Style for benchmarks

Some managers match benchmarks on style

Ie small cap or mid cap

These narrow benchmarks aren’t suitable for all managers

Absolutely benchmark

This is just a clear target return for manager to hit, no index for it

Why are benchmarks useful for absolute return investors (market neutral )

Provide element of risk control

Help to establish market neutral strategies

What are customised benchmark and why good

Made up of multiple investment indices and good for complex investor needs

Sharpe measure ratio

(Rp - Rf) / SDp (Return on portfolio - risk free rate) divided by standard deviation of portfolio

What’s a good sharpe

Higher sharp mean BETTER value for investor

Limitation of sharpe ratio

CANNOT INTERPRET NEGATIVE SHARP RATIOS

Treynor measure

(Rp-Rf) / Bp Bp is the is the capm beta of the portfolio

What value of treynor is better

Higher the value of treynor, the better the value Higher beta indicates higher systematic risk

Who might prefer the treynor measure

Preferred by investors with well diversified portfolios since the measure does not consider unsystematic risk

What is the information ratio

(Rp - Rb) / SDsurplus Rb is the benchmark return Standard deviation surplus is the standard deviation of Rp - Rb

What does negative info ratio mean

Manager has failed to beat index

Jensons alpha ratio what does it measure

Risk adjusted returns Benchmark can be constructed so risk inherited in benchmark is equal to risk in portfolio

What is jenson alpha interpretation

If manager beats benchmark with equal risk characteristics, the difference is due to managers skill, this is known as jensons alpha.

Jensons alpha equation

J = Rp - Rb Rb = Rf + B(Rm - Rf)

Measuring performance of bond portfolios

Portfolio return in excess rope risk less return divided by relative duration (Rp - Rf) / (Dp / Dm) Dm is duration of bond market

When is jenson alpha inappropriate

If fund manager takes on a lot of specific risk

Standard deviation of a well diversified benchmark portfolio

Beta of benchmark x SD market

Limitation of risk measure

Only account for average risk whereas actual risk may massively vary over time

Return of benchmark portfolio

Sum of (weights of asset class x return of benchmark asset classes)

Return from stock selection formula

Sum of (weights of asset class x actual return of asset class)

Implementing tactical asset allocation decision returns formula

Sum of ( weights of actual asset classes x benchmark returns for asset)

Actual portfolio retruns formula

Sum of ( actual weights x actual returns)

How is timing attribution worked out

Tactical asset allocation(changed weights compared to benchmark) returns - benchmark returns

How is selection attribution worked out

Stock selection (weights same as benchmark but retruns different) returns - benchmark returns

Interaction attribution formula

Benchmark returns - actual returns - asset allocation returns - stock selection returns

Total contribution formula

Actual returns minus benchmark returns

Tracking error

Measured as the standard deviation of the differences between an investment funds retruns and its benchmark returns over given period

Why may tracking error occur

Timing of income payments Taxation Dealing costs

What is standard deviation surplus equal to

Tracking error

Time weighted rate of return, how do you work it out

Work out return in each period Multiply all the returns together and then minus 1 (1+r) (1+r2) (1+r3) -1