Everything Flashcards
(179 cards)
1
Q
How do you measure a manager’s performance?
A
- Sharpe
- Treynor
- Information ratio
- Jensen’s alpha
2
Q
How do you calculate the Sharpe Ratio?
A
(Rp-Rf)/stddevp
3
Q
How do you find the Treynor ratio?
A
(Rp-Rf)/beta
4
Q
How do you calculate Jensen’s alpha?
A
(Ri-rf) - (RF + beta(rm-rf)) = alpha
Rp - (RF + beta(rm-rf)) = alpha
5
Q
What is the definition of asset management?
A
A (professional) asset manager makes the decisions regarding the client(s)’ portfolio according to the clients’ needs
Such an activity is rewarded by a fee (management fee)
6
Q
What other management styles are out there?
A
Collective management (through collective investment programs)
Separate accounts or Individual management under (discretionary) investment mandates
7
Q
How does collective management work?
A
Investors pool capital.
The company and their analysts made choices on how to run the portfolio.
The investors take a % of the returns, proportional to the % of their investment
8
Q
What are the main benefits for small investors who invest through collective management?
A
Record keeping and administration
Diversification and divisibility
Professional management
Lower transaction costs
9
Q
Explain “Record keeping and administration “ as a benefit of collective management?
A
They issue periodic status reports
Keeping track of capital gains distributions, dividends, investments and redemptions
Reinvestment of dividends and interest income for the shareholders
10
Q
Explain “Diversification and divisibility” as a benefit of collective management?
A
By pooling their money, investment companies allows investor to hold fractional shares of many securities.
They can act and diversify like a large shareholder even that they as individual investors cannot.
11
Q
Explain “Professional management” as a benefit of collective management?
A
Due to its scale, the investment company can hire full time security analysts and portfolio managers to make better investment decisions compared to individual investors.
12
Q
Explain “Lower transaction costs” as a benefit of collective management?
A
Because they trade large blocks of securities, they can achieve substantial savings on brokerage fees and commissions.
13
Q
What are the two retail clients of asset managers?
A
Households
High-Net-Worth Individual (HNWI)
14
Q
What does HNWI stand for?
A
High-Net-Worth Individual
15
Q
What are the institutional clients of asset managers?
A
Insurance companies
Pension Funds
Banks
Others: (foundations, charities, governments, central banks, etc.)
16
Q
What is a custodian in the fund industry?
A
An actor on the fund industry who is responsible for securing and managing the securities held within a mutual fund.
custodian also typically offers trade settlements, foreign exchange transactions, and tax services for its clients.
17
Q
Who holds the securities of a mutual fund and why?
A
the securities owned by the fund are held with the custodian and not directly with the fund itself. This is done to reduce the risk of fraud.
18
Q
What is a Distributor in the fund industry?
A
Mutual fund distributor is an individual or entity that helps investors to buy and sell mutual funds
19
Q
How do you calculate the NAV?
A
𝑁𝐴𝑉= (𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑒𝑠)/(𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔)
20
Q
What does NAV Stand for?
A
Net Asset Value, aka. the value of the share.
This is “comparable” to the share price of buying equity.
21
Q
How do we calculate the Rate of Return?
A
𝑅𝑎𝑡𝑒 𝑜𝑓 𝑅𝑒𝑡𝑢𝑟𝑛= (𝑁𝐴V1−𝑁𝐴𝑉0+𝐼𝑛𝑐𝑜𝑚𝑒 𝑎𝑛𝑑 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛𝑠)/𝑁𝐴𝑉0
22
Q
What are open end funds?
A
These funds are open to have new investors & open to have investors leave.
23
Q
What happens when a new investor joins an open fund? And when it leaves?
A
The fund issue new shares to new investors (that wants to enter the fund)
Investors can redeem (sell back their shares to the fund) their shares at NAV at any point in time
24
Q
Why do open funds have more cash on them than usual?
A
Meaning that they always have to have some cash on them incase people want to redeem their shares at the same moment
25
Explain open ended funds with cake analogy.
The portfolio is a cake.
And with new shareholders they need to make more cake with the newly gotten equity.
The shareholders are entitled to walk away with their pieces of the cake.
