Portfolio Management

Question 1

This is desirable for investors, who are “net long” and occurs when the future prices are lower than spot prices, in an inverted yield curve. And indicates short supply.

Answer 1

Backwardation

Question 2

This occurs when future prices are higher than spot prices with an upward sloping yield curve. It indicates immediate supply.

Answer 2

Contango

Question 3

This is a concept that relates to the expectation, that for some investments, such as private equity, there are negative cash flows for several years before leaving to positive cash flow in later years.

Answer 3

The J-curve concept

Question 4

Another tax efficiency measure based on capital gain realizations. Eight equals the ratio of short term capital gains realize during the measurement. To total capital gains realize during the period.

Answer 4

Accountants ratio.

The logic behind this measure is that if my manager is realizing many short term gains, the manager may not be considering the tax consequences of trading decisions. This ratio does not consider the broader question of the level of capital gain realizations. Therefore provides only a partial perspective on the portfolio manager sensitivity to task management issues.

Question 5

What are characteristics of alternative investments?

Answer 5

Concentrated or diversified
Often illiquid
Hi fees and expenses
Low to no correlation to traditional investments
Low to high risk spectrum
Not very transparent
Not highly regulated
Constraints for investments and withdrawals
Reporting inaccuracies and biases 

Question 6

What is the vintage year concept?

Answer 6

Vintage year refers to the first or initial year of an investment. It is common for venture, capital projects, and other private equity investments, as well as real estate.

Question 7

This is a type of limited partnership trade it on a public exchange. Limited partners typically provide the investment and general partners typically manage operations.

Answer 7

Master limited partnerships

Typically includes a requirement that 90% of cash flow comes from real estate, commodities, or natural resources.

Many MLP’s are not appropriate for tax deferred accounts because of UBTI and other tax related consequences. 

Question 8

What is backfill bias?

Answer 8

When hedge funds report returns, only if they choose to and they may do so only when they’re prior performance is good.

Question 9

In reference to hedge funds, what is survivorship bias?

Answer 9

Failed funds drop out of the database. Hedge fund attrition rates are more than doubled those four mutual funds.

Question 10

What is meant by the Highwater mark when referring to hedge funds?

Answer 10

A hedge funds fee structure, can give incentives to shut down a poorly performing fund. If a fund experiences losses, it may not be able to charge an incentive, unless it recovers to its previous higher value (Highwater mark).

With deep losses, this may be too difficult,so the fund closes. 

Question 11

What are the ramifications of UBTI – unrelated business, taxable income on tax deferred accounts?

Answer 11

UBTI can create current tax liability and possible re-characterization for tax deferred accounts. This is due to gains realized from investment activities, such as leveraged trading strategies and other gain producing activity not considered directly related to the main function of the entity. Making it subject to federal and state income tax.

Question 12

What are the disadvantages of “mean – variance optimization”?

Answer 12

Assumes: investors are rational; assumes history of risk and return characteristics are reasonable predictors of future performance; fundamental characteristics of capital markets will remain the same; does not incorporate the potential for major shocks to economies or financial markets. 

Question 13

What is the method that measures the efficiency of various mixes of assets or investments that seeks the optimal combination of choices through diversification that minimizes risk per unit of return gained?

Answer 13

Mean – variance optimization 

Question 14

This asset allocation strategy involves crafting a portfolio of various asset classes with specs, specific target mixes. The objective is to maintain these mixes.

Answer 14

Strategic asset allocation

May be easier to implement and manage. Once the appropriate mix of asset classes for the investor is determined, the mix will not be changed over time unless there are significant changes in the investors objectives or risk tolerance. The rebalancing should be based on economic decisions rather than strictly tax decisions. The advisor should attempt to be tax, aware, not tax efficient.

Question 15

This asset allocation strategy, is a method of changing the allocation of the portfolio based on market conditions.

Answer 15

Dynamic asset allocation.

Many advisers find it difficult to adhere to a strategic asset allocation policy. Dynamic rebalancing may be difficult for private investors or institutions. Dynamic asset allocation is assumed to outperform a constant mix portfolio, especially during extended bull or bare markets. Most investors are more worried about downside risk than their gains, because of this dynamic asset allocation approach may be preferred. One approach to DAA is when the risky part of a portfolio outperform is it safe for a part the investor what is Sue Morris by increasing the allocation to the risk is part of the portfolio. If the risky part of the portfolio under foot under performs, the safer part investor would take less rest by changing the allocation favor of safer investment.

