Trading and Performance Evaluation Flashcards

Question

Principal trades

Answer 1

* “Agency” they can act as the buyer to any seller or the seller to any buyer * Done using the dealer’s own inventory * Dealer/market makers assume all the risk in executing the order, priced into their spread “bid-ask” * Other markets: Quoted driven, OTC, and RFQ markets

Answer 2

* Where the broker finds the other side of the trade * Risk for the execution remains with the portfolio manager or trader.

Answer 3

* Trading via computers, done in more liquid markets * The trading is order driven cause it allows the buyer and sellers to advertise their limit orders in a central limit order book * Allows direct market access (DMA) * Algorithmic trading * Provides anonymity

Answer 4

Allows a person on the buy side to access the order book of the exchange directly through the structure the broker has. **Used for:** * Small currency trades * Buy-side traders for exchange-traded derivatives (particularly smaller trades)

Answer 5

Use of programs rules to electronically trade order for trade execution or profit seeking

Answer 6

Execution algorithms that trade by specified rules set by the portfolio manager to meet their **Specific objectives they have:** * Scheduled algorithms * Liquidity seeking * Arrival Price * Dark Strategies or liquidity aggregators * Smart order routers

Answer 7

* Percentage of volume participating algorithm will send order on a volume participation schedule * They execute trades using rules driven based on a historical time period or historical volume * Are most appropriate for smaller orders in liquid markets that have less urgency to execute the trade while, trying to minimize the market impact * Market Impact cost decreased; execution risk increased **Disadvantages:** * They continue to trade at any price can be adverse * May not fill the order in the specified time in there is a lack of trading.

Answer 8

* Schedule Algorithm * Weighted average of execution price during the day where the weight is applied is the proportion of the days trading volume * Breaks the trade down and sending the order based on historical intraday volumes * Trades more at the opening and the closing not the trading day and not so much in the middle of the day **Disadvantages:** * Not useful if a trader is a significantly part of the trading volume * Unethical; Can simply trade at the end of the day to execute a trade order * If prices are moving Down = only execute buy orders * If prices are moving Up = only execute sale which would be above the VWAP

Answer 9

* Schedule Algorithm * Used for thinly traded stocks * Is the equal weighted average price of all trades over a specific trading horizon * Ignores actual volume good for highly fluctuating volume throughout the day. * Excludes Potential Trade Outliers * Equal number of shares are being traded over the period of the day.

Answer 10

* Opportunistic Algorithms * Try to take advantage of favorable liquidity conditions * Will use both Lit and Dark venues to get their trades done * For large orders in less liquid markets * Have a high urgency to mitigate market impact costs * Concerns for when management displays their limit orders that can lead to information leakages.

Answer 11

* Try to trade close to market prices, prevailing at the time the trade is entered * Trades more aggressively than other algorithms * For small orders in more liquid markets * For managers that believe the price will move adversely and has a high urgency to trade * Market Impact cost increased; execution risk decreased * For profit seeking management with high alpha decay.

Answer 12

* Execute strategies in the dark pools venues * Aggregators trying to optimize the trade across multiple dark venues * For large orders in illiquid markets * For management that does not have to execute the whole order immediately

Answer 13

* Algorithmics that try to determine the best destination (Dark or Lit venues) to route an electronic order * Tries to find the best market pricing * Appropriate for small market orders, low market impact, where the price/market moves very quickly * For small limit orders with low information leakage

Answer 14

Electronic trading order with anonymity (not urgent trading)

Answer 15

* The actual price a security was bought or sold at * Relates to shares transacted in the market and corresponds to price drift from buying (which can increase the market price) or selling (which can decrease the market price).

Answer 16

* Another way to calculate trade cost but is more comprehensive * Takes a portfolio wide perspective * Most enact approach to cost measurement * It captures all elements of transaction costs * Can be decomposed into all different costs * Is a frontloaded strategy that can be adjusted to aggressively execute an order when the order has a high urgency.

Answer 17

* Paper return: hypothetical return, at the original decision price with not cost * Actual return: net of all the cost Difference Between is the total cost of executing the trade can be presented * A dollar amount * Percentage amount * Per share amount of the initial order * Basis points amount

Answer 18

The average of the best bid and best offer. * Uses a benchmark to see if it’s too over/under valued * Can be used to calculate an effective spread * If the mid-quote is not be available, cannot use a mid-quote as a benchmark * To measure your implicit cost another alternative to use is the VWAP

Answer 19

Market price of a security is order is not fully executed on the remaining portion of the traded is canceled

Answer 20

* Best Execution: Meaning of * Optimal Trading Approach: Factors that determine * Eligible Brokers and Venues: List of the approved * Monitoring: Any details of the process that are used by the asset management

Answer 21

* Nature of the trade and order size * Execution price * Trading costs * Execution speed * Execution risk * Settlement risk

