class 3: Investment process and the IPS

Question 1

asset allocation

Answer 1

the process used to determine what proportion of money we should put in each asset class

Question 2

asset class

Answer 2

group of securities that exhibit similar characteristics

behave similarly in market place

subject to same laws

investable

Question 3

steps to do asset allocation

Answer 3

1. determine strategic asset allocation
2. choose benchmark
3. rebalance portfolio
4. tactical asset allocation (optional)

Question 4

the difference between strategic asset allocation and tactical asset allocation

Answer 4

strategic asset allocation is long term

tactical asset allocation is temporary

–> when we spot exceptional opportunities in the market

Question 5

determining the asset allocation (steps)

Answer 5

1. client’s investment objectives and constraints

2. capital expectations (like assignment #1)

Question 6

IPS (investment policy statement) (components)

Answer 6

1. objectives

2. constraints

Question 7

IPS objectives

Answer 7

Risk

–> willingness to assume risk

–> ability to assume risk

Return

–> difficult to articulate (never give a certain amount)

Question 8

VaR (value at risk)

Answer 8

an estimate of the minimum loss with a given probability over a specified period

–> expressed as a $ amount or a % of portfolio value

Question 9

VaR components

Answer 9

1. amount of loss
2. probability
3. period of time

Question 10

IPS constraints

Answer 10

1. time horizon
2. taxes
3. liquidity
4. legal and regulation
5. unique circumstances

Question 11

investment horizon (time horizon) constraint

Answer 11

the planned liquidation date

affects portfolio risk and security maturity dates

Question 12

taxes constraint

Answer 12

income tax

tax on interest

tax on dividends

capital gains tax

estate tax (not in canada)

gift tax (not in canada)

wealth tax (not in canada)

Question 13

liquidity constraint

Answer 13

speed and easy with which an asset can be converted into cash

need for cash in short notice increases liquidity requirement

Question 14

liquidity

Answer 14

how easy we can convert asset into cash without needing to drastically reduce price

Question 15

legal and regulations constraints

Answer 15

specific regulations that may apply to institutional investors

prudent investor rule

Question 16

prudent investor rule

Answer 16

the fiduciary responsibility of a professional investor

a legal principle that is used to restrict the choices of the financial manager of an account to the types of investments that a person seeking reasonable income and preservation of capital might buy for his or her own portfolio

Question 17

unique needs constant

Answer 17

special considerations related to the underlying investors

Question 18

capital market expectations sub categories

Answer 18

expected return

risk

correlation

Question 19

how do we forecast the fixed income market?

Answer 19

we look at interest rates

Question 20

theory of the term structure

Answer 20

1. liquidity preference theory
2. the expectations theory
3. market segmentation theory

Question 21

liquidity preference theory

Answer 21

yield curve should be upper sloping

a model that suggests that an investor should demand a higher interest rate or premium on securities with long-term maturities that carry greater risk because, all other factors being equal, investors prefer cash or other highly liquid holdings

Liquidity Preference Theory refers to money demand as measured through liquidity

Question 22

the expectations theory

Answer 22

attempts to predict what short-term interest rates will be in the future based on current long-term interest rates

The theory suggests that an investor earns the same interest by investing in two consecutive one-year bond investments versus investing in one two-year bond today

Question 23

market segmentation theory

Answer 23

long and short-term interest rates are not related to each other

the prevailing interest rates for short, intermediate, and long-term bonds should be viewed separately like items in different markets for debt securities

Question 24

what drives the stock market?

Answer 24

the GDP

all capital markets driven by miacroeconomic factors

Question 25

what drives the GDP?

Answer 25

intérêts rates / inflation fiscal and monetary policy unemployment retail sailes consumer confidence durable sales $US Inventory transportation and warehousing budget deficit etc.

Question 26

fundamental analysis (top down approach) --> why is this recommended?

Answer 26

1. macroeconomic analysis 2. industry analysis 3. company analysis

Question 27

choosing our benchmark (second step of asset allocation)

Answer 27

we need it to compare to see if we did well or nah we need it to achieve client's long term objectives we need it to see if its consistent with risk tolerance

Question 28

what is a good benchmark

Answer 28

specified in advance appropriate measurable unambiguous reflective of current situations accountable investable SAMURAI

Question 29

rebalancing our portfolio (third step of asset allocation)

Answer 29

should be rebalanced to periodically maintain Asset Allocation Drift

Question 30

drift in rebalancing the portfolio

Answer 30

appreciation or decline in values (will influence our AA allocation) interest income (we gotta put it somewhere and it will change the AA) dividend income (we gotta put it somewhere and it will change the AA) Macroeconomic factors client

Question 31

the different types of clients

Answer 31

1. individuals 2. life insurance 3. casualty insurance 4. banks 5. pension funds 6. endowments/foundations

Question 32

life insurance

Answer 32

term insurance whole life think long term

Question 33

casualty insurance (non life)

Answer 33

short term profit seeking and are willing to get more risk

Question 34

how long do we keep bank deposits for?

Answer 34

not longer than a few weeks they think medium term heavily regulate work on spreads

Question 35

two types of pension funds

Answer 35

defined benefit plan defined contribution plan

Question 36

defined benefit plan vs defined contribution plan

Answer 36

defined benefit plan is the best choice for us --> pension is guaranteed even if the investments are terrible defined contribution plan --> if they fuck up, we won't get our pension

Question 37

do pension funds pay taxes? when could they pay taxes?

Answer 37

nooo they are tax free only pay taxes if they have 40% of their assets outside Canada

Question 38

ar pension funds heavily regulated?

Answer 38

yeee

Question 39

AA approaches

Answer 39

1. asset only 2. liability driven investments (LDI) 3. goal-based

Question 40

asset only AA approach

Answer 40

fixed income equity alternatives maximize assets to be able to meet PBO

Question 41

liability driven investments (LDI)

Answer 41

PBO have enough $ to meet future liabilities

Question 42

endowments/foundations

Answer 42

non taxable unless they fail they pay out around 5% of their money to different projects