Question 16

This asset allocation strategy, is an active management strategy that allows the advisor to make changes to a portfolio based on their convictions about various asset classes in the future.

Answer 16

Tactical asset allocation

This method is sometimes referred to as market timing. While strategic allocation has a component of tactical allocation as it rebalances portfolios back to their targets, the tactical asset allocation will require more effort. Critics of tactical asset allocation imply that this approach has a possibility of missing the best performing days or months over long periods of time and hands will under perform a strategic asset allocation approach.

Question 17

This option strategy is when investor purchase both a put an a call on the same security with the same straight price and expiration. It is done when the investor believes the stock price will move significantly but but is unsure of in which direction.

Answer 17

Straddle

Question 18

This option strategy involves selling a call and buying a put out of the money. The strategy intends to lock in profits by buying downside protection, why, while calls are sold to generate income to help pay for this downside protection.

Answer 18

Collars. Properly executed collars preserve capital during the holding period of low cost basis stock.

Question 19

This option strategy is where an investor buys and sells two options on the same underlying asset. They have the same expiration date, but different straight prices.

Answer 19

Vertical spread options

Gains and losses are a result of the widening or narrowing of the difference between option premiums on the two positions

Question 20

This option strategy is where investor buys and sells two options on the same underlying asset. They have the same strike price but different expiration dates.

Answer 20

Horizontal spread option

Profits are made from changes in the price difference as securities move closer to expiration date. Also called calendar spreads and times spreads.

Question 21

This option strategy is where an investor simultaneously enters into a long and short position in the same type of option. (call options or put options), and where the contracts have different strike prices, and expiration dates.

Answer 21

Diagonal spread option

This combines a horizontal spread (different expiration date) and a vertical spread (different strike price)

Question 22

This rate of return calculation applies the concept of IRR to investment portfolios. It is defined as the internal rate of return of a portfolio, taking into account all cash, inflows and outflows.

Answer 22

Dollar-weighted return

Question 23

What’s the difference between the arithmetic and geometric averages?

Answer 23

The geometric average is calculated by multiplying the different stock prices to the nth power. We’re “n” equals the number of stocks.

The arithmetic average is calculated by adding the stock prices, and dividing them by the number of stocks

The geometric average is usually lower than the arithmetic average.

Question 24

This rate of return method does not weight the amount of all dollar flows during each time. Instead it computes the return for each period and takes the average of the returns.

Answer 24

Time – weighted return

The time weighted return is the preferred method of performance measurement because it is not affected by the timing of cash flows. If a client has funds to an investment portfolio at unfavorable time, the dollar weighted return will tend to be depressed. If funds are added at a favorable time, the dollar weighted return will tend to be elevated.

Question 25

What is a broad category or composite of risk that affects the entire market rather than a particular Security.

Answer 25

Systematic risk

All securities tend to move together in a systematic manner in response to the entire market.

As a result, systematic risk is non-diversifiable, it cannot be eliminated through diversification or minimized, because it affects the entire market.

Beta is a measure by which systematic risk is determined. Beta is only an accurate measure of systematic risk for diversified portfolio.

Question 26

This risk is unique to a single business or industry, such as operations and methods of financing. These risk include business risk and financial risk.

Answer 26

Unsystematic risk

Examples of unsystematic risk include business risk, financial risk, default, risk, and regulatory risk. Unsystematic risk can be eliminated through diversification.

Question 27

This is a measurement of variability of returns of an asset compared to its mean or expected value. It measures total risk (systematic and unsystematic risk).

Answer 27

Standard deviation

The Sharpe ratio uses standard deviation as represented by the Greek symbol sigma .

Question 28

What is the beta coefficient?

Answer 28

The beta coefficient is a measure of systematic risk and should be used for diversified portfolio. The beta coefficient is a measure of volatility for diversified portfolio relative to a benchmark (S&P 500 index).

In contrast, standard deviation is a measure of variability of returns from average return

If a stock has a beta of one, the implication is the stock moves exactly with the market. A beta of 1.2 is 20% riskier than the market and a beta of .8 is 20% less risky than the market.

