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CFA Level 3 Part 1
Notes
| Question | Answer |
|---|---|
| Monte Carlo Simulation | Generate a large number of potential outcomes from asset allocation strategies resulting in a frontier of risk and reward. This is analogous to the efficient risk-return frontier concept in traditional finance. |
| Lifestyle planning strategy | The lifestyle protection strategy allocates amounts to equity and debt in order to minimize shortfall risk (the risk that the objective is not funded). It allows for more upside potential than the fixed planning horizon method. |
| Fixed Horizon strategy | The fixed planning horizon method dedicates an amount to zero coupon bonds that when mature will fund the minimum objective. It is less likely to fund the more expensive objective. |
| IPS - Objectives and Constraints | OBJECTIVES 1. Risk Tolerence A. Ability B. Willingness 2. Return Objectives CONSTRAINTS 1. Time horizen 2. Liquidity horizen 3. Legal/regulatory 4. Taxes 5. Unique considerations |
| Currency Risk | Measures the risk incremental to foreign asset risk from currency risk. The difference between the asset risk in domestic currency terms and the risk of the foreign asset in foreign currency terms. |
| Roy's safety First | Used to determine the number of standard deviations the expected return on the portfolio is away from the minimum threshold SF = (RP – RMIN)/σP |
| safety first ratio | E(r) - 2 std dev |
| Buy and hold vs. Constant mix vs. CPPI | Trending markets: CPPI > Buy and Hold > Constant Mix Flat but oscillating markets: Constant Mix > Buy and Hold > CPPI |
| Sharp Ratio | (R - Rf)/(std dev) |
| Risk of foreign investment in domestic terms | A = Std dev of foreign stocks to foreign dollars B = Std dev of domestic currency to foreign exchange rate C = Correlation between exchange rate and foreign investment portfolio std dev^2 = A^2 + B^2 + (2 x A x B x C) |
| Contribution of Currency Risk | Diffence between risk of foreign stocks in domestic terms and risk of the foreign stock in foreign terms |
| Correlation between asset and currency movement | Developed markets: negative - when currency depreciates, the firms in those markets can export more and their stock rises. Emerging Markets: Positive - currency devaluations are often accompanied by a lack of confidence in the stock markets |
| Utility Adjusted Return | U = R - 0.005*A * variance If you use percentage form for U, R and variance, then the coefficient is 0.005. If you use decimal for all of them, then the equation becomes: U = R - 0.5 *A *variance |
| Total dollar return on a foreign asset | R$ = RLC + S + (RLC x S) RLC = return in local currency S = Change in the foreign currency |
| Constant proportion portfolio insurance (CPPI) | Set a floor on the value of portfolio, then structure asset allocation. Two asset classes are a risky asset and riskless asset. % allocated to each depends on "cushion" value (current portfolio value – floor value), and a multiplier coefficient. |
| Rebalence portfolio to original dollar duration while maintaining proportions | Rebalancing ratio = old DD / new DD Subtract 1 from the answer and multiply each security to find the increase or decrease necessary |
| Repo loan | Amount of Loan = Nominal loan amount × (100%- repo margin) Cash due at conclusion of repo = Loan amount + (Loan amount × repo rate × (days/360)) |
| Duration of a leveraged portfolio | Dollar price change in the leveraged portfolio when rates change 100 bps: Portfolio Value × duration × .01 % change in equity portfolio value for a 100 bps change in interest rates: Dollar price change / Equity |
| convexity | Negative convexity means that as market yields decrease, duration decreases as well. Positive convexity means as market yields decrease, the duration increases (and vice versa). |
| breakeven yield change in basis points | 100 × (% change in price / -duration) The price of the higher yield bond has to appreciate in order to make up the yield differential. |
| foreign currency bond vs domestic currency bond | foreign currency bond trades at a yield disadvantage if the forward discount/premium combined with the yield differential has a negative value. (foreign bond yield − domestic bond yield) − (foreign risk-free rate − domestic risk-free rate) < 0 |
| information ratio | expected active return divided by tracking risk The information ratio is calculated as the surplus return divided by the standard deviation of surplus returns. The cost in the information ratio is the standard deviation of surplus returns. |
| short extension strategy | Short part of the portfolio and take the proceeds & purchase undervalued securities in the same amount. Doesn't use derivatives. A short extension strategy has a beta of greater than 0. |
| Alpha and beta separation strategy (AKA portable alpha) | Get beta exposure from passive (indexed) strategies and alpha exposure from long-short market neutral portfolios. |
| Information Ratio | Information coefficient times the square root of the investor’s breadth |
| opportunity cost selling straegy | Investor factors in the transactions costs and tax consequences of the sale of the existing security and the purchase of the new security |