Answer 22

* Componet of Portfolio Evaluation * Calculating both a return and the risk over a time period(s) * Can be looked at it on a relative or absolute benchmark (target, specify in advance)

Answer 23

* Componet of Portfolio Evaluation * Determine what are the key factors generated the performance of the account. * Explains how the return was achieved given the level of risk taken

Answer 24

* Componet of Portfolio Evaluation * Looks at different ratios to see if the performance was by effected by investment decision, the market price, or by chance * Renders a professional judgement of the fund * Design to asses if the portfolio manager where the investment results are due to skill or luck * Can the portfolio manager outperform their benchmark on a risk adjusted basis consistently

Answer 25

Evaluates the impact that active management decisions have on the funds returns

Answer 26

* Done in sync with return attribution and analyzes the active management decisions and impact on portfolio risk * Risk is generally compared to portfolio appropriate benchmark and also calculated on absolute terms

Answer 27

* Done at the individual Portfolio management level (the specific manager) * Tries to determine or verify what the portfolio managers actual did, what they said they would do, and to understand what are the actual factors/drivers of the portfolio return

Answer 28

* Done on a fund sponsor level * Quantifying the fund sponsor decisions to deviate from the SAA or TAA and the timing when they made their decisions

Answer 29

1. Brinson-Hood-Beebower (BHB) 2. Factor-based Attribution Model

Answer 30

Quantifies a portfolio return into 3 attribution effects this shows the value added 1. Allocation effect: Pure selector allocation 2. Security selection effect: security selection; within sector selection 3. Interaction Effect: allocation selection interaction

Answer 31

* Decision to under/over-weight specific sector weightings in the portfolio vs the benchmark * Purely capture the portfolio managers ability to select outperforming sectors and avoid underperforming ones.

Answer 32

* Was the decision to under/over-weight within certain sectors vs a benchmark a good or bad decision * Portfolio managers stock picking skills

Answer 33

* “Plug” residual amount of the benchmark * It considered to be a really good if it captures the style and the effect it should be zero * It must sum up the total return with the others effects (allocation and selcetion) to 100%

Answer 34

Used where a portfolio’s sensitively to additional factor can be tested and example is the Carhart Model.

Answer 35

* Duration based * Top-Down approach, process the segments risk by same specific attributed or characteristics * Tries to quantify what arises from interest rate risk * Segments the portfolio by its market value weights * Assigns securities to the difference duration bucket, by the nature of each security

Answer 36

* Can be top down or bottom up * Uses both YTM and duration to calculate price return * Looks what factors that drive the return when the YTM changes * It requires a lot more data because it has to performed on the portfolio and the benchmark

Answer 37

* Alternative to the Yield Curve Decomposition * Securities can be repriced by using spot rates * The use of spot rates is known as the full repricing method * It is the most accurate measure of reprising securities as its more in depth * It will bemore difficult and costly.

Answer 38

* Used when a specific liability needs to be paid in the future * Will focus on the cash flows when they are needed as the liabilities come due * It might limit the number and type of investment choices such as inflation-adjusted bonds, nominal bonds, high quality stock

Answer 39

**S – Specified in Advance:** The benchmark is known by the portfolio manager and fund sponsor before the investment period **A – Appropriate:** the benchmark has a consistent style or approach **M – Measurable:** The benchmark’s value or calculated on a reasonable basis **U – Unambiguous:** Clearly identities and weights of securities that make up the benchmark **R – Reflective of Current Investment Options:** Whatever is in the benchmark or expertise of those securities in the benchmark **A – Accountable:** portfolio manager accepts the applicability of the benchmark in advance and agrees to it any difference is only their active decisions make **I – Investable:** We can replicate the benchmark passively and can forgo active management if desired.

Answer 40

* A return objective that tries to get a desired return that exceeds a minimum target return, or return of a specific percentage * Disadvantage: Will fail the investability test, not an investable benchmark

Answer 41

* Measures performance of a broad category of assets (like the S&P 500) * Disadvantage: May be inappropriate if the management style deviates from the style reflected in the index

Answer 42

* Represents specific portions of an asset category based on natural characteristics (value or growth) **Disadvantage:** * Some of the style indexes can contain weights on security and sectors that might not be appropriate or prudent * Different definitions of investment style

Answer 43

* Specify a set of a factor exposures to a return of an account measures the sensitivity to risk exposures Disadvantage: * Focusing on factor exposure might not be easily explained * The data and modeling are not always available and might be expensive * May be ambiguous which can lead to misspecifications

Answer 44

* Looks at portfolio return and tries to explain the return * Based on sensitivity to style indexes/approaches **Disadvantage:** * Might not reflect what is currently owned or is willing to own * Not good at detecting (Style drift) * For any meaningful analysis we need enough data to come up with a statical significant pattern of style exposures

Answer 45

* Median Manager, the fund at the middle, where funds are ranked from highest to lowest Disadvantage: * Doesn’t fit any of the criteria but being measurable * Subject to the survivorship bias (not unbiased)