26
What are closed-end funds?
A fund that does an IPO to gather capital and then it does not redeem or issue shares.
27
What happens when a new investor joins an closed fund? And when it leaves?
investors in closed end funds must sell their shares to other investors to exit
shares of closed end funds usually traded on exchange by brokers
28
Explain a closed fund with the cake analogy
Either you were there to bake the cake, or you will have to pay someone to get their cake slice.
The closed funds have one cake and it never grows from external equity after the IPO (besides the returns of the investments).
If the management fees are bigger than the returns the cake becomes smaller.
The stocks listed are valued for 1 cake piece.
29
Why are closed end funds traded at a discount compared to their Net Asset Value?
They account for manager fees
30
Active management’s goal is to outperform benchmarks with a focus on:
Strategic asset allocation: making a portfolio w good assets & weights -> taking into account investor objective
Tactical asset allocation: timing the short term adjustments
Security selection: Find undervalued securities
31
What is an actively managed fund?
As the name implies the fund actively buys and sells on the market to make strategic allocations, attempting to exploit mispricing, with the desire to outperform the market returns.
32
What is an passively managed fund?
Focus on holding an efficient portfolio
No attempt of market timing or security selection
33
What are the different types of funds?
Mutual Funds
Commingled Funds
ETFs
Funds of Funds
Real Estate Investment Trusts (REITS)
Hedge Funds
Private Equity/Debt
34
What are mutual funds?
the common name for open-end investment companies
Accounting for roughly 87% of the investment company assets in the U.S.
A management company usually manage several funds.
35
What are the different investment policies mutual funds have?
Fixed income
Equity
Combined
Index funds
36
What are the sub sections of mutual funds focused on "Fixed income"?
Money market funds
Bond funds
37
What are the sub sections of mutual funds focused on "Equity"?
Equity funds
Sector funds
International funds
38
What are the sub sections of mutual funds focused on "Combined"?
Balanced funds
Asset allocation funds
39
What are money market funds?
They are a substitute to holding cash, but offers some “risk-free” return.
investments in short horizon fixed income investments with low risk exposure
40
Seeing money market funds want to be a substitute to cash the funds’ investments should therefore have low exposure to:
Credit risk
Market risk
Liquidity risk
41
Why invests on money market funds?
They are held by retail investors, Corporations and institutional investors.
42
Who are the biggest players of money market funds?
USA => 82.5% of the total market with 5 Billion
EU=> 9.2% of the total assets
43
What are the types of money market?
Government money funds
Prime money funds
Municipal money funds
44
Explain what a "Government money funds" is.
(W context of money markets)
Invests in short term government issued securities
-Cash
-Treasuries
-Repurchase agreements (usually from the central bank for 24-48 hours)
45
Explain what a "Prime money funds" is.
(W context of money markets)
Invests in short term non-government debt
-Commercial papers (CPs, unsecured short term corporate debt)
-Certificate of deposits (CDs, fixed period bank deposit)
-But also some government securities and cash to ensure liquidity in case of redemptions
46
Explain what a "Municipal money funds" is.
(W context of money markets)
Invest in short term papers issued by municipalities
47
What is the proportion of money market fund types?
82% are Government money funds
16% Prime money funds
2% Municipal money funds
48
What are bond funds? And what are the different specialization?
Bond funds invests in fixed income securities.
Issuer types
Maturities
Risk profile
49
What are the possible securities purchased by a bond fund focused on "Issuer types"?
Corporate bonds
Mortgage-backed securities
Government bonds
Municipal bonds
50
What are the possible securities purchased by a bond fund focused on "Maturities"?
Short (1-3 years)
Intermediate (3-10 years)
Long-term (>10 years)
51
What are the possible securities purchased by a bond fund focused on "Risk profile"?
Low risk funds (>BB+)
High-yield (Junk,
52
What are Equity funds?
Invests primarily in stocks.
but needs to keep some funds in liquid assets (money market securities) to provide liquidity to meet potential redemptions.
Usually around 4-5% of Assets under Management.
53
What are the different focuses of Equity funds?
Cash flows
--Current income funds
--Growth funds
Firm size
--Large/Mid/small cap
Geography
Sector
54
What are Income Equity funds?