Question 29

What is the measurement of systematic risk?

Answer 29

Beta

Beta is used in the capital asset pricing model and trainers ratio. Beta indicates an assets likelihood of moving up or down with the market. A beta of one indicates that an asset will move directly in proportion to the market as a whole. A low beta indicates that an asset has been less volatile than the market, while the high beta indicates that an asset has been more volatile than the market. 

Question 30

What is the correlation coefficient?

Answer 30

The correlation coefficient is a easier interpretation of covariance. Covariance measures how much random variables move or change together

Negative covariance means variables move inversely. High covariance assets do not offer much diversification.

If Securities have a correlation coefficient of 1, the securities are perfectly positively correlated.

If securities, have a correlation coefficient of -1, the securities are perfectly negatively correlated. 

Question 31

This ratio is a metric to measure performance relative to risk taken as measured by beta.

Answer 31

Treynor ratio

Same formula as Sharpe ratio, except that it uses beta, which measures systematic risk instead of standard deviation, which measures total risk

The higher the trainer ratio, the better

Question 32

This risk adjusted performance ratio measures how much return is achieved per unit of risk taken, using standard deviation.

Answer 32

The Sharpe ratio

Modern portfolio theory serves as the foundation for the sharp ratio. The higher the sharp ratio the better. The sharp ratio is better. Use when analyzing portfolios with low volatility versus the Sortino ratio.

Question 33

This is a risk adjusted performance metric that measures return in relation to downside risk using down size semi standard deviation.

Answer 33

The Sortino Ratio

This is identical to the sharp ratio, except that it uses downsides in my standard deviation – which includes deviations of both positive and negative returns.

The Sor Tino ratio is better use when analyzing portfolios with high volatility. 

Question 34

A hedge fund style that attempts to profit from merger and acquisition, activity, restructuring, bankruptcy, re-organization, etc is called?

Answer 34

Event driven

Question 35

This hedge fund style involves long and short positions in capital or derivative markets across the world. Portfolio positions reflect views on broad market conditions and major economic trends.

Answer 35

Global macro

Question 36

This hedge fun style invest in convertible securities, typically long convertible, bonds, and short stock

Answer 36

Convertible arbitrage

Question 37

This hedge fund style seeks profit, regardless of whether the market is going up “ bull market” or going down “ bear market”.

Answer 37

Market neutral

Question 38

What are four main examples of socially responsible investing (SRI) or environmental, social and governance open parentheses ESG) investing?

Answer 38

Environmental impact, shareholder, activism, negative screening, human capital and rights.

Shareholder, activism, and seeking transparency around executive compensation, and conflicts of interest.

Question 39

What are the risk of investing in hedge funds over mutual funds?

Answer 39

Most hedge funds are less liquid than most mutual funds

Hedge funds, unlike mutual funds are subject to backfill bias

Backfill bias is the requirement to file performance data. Hedge funds are not required to file data each year.

Both hedge funds and mutual funds are subject to survivorship bias. 

Question 40

What is the default accounting method used by some brokerages and custodians that can be detrimental to investors.

Answer 40

Average cost.

Question 41

Which are often the two prefer choices for calculating gains and losses in a portfolio, but are not always applicable or allowed.

Answer 41

Specific lot identification or highest in first out (HIFO)

Question 42

True or false, the impact of 150 basis point a year tax drag on a $1 million portfolio over 20 years could cost the account over $1 million in value over that time.

Answer 42

True

Question 43

This gives the proportion of variation in one variable that can be explained by another variable. This metric indicates the closeness of fit.

Answer 43

Call efficient of determination (R – squared)

No causality is claimed by the coefficient of determination. 

The higher the number, the more meaning for the relationship.

R Dash squared gives us an indication of the level of diversification in a portfolio.

R Dash squared on a portfolio also gauge is the reliability of alpha as an indicator of the managers, return and beta as an indicator of risk.

Question 44

Disc is the proportion of variation in one variable that can be explained by another variable. This metric also indicates the closeness of fit.

Answer 44

Call efficient of determination (R – squared)

R-square does not claim causality.

The higher the number, the more meaningful the relationship.

Gives us an indication of the level of diversification in a portfolio.

Gauges the reliability of alpha as an indicator of the managers return and beta as an indicator of risk.