Answer 46

* Satisfies all of the criteria * Designed to reflect the management security allocation and investment process * Also, knowns as a “normal portfolio” the universe of all the potential securities that are investable the management can select from **Disadvantage:** * If you allow a manager to create their own benchmark they will use one that is easy to beat * Expensive to contract and maintain them

Answer 47

* Assumes returns are normally distributed risk adjusted measure of performance * Considers the risk relative return per unit of risk **Disadvantage:** * It doesn’t differentiate between volatility that is upward or downward; it takes all volatility into account. * There is a penalty for all volatility even good volatility

Answer 48

* Similar to the Sharpe-ratio but uses beta only considers systematic risk (by using beta) * Considers the risk-relative return per unit of systematic risk * Disadvantage: Only useful to evaluate portfolios that are well diversified.

Answer 49

* Ex-ante future returns expected it’s a standard deviation of error * Used to measure a portfolios performance with a benchmark, but accounts for differences in risks. * Rewards per incremental unit of risk created by deviating from the benchmark holdings

Answer 50

* Raito of returns to risks from active management * The active return per unit for a unit of active risks * Considers the managers value per unit of non-systemic risk

Answer 51

* Very Similar to the Sharpe ratio * Only considers the standard deviation of the downside risk * Clients are more concerned with risks of negative returns * Penalizes bad volatility by considering returns only below the minimum accepted return * For investments that have non-systematical or skew return distributions * Considers target-relative return per unit of downside risks

Answer 52

* Determines the management relative performance when a market is either up or down * This both would be the opposite in an upward market * Downside capture vs upside capture **If the capture ratio is:** * >1 positively asymmetrical convex return profile more upside than downside * <1 negative asymmetrical concave return profile more downside vs upside

Answer 53

* Represents the peak to trough loss in portfolio value during a continues period of negative returns * Measures the total time from the start of the drawdown until recovery to the previous peak **Can be broken-down into:** * Drawdown Phase * Recovery Phase

Answer 54

Total time that is full recover form a drawdown when a drawdown begins to when up to a cumulative drawdown reverse cand becomes zero

Answer 55

Occurs at the very end of the drawdown phase and right before it hits the recovery phase it’s the point at which the cumulative drawdown is at its highest

Answer 56

is used to evaluate the external managers returns because they ignore factors they have no discretion.

Answer 57

* Rejecting the HO when in fact it is true * Believe the manager adds value when they do not * Are easier to determine because we can measure a manager’s vs a benchmark * Results in costs associated in retaining management is weak

Answer 58

* Accepting the HO when in fact it is false, Beta Error * Believe the manager does not add value, when they do * Errors are harder to determine as how do we compare them (there are opportunity costs) * If there is an excessive number of type-2 errors indicates that there is a problem of hiring and firing * Bad decision result in cost associated with not retaining these managers **Solutions to Prevent Type 2 Errors:** * Reduce by tracking the subsequent performance of those managers that were not hired or fired * When there is any type of personal changes should not be done by short-term performance

Answer 59

* Fees based on a percentage of assets under management. * The assets will grow due to manager skill and effective marketing * Over the short term, market cycles can affect AUM for reasons not linked to the manager. * The principal-agent problem can occur * This potential conflict is addressed through performance-based fees.

Answer 60

* Fees designed to reward manager performance. * May be based on absolute returns, or benchmark-relative returns. * Symmetrical exposure: Manager earns a base fee and shares in the gains/losses of the fund * Capped symmetrical exposure: Manager shares in gains above the base fee up to a limit, but not losses **Asymmetrical (upside) exposure:** * The manager shares in gains above the base fee, but not losses * Offers the manager unlimited upside and capped downside, similar to a call option.

Answer 61

* Create tension when base fees must be paid in periods of poor performance. * Reduce variability in net returns * Cause managers to unethically favor clients * Cause delay in realizing investments until performance fees can be earned * Cause hedge fund managers to return capital to investors when significantly below the high-water mark

Answer 62

* Most effective for active stock selection portfolios * Captures both the holdings and the transactions (purchases/sales) completed within the period * Allow the entire excess return to be quantified and explained

Answer 63

Most appropriate when the underlying portfolio holdings are not readily available with sufficient frequency at the required level of detail (hedge funds).

Answer 64

* Most appropriate for investment strategies with little turnover (passive strategies) * Only references the beginning-of-period and end-of-period holdings and ignores individual transactions.

Answer 65

* Sufficient expertise and experience * Sufficient depth to execute the strategy * Exposure to key-person risk * Incentives to reduce personnel turnover * Consistent investment strategy

Answer 66

* Trade policy document should describe the factors used in determining how an order can be executed in an optimal manner for a given scenario. * Any resulting gains/losses need to be disclosed to the compliance department and documented in a trade error log. * The priority is to ensure errors are resolved in a way that prevents adverse impact for the client, not to ensure complete disclosure.