Focuses more on current income instead of capital gains.
They invest in stable companies in firms with high dividend yield (annual dividend/price) supplying steady dividend streams.
investments of the fund would have cash flows in the near future (dividends)
55
What are Growth Equity funds?
Willing to forego current income for capital appreciation stemming from growth potential (cash flows in the future).
This leads growth funds to invest in younger, riskier firms in the earlier stages of their life-cycles.
56
What are Sector Funds?
mutual funds specialized in an industry
57
What are the different types of international funds?
Global, Regional, Emerging countries
58
What are the characteristics of a balanced fund?
Holds a mix of equity and bonds in stable proportions
They are designed to be an investor's entire portfolio
59
What are the two types of lifecycle funds?
Aggressive strategy (for young investors)
less risky for older investors
60
What is the difference between balanced funds and flexible funds
The balanced funds hold a stable mix of equiyty and bonds whereas flexible funds try to time the market in their asset allocation & and risk profile
60
What are the two types of allocation
Static allocation (stable mix of equity and debt)
targeted maturity funds
61
What does the excess return of a flexible fund depend on?
The manager's skill and luck
62
What are ETFs?
You trade index portfolios like regular stock
63
What is the difference between mutual funds and ETFs
An ETF can be sold at any time unlike a mutual fund which can only be sold at the end of the day when NAV is calculated
64
Are ETFs closed end or open end funds?
They are closed end for smaller investors and open end for big investors
65
What is the stucture of an ETF?
large institutional investors receive creation units (from the unit) and then give elementary units to the retail investors
66
What are some different types of ETF?give examples
Actively managed
Leveraged
Industry-based
International
67
What are the advantages of ETFs?
Can be sold short
Continuous trading
Sold thru brokers (lower management fees)
68
Disadvantages of ETFs
Transaction costs
Market prices can deviate from NAV which can swamp the ETF's cost advantages
69
Differences between closed-end funds and ETF
Closed-end funds trade at a discount while ETFs trade close to their NAV
Closed end funds are actively managed while ETFs often track the market
Closed end funds report quarterly, ETFs need daily disclosure
70
Types of alternative investements
Hedge funds
PE
Real Estate
Commodities
71
Four types of main fees
Back end
Front end
Operating expenses
12b-1fees
72
How high are operating expenses usually?
Between 0.2% and 2%
73
What is a front-end load?
commission charged when you purchase fund shares
74
How high are front end loads usually?
between 3% and 6%
75
What is a back end load?
A redemption fee.
Meaning that when the investor decides to leave their position they get charged a % after the compounding.
76
traditional investment make up 77% of what?
Assets Under Management
77
What is the difference between strategic asset allocation and tactical asset allocation?
Strategic asset allocation makes long-term changes in asset allocation depending on risk profile
Tactical allocation times the marekt
78
How do you find the optimal portfolio according to Markowitz?
You maximize the sharpe ratio
79
What are the imputs in the Markowitz framework
risk aversion
expected returns
risk (var, stddev)
weights
covariances
80
What are the assumptions of the Markowitz portfolio?
Returns are independent over time
Security returns follow a normal distribution
81
What is the formula of the expected return?
r' * w
r' = Transposed return
w = Weights
82
What is the formula of the portfolio variance(𝜎𝑝^2)?
w' * VarCovar * w
83
What is the Capital allocation line (CAL)
It's the line that has an intercept equal to the rf and a slope equal to the sharpe ratio of the optimal portfolio
84
How do you determine the client's ideal portfolio holding risk-free and risky assets?
The risk preference allows us to place the portfolio somewhere on the CAL
85
What is the Utility formula?
E(r)-0.5A(var)
Where A is the risk aversion
86
How do you calculate the weight of the risky portfolio?
(1/A)*((Rp-rf)/varp))
87
What is the case for overweighting stocks?
The equity premium
For longer holding periods, stocks are less risky than debt securities
88
What is the equity premium puzzle?
The models used to calculate the equity premium show a premium of 1% whereas in real life it is much higher and nobody knows exactly why
89
What are the risk based explanations of the equity premium puzzle?
