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Term 2 Flashcards

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1
Q

Define passive management?

A

Long term buy and hold that tracks an index

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2
Q

Define Active Management?

A

Attempts to outperform a benchmark by moving assets

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3
Q

Discuss ETF’s and their growth

A

Allow an easy way to track a fund
Lower managment, transaction fees
Eating into active’s market share

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4
Q

Provide an overview of passive stratergies?

A

Attempt to replicate an index, may fail due to weighting or transaction costs

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5
Q

What are the construction techniques

A

Full replication
Sampling
Quadratic Optimisation / Programming
Synthetic Replication

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6
Q

Discuss full replication?

A

Purchase all the securities in an index
Ensures close tracking
Has high transaction and management costs
Dividends / changing weights

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7
Q

What is sampling?

A

Purchase a representative basket according to their weights

Lowers transaction costs but has a higher tracking error

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8
Q

What is a tracking error?

A

The extend to which returns differ between portfolio and index

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9
Q

Calculate tracking error

A

Deltat=WiRi-Rbt
Var=(Deltat-Deltabar)^2/T-1
Root(Var)*Root(P)
p=periods

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10
Q

Discuss the relationship between tracking error and portfolios?

A

The higher the tracking error the lower the cost
A passive portfolio will have TE<1
TE>3 is active

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11
Q

What is quadratic optimisation?

A

Input data into a computer to generate portfolio

However, past data is used so may be incorrect

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12
Q

What is synthetic replication?

A

Purchase a derivative instead of underlying assets

Can be used with commodities

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13
Q

What is a mutual fund?

A

Purchase a share of a fund managed by a manager

Easy way to track an index

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14
Q

What is the advantage of a mutual fund?

A

Low minimum investment, ]

Low management fees

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15
Q

What is the disadvantage of a mutual fund

A

Cannot sell until end of day or short

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16
Q

What is an ETF?

A

Uses a full replication stratergy to track a fund

Can copy industries or countries

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17
Q

What is the advantage of an ETF

A

Can sell in middle of day as well as short

Lower management fees

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18
Q

What is the disadvantage of an ETF?

A

Higher broker commision, cannot reinvest easy

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19
Q

What are the extensions to passive management?

A

Index Futures
Enhanced Indexing
Smart Beta

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20
Q

What is enhanced indexing?

A

Passive indexing with a hint of Active Management

Must have a TE<3

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21
Q

What is Smart Beta?

A

Builds a beta based on attributes that are associated with higher returns

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22
Q

What are a managers key objectives?

A

Derive above average returns given risk

Diversify a portolio to remove unsystematic risk

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23
Q

What is the Teynor Ratio?

A

Evalaute performance based on returns and systematic risk
T=(Ri-Rf)/B
Higher is better

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24
Q

What are the problems of the Teynor ratio?