Rare disaster risk that didn't take place
Structural uncertainty outside the model
Long-term risk is difficult to measure
90
What are the 2 main reasons to allocate a heavy weight to bonds in a portfolio?
Lower risk
non-perfect correlation
91
What can we observe from the Utility function?
Utility is increasing with E(R)
Utility is decreasing with Variance
The Variance induced ”penalty” increases with risk aversion
92
Are there times where there's been a high positive correlation between bonds and equity?
Today's climate: high inflation + slowing world economy
93
What does it mean that dividend yield (dividend/price) is mean reverting?
When Dividend yield is low, prices are high, expected returns are low and viceversa
94
Why is the dividend yield mean reverting?
Dividends are stable over time while equity prices are rather volatile
95
What is the single index model?
E(r) = alpha + beta(risk premium) + error
The model only describes the link between market returns and the return of 1 stock
96
What is a cyclical stock?
A stock that tend to rise and fall with the overall economy, beta close to 1
97
What is the CAPM model
E(r) = rf + beta*risk premium
98
What are the theoretical assumptions behind CAPM
Investors are always rational
The horizon is just 1 period
All investors have the same portfolio securities and the same expectations
All assets are traded publicly
No tax
No transaction costs
Can borrow/lend at a common rf
99
What is the optimal portfolio in the CAPM model?
the market portfolio
100
What happens to the CAL in the CAPM model?
It becomes the SML, where the slope is now given by E(rm)-rf and not E(rp)-rf
101
According to CAPM, what does the risk premium depend on?
risk of the market portfolio and risk aversion
E(rm)-rf = A(VARmarket)
102
How do you measure the weight of the market portfolio according to risk aversion?
wm = (1/A)*((E(rm)-rf)/VARm)
103
What are the traditional risk adjustment techniques?
Sharpe ration
Treynor ration
104
What is the information ratio?
appropiate reward to risk measure for an actively managed portfolio, what the manager earns not attributed to the market
105
What is the tracking error?
Basically the information ratio but the benchmark portfolio is given by fund mandate
106
How do you calculate the tracking error?
𝑅𝑝−𝑅𝐵𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘/𝜎(𝑅𝑝−𝑅𝐵𝑒𝑛𝑐ℎ𝑚𝑎𝑟𝑘
107
What is the case for passive management?
Diversification
It's difficult to beat the market
(CAPM) it's optimal to hold the tangency portfolio
108
What is the theory on active management?
Net of fees, active managers have a similar performance to passive managers, however with fees they underperform
109
What is a prime money market fund?
They invest in short-term securities and issue monthly dividends
110
What is a money market fund?
- fund that invests primarily in highly liquid, near-term instruments
- includes cash, cash equivalents, high-rating debt securities with short-term maturity (US Treasuries)
- Intended to offer investors high liquidity with a very low level of risk
111
What is the disposition effect?
- Behavioral anomaly (irrational)
- sell assets that have increased in value to lock in the revenue instead of keeping them to make more money
- keeping losing assets instead of closing their position because they don't wanna realize their losses
112
Explain pension fund underfunding?
- Only happens in defined benefit scheme (not defined contribution): aka the fund has already committed to pay pensions in the future so they need to have assets to offset the liabilities
- Underfunding: returns are lower than fund's expectation
- pension fund assets < PV(liabilities)
113
What is the main risk in merger arbitrage?
D) the main risk with merger arbitrage is that the deal falls through and you lose money
Reasons deal fails:
anti-trust (competition) law: regulators may block transactions
the acquiring firm withdraws
target firm rejects the bid
114
What does it mean that CAPM is an equilibrium model?
CAPM is an equilibrium model because we assume the market functions perfectly (no assymetries or mispricings). Therefore, under CAPM there is no way to outperform the market
115
Why use High Water Marks (HWM)?
Ensure that the fund manager only gets rewarded for reaching a NAV one time in the fund's history
116
What are the pros and cons of incentive fees?
Pros
motivate personnel and attract talent
Con
It's pretty expensive, they may also lead to increasing risk taking because of their option-like structure
117
What are some of the most famous indexes?
Dow Jones
S&P 500
Nasdaq
CRSP
Russell
CAC40
FTSE100
DAX
118
What are the 2 ways for a passive manager to track an index?
Full replication
Optimization
(ETFs do Synthetic Replication using derivatives)
119
What does the full replication strategy entail?
Hold all the assets in the index with the same weight as the index
120
What are the pros and cons of the full replication strategy?
Pro: minimizes the tracking error
Con: can be costly, involves trading many small and illiquid assets (some that haven't been traded for years like some bonds)
120
What is the optimization strategy in index tracking?
Buying the securities that provide a representative sample of the index to reduce tracking error
120
Tilted ETFs
Hold well well-diversified benchmark index with tilted weights in certain categories (Value, Growth, etc) by overweighing and underweighting some assets
121
What are some arguments against ESG investing?
Lower Sharpe ratio due to a smaller list of assets
Low expected returns due to the amount of funds going to ESG because of high demand
122
What sources of value can ESG have?
Positive externalities
ESG characteristics have proved to enhance value and not be fully priced on the stock market
greater employee satisfaction = positive alpha
good governance = positive alpha (think Credit Suisse's LBTQ portfolio)
123
What are the 3 investor types considered by Pedersen (ESG)
ESG unaware: optimize solely on mean-variance, don't care about positive returns from ESG
ESG aware: have mean-variance preferences but use ESG indicators to value their risk and return
ESG motivated: portfolio optimizing mean-variance relation but also high ESG scores
124
Take a break soldier. Stand aside me on this campfire.
You’ve done well so far. But the journey continues.
125
What are the ESG investment implications on pricing?
If you have mostly ESG motivated investors, you will see higher returns on "sin" stocks (tobacco) since they will increase demand on ESG stock
If you have ESG unaware investors, then the ESG stocks will have higher expected returns
ESG aware investors take into account the benefits of ESG and everything will be priced accordingly (stays the same, see graph)
126
What is the difference in the mean-variance frontier between normal portfolios and portfolios with ESG stock?
The risk-return trade-off in ESG portfolios will be worse due to the smaller input list
127
What are the return and statistical characteristics of alternative investments?
Diversification: low correlation with trad. inv.
Illiquid: many alt. inv are illiquid, which can give them lower prices but a higher return (risk premium)
Inefficiency: less competition can cause mispricing, you can do arbitrages on that
Non-normalities: short term alt. inv. can be characterized using a normal distribution but mid-to-long term can't because of:
- infrequent trading
- use of securities
- trading structures
128
What are the implications of non-normal distribution?
Returns can't be characterized only by mean and variance, need to take into account skewness and kurtosis, huge implications for risk management
129
What are the goals of alternative management?
Adding value through active management
Achieving absolute and relative returns
Pursuing arbitrage and return enhancement
Lower risk thru diversification
Avoiding obsolescence (first comers have higher returns)
130
What is the absolute return standard?
Returns evaluated relative to 0 or the risk free rate. Independent from performance in equity, debt, other markets
131
What is the relative return standard?
Returns evaluated relative to a benchmark to be surpassed. Goal is to take advantage of equity premium + superior security selection
132
What is the difference between arbitrage and "pure" arbitrage?
pure arbitrage is free of risk whereas arbitrage has risk due to differing assets and time frames
133
What is the difference in performance between alt inv and trad inv. ?
On average there's not much difference however there's much more variation of returns in alt. inv. The best ones far outperform the market
134
Alt. Inv. Why chose PE?
Enhance returns
135
Alt. Inv. Why choose Hedge Funds?
Diversification of returns
136
Alt. Inv. Why choose Real Estate?
Inflation hedge
137
Alt. Inv. Why choose Private debt & structured products?
Enhanced yield
138
How can Pension funds (under defined benefit and not defined contribution) deal with underfunding?
Cut benefits
Increase pension contributions
find new sources of returns: Alt. Inv.
139
What are the 3 primary elements of a Hedge Fund?
- privately organized (less regulated)
- performance-based fees to managers
- allows more investment flexibility (use of derivatives, leverage, private securities)
140
What are the 2 types of fees a hedge fund has?
Management (on NAV of fund)
Incentive fee (on performance)
141
What strategies do Managed Future Hedge Funds follow?
Trend-following strategies (especially time-series momentum)
142
What is time-series momentum?