A

Cannot be used if portfolio is not fully diversfied

Fails if performance is very bad or low risk

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25
How do we interperate a T value?
Plot on SML line If T>Tm, need to plot above line If T
26
What is the Sharpe Ratio
Compares returns and total risk Ri-Rf/Sd Compare to CML rather than SML
27
How passive is passive managment?
Manager still needs to alter portfolio for changes in firms Reinvest cash flows Rebalnce to minimse TE
28
What are the decisions for a passive investor
What index to track | Country , Sector, Style, Weighting, calculating returns
29
What is the emprical evidence?
Variable even within an index Investors do not do enough due dilligence Supports EMH Active managers are outperformed yet people dont switch
30
What are the shortcomings of the Sharpe Ratio?
Assumes returns are normally distributed | Can be manipulated by hedgefunds
31
What is Jensens Alpha?
Discusses the deviation from the CAPM expected returns Regress: Ri-Rf=a+Bi(Rm-Rf) a thus reveals performance
32
What are the limiations of Jensens alpha?
``` Assumes portfolio is well diversified Must compare assets within the same class for the benchmark ```
33
What are the beenfits of Jensens alpha?
Easy to interprerate | Can use statistical s ignificance
34
Discuss the M2 Measure
Like sharpe ratio but gives a % answer Calculate sharpe ratio Multiply by SD of market Add Rf rate
35
What is the information ratio?
Rp-Ri / TE Measures the consistency of a managers performance
36
Discuss the extensions to performance measurement?
Excess return = Portfolio risk + selectivity Selectivity = Actual return - CAPM expected return This shows us the benefits of the managers selection over the market
37
What is holdings based performance management?
Looks at the perofrmance of a managers holdings
38
What is teh grinblatt-Titma measure
Measures the change in holdings
39
What is the Disadvantage of the GT measure?
No consideration of market timing
40
What is the Charateristic selection?
Compares performance to a similar portfolio i.e value v value This benchmark is hard to indentify
41
What is performance attribution analysis?
Examines whether market timing or security choice is responsible for performance
42
What are the major types of bond?
``` Zero Coupon Floating Rate Inverse Floating RAte Inflation Protected ABS ```
43
What factors effect maturity of bonds?
Noncallable Converatible Put Bond
44
How do you calculate the Bid or ask value for a bond?
No of days * Rate / 360 = x 100-X = Price offered 10000-PO = Y Y/10000 * 360/Days = Bid
45
How do you calculate the asked yield for a bond?
Previous asked X / Asked price * 365 /Dates
46
Who are the major bond investors?
Life insurance, Commerical Banks
47
Who are the credit rating agencies?
Moodys, S&P, Fitch
48
What is the formula for a bonds present value?
C/(1+r)^t + F/(1+r)^n
49
What are the three types of yield?
Nominal Yield = Coupon Rate Current Yield = Coupon payment / Current Price Yield to Maturity
50
What is the YTM, What are its limitations?
The discount rate that when applied to payments yield the current market price Assumes the reinvestment rate of coupons is the YTM rate Assumes a horizontal yield curve
51
What is a spot rate?
The YTM of a zero coupon bond | F/Pm (1/n)-1
52
What is quality spread?
Difference in yield of differently rated bonds?
53
What is credit spread?
Difference in yield for identical bonds of different quality?
54
What are the four yield curves?
Normal - Upwards Sloping, most common Steep - Like normal but does not flatten out - Boom Flat - Uncertainity in the market Inverted - Recession
55
What are the four theories of the yield curve
Pure Expectation Liquidity Segmentation
56
Discuss the pure expectation hypothesis?
If short term inflation rates are expected to rise, long term bonds will require a higher yield as compensation
57
Discuss the liquidity preference theory?
Longer investment is riskier, due lack of liquidity and other investments, thus requires compensation
58
Discuss the segmentation hypothesis?
Banks congregate at low end of market, mutual funds are high end
59
What is Macualy Duration? How is it calculated?
Measures the time required to recoup the PV of a bond Calculate CF, DCF, calculate weight of total PV, multiply by time and sum
60
What is modified duration? How is it calculated?
Measures the responsiveness of price to a change in yield MCD / 1+YTM/payments per year
61
What is a key point of modified duration?
Is always less than time to maturity
62
What is convexity? How is ti calculated
Captures the non-straight component of the price yield curve, thus price will always increase following a change in yield. CF, DCF, PV, T2+t*PV T2+t*PV / (1+Y)^2 x Price
63
How do you calculate the change in price using convexity?
0.5*Convexity * (Change in Yield)^2
64