Take a long position in a market with positive returns and go short otherwise
143
What is the reasoning behind time-series momentum?
A catalyst causes the value of an asset to change, the market underreacts, trend buyers and momentum traders come in (price gets closer to FV), trend continuation, ends when prices go way beyond FV and investors start investing against the trend
144
What can cause the underreaction in time-series momentum?
anchor-and-insufficient-adjustment
the disposition effect
non-profit seeking activities
frictions snd slow moving capital
145
What can cause trend continuation (overreaction)?
Herding
Confirmation bias
fund flows and risk management
146
How does time-series momentum perform?
High significant alphas
best to diversify over strategies and time frames
147
Do Managed future strategies provide diversification benefits?
Because they perform well when equities are high or low, they are great for pension funds to offset the loss from equities
148
What are event-driven hedge funds?
opportunistic strategy investing around corporate-specific events or/and market wide events.
149
What are the most common types of event-driven funds?
Activist
Merger Arbitrage
Distressed Securities fund
150
What do event-driven funds do?
search for mispriced securities during the anticipation and realization of events like M&A and spinoffs?
They usually long one position and short another
151
How do relative value funds function?
They take long and short positions that relatively equal in size, vol, and risk exposure
Ideally they have low net market risk
They go long on the undervalued leg and short on the overvalued leg which will later converge into a single price
152
What is the classic relative value strategy based on?
The idea that the relationship/spread between two prices has become abnormal and will therefore return to normal
153
What are 2 examples of relative value strategy?
Convertible bond arbitrage: long position in undervalued convertible bond and hedge with a short position on the underlying equity
Fixed income arbitrage: simultaneous long and short position over FI asset that will converge over the holding period
154
What is factor investing in long-short equity funds?
Systematically taking long positions in in one group of stocks and short another group of stocks.
155
What are the strats of factor investing?
Value: long val, short growth
Momentum: long past winners, short past losers
156
What is the issue with momentum strategies?
High turnover of stocks in the portfolio, huge need for rebalancing (constantly changing)
157
Why do value and momentum strategies make a good combination in a portfolio?
They are negatively correlated
158
What is the idea of value investing?
find stocks with high FV relative to market value, sort stocks according to their Book Value/Market Value
159
What do dedicated short bias funds focus on?
Problems that stocks may have:
overstated earnings
aggressive accounting methods
incomprehensible SEC filings
160
How do dedicated short bias funds make money?
They investigate irregularities in their stock and when they find something of note they take a big short position on them and then publish their findings to get an even bigger price reaction
161
What benefits do commodities offer to a portfolio?
Diversification: lower volatility
162
How do you calculate Incentive net of assets?
Max(0,(Gross HWM-mngmnt-hurdle)*incentive fee)
163
How do you calculate the Gross over HWM after the 1st year?
(NPV (t)*(1+return))/HWM(t-1) - 1
164
What is the Fama-French 3 factor model?
They added 2 additional factors to the CAPM model: Small Medium Business, High Minus Low to better adjust the market risk.
165
When do you use Jensen's alpha?
All types of investment, always want a positive one if you're active
166
When do you use the Sharpe?
When you have to evaluate the entire portfolio (total risk)
167
When do you use the information ratio?
When you evaluate active strategies and portfolio
168
When do you use Treynor?
Evaluate well-diversified portfolios: which one of these portfolios would fit better in your well-diversified portfolio
169
What does a R-square show in a regression?
How much of the stock's volatility is explained by market movements
170
What does beta show in a regression?
The market risk
171
How do you find firm-specific risk in a regression?
Excess standard deviation
172
What is a tilted ETF?
ETFs designed to overweight their holdings towards a soecific factor
173
TSMOM formula?
sign of excess returns over a period of time (long or short position)
Weight of the position
sign * (target vol/asset vol) at t *Revenue at t+1 = TSMOM t+1
174
How do you calculate the deal spread in merger arbitrage?
(offer price - target price)/target price
175
What can you say about multi-manager funds in comparison to traditional funds
They outperform other types of funds, they have high alphas that are closer to being the true alpha and their performance does not come from market factors
176
What is a multi-manager fund?
Many specialized hedge fund managers and strategies functioning as a unit