What happends if a bonds maturity increases?
Convexity and duration increase
65
What are the overall effects on a bonds price?
A Bonds price will increase if YTM falls Coupon increases A shorter Maturity
66
What are the passive stratergys of bonds?
Buy and Hold to maturity, therefore do not care about changes in price, IR, etc This struggles as you cant reinvest
67
Discuss the passive indexing of bonds?
Passive Equity Not as effective due to maturity needs Three Stratergies Exist Full Replication difficult due to large number of consitutents Sampling involves division into cells and purchase according to weighting Quadratic Optimisation
68
What are some practical considerations of passive bond investing?
A large number of consitutetns create difficulties May struggle to purchase due to illiquidity Index's may use different prices
69
What are the active stratergies of bond investing?
IR Anticipation Yield Curve Fundamental Valuation Credit Analysis
70
What is IR anticipation
If you believe IR will fall, increase portfolio duration Also cushion bonds to shorten duration A callable bond with a coupon above the market rate, reducing duration
71
What is the yield curve stratergy? What are the types of yeld curve shifts?
Based on predicting the movements of the yield curve Parellel shift: Up or down Shift with Twists: Flattening (Spread falls) or Steeping (Spread increases) Shift with Humpedness: Positive butterfly (SMile) Negative Butterfly (Frown)
72
What are the types of stratergy, when should they be used?
Bullet: Focus on one area Use with shift with a twist Barbell: Split at either end: USe with positive butterfly Ladder: Equally split Parellel shift
73
What is total return analysis?
Simulating each stratergy and seeing what does best
74
What is fundamental valuation analysis
Determine the fundamental value of a bond by considering | R=Rf+Bonds default risk + Bonds liquidity premium + The option adjusted spread
75
What is credit analysis
Identify a possibility of a credit downgrade or upgrade and purchase accordingly
76
What are the two liability management stratergies?
Cash flow matching Set coupons and maturities such that they match future needs May fail due to risk Immunisation Set Duration of bonds = Duration of liabilities
77
What are the types of immunisation?
Classical: Duration of Bonds = The horizon of investment, then the price risk and coupon risk offset Rebalancing: As bonds duration changes over time, the portfolio needs frequent rebalncing Combination: Cash flow matching for early liabilities, Immunisation for long term liabilities Contingent: Combine active management with a stop
78
What are the problems with hedge funds?
Returns are not risk adjusted and very volatile
79
What are the differences in hedge funds and mutual funds?
``` Transparency Investors Investment Stratergy Leverage Liquidity Compensation ```
80
What are the two hedge fund styles?
Directional and Non-Directional
81
Discuss directional hedge funds
Betting on one movement direction using leverage Has sensitivity to market beta Not a traditional hedge fund Betting on things such as IR movement
82
Discuss non-directional hedge funds
Exploit misalignments in relative valuations Buy one security and sell the other reduces risk When the misalignment reverts to its original difference, you realise profit.
83
How do you calculate a portfolios hedge?
Calculate hedge ratio: B x Portfolio Value / (Mult x Current Future P) Round to nearest number as futures are whole Calculate market return after one month Calculate portfolio return by CAPM Calculate value of hedged position (F1-F0) x Mult x QHedge
84
What are the limitaitons of hedging?
Not true arbitrage as profits are dependant on alpha A bad error can harm returns Leverage can increase volaitlity
85
Discuss statistical arbitrage?
Use quantitive trading to automate missalignments between prices Pairs Trading - Pairs of correlated stocks
86
Discuss Funds of funds?
Diversification through many hedge funds Reduces risk but higher fees
87
Discuss hedge fund performance
Report nominal returns with no benchmark comparision Often use Sharpe ratio, adjusting for market risk
88
Discuss illiquidity and hedge fund performance?
The premium returns may be attributable to illiquidity premium As you cannot withdraw returns As assets are illiquid, funds can repurchase assets before reporting to raise price
89
When is illuqidity indicated
If there is serial correlation in returns | As price is estimated based on last price
90
What is the backfill and survivorship bias?
Backfill: Only report if performance is good Surviorship bias: Many funds fail and disapear
91
Discuss hedge fund risk
Managers apatite changes over time, therefore cannot use Beta Very opportunistic, rapidly change Expose investors to tail events

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