| Value at Risk (AKA variance-covariance or delta normal method) | Measures left-tail risk. Assume normal distribution. Calculate the stddev of daily returns in the past & assume it will be applicable to future Use expected 1 day return and std dev to etimate the 1 day VAR at desired level of significance. |
| Option hedge ratio | Number of options = Total Stock Value x (-1 / Delta Per option ) |
| adjust duration in portfolio | notional principal = portfolio value x (new D - Old)/ (instrument duration) |
| Number of contracts needed to create a synthetic position | (Value × (1 + risk free rate)^T) / (futures price × multiplier) |
| 3 types of Exchange Rate risk | 1. Transaction - exchange rates will change the real value in the domestic currency of the contracted price 2. Translation - Causes variance between reported figures 3. Economic - loss of sales if domestic currency appreciates relative to a foreign |
| Synthetic T bill | synthetic T-bill = Stock - Stock future synthetic stock = Synth. T bill + stock future |
| Bear Call spread | Used when a decline in the price of the underlying asset is expected. Sell call options Buy the same number of calls at a higher strike price. Max profit = price paid for the long option less amount collected on the short option. |
| straddle (option strategy) | Buy both a call and put with the same strike price and expiration date. Use if stock price will move significantly, but unsure as to which direction. The stock price must move significantly if the investor is to make a profit. |
| net profit/loss of a hedged position in domestic currency terms | (Vt St - V0 S0) – V0 (Ft - F0) V0: Value of foreign assets at t0 in foreign currency Vt: Value of foreign assets at t in foreign currency Vt*: Value of foreign assets at t in domestic currency St: Spot rate at t Ft: Futures exchange rate at t |
| sortino ratio | The Sortino ratio examines the downside risk of returns. It is calculated as the portfolio return minus the minimum acceptable return (MAR) divided by a standard deviation that only uses returns below the MAR |
| Value at Risk | VAR = (portfolio value)[expected Rp + Z(σ)] |
| commodity forward price with an active lease market | F = S x e^[(rf-LR)T] LR = Lease Rate |
| backwardation | Downward sloping forward curve (as in an inverted yield curve). Difference between the forward price and the spot price is less than the cost of carry, or when there can be no delivery arbitrage because the asset is not currently available for purchase. |
| Contango | Upward sloping forward curve (as in the normal yield curve). The price of a commodity for future delivery is higher than the spot price, or a far future delivery price higher than a nearer future delivery. This is a normal situation for equity markets. |
| Ethical responsibilities in the Asset Manager Code of Professional Conduct | Act ethically & professionally Act in best interest of client Act in an objective & independent manner Use skill, competence, and diligence Communicate accurately with clients on a regular basis Comply w/ all legal and regulatory requirements |
| How often to value portfolios under GIPS | Prior to 2001 - at least quarterly 2001-2010 - monthly 2010 - w/ any large, external cash flow |
| Modified Dietz Method | (EMV - BMV -CF)/(BMV + Sum weighted cash flows) Wi = (CD-Di/CD) CD = # of dates in period Di = cash flow date |
| Input data under GIPS | From 2010 - Use calender or business month end From 2005, use trade date accounting Accrual accounting for fixed income From 2006, all composites must have same beginning and ending annual dates. |
| required ratios for presentation for GIPS private equity | Total value to paid-in capital Cumulative distributions to paid-in capital Paid-in capital to committed capital Residual value to paid-in capital. |
| Term Structure of interest rates - flat yield curve | Interest rates increase due to higher inflation expectations and tighter monetary policy. Higher short term rates reflect less available money, as monetary policy is tightened, Higher inflation later in the economic cycle. |
| Term Structure of interest rates - steep yield curve | "Loose" monetary policy Credit/money readily available Occurs when stimulating economy post recession or slowdown Low short term interest rates: easy availability of money and low/declining inflation. Higher long term rates: fear of future inflation |
| term structure of interest rates - higher short than long | Tight monetary policy Shortage of money and credit drives up the cost of short term capital. Longer term rates stay lower, as investors see an eventual loosening of monetary policy and declining inflation. |
| Treynor measure for portfolio performance | Measures risk-adjusted portfolio performance. (port. return - rfr)/(port beta) |
| steps to construct a custom security based benchmark | 1. Identify the manager’s investment process including asset selection and weighting. 2. Use the same assets and weighting for the benchmark. 3. Assess and rebalance the benchmark on a predetermined schedule. |
| within sector selection return | ∑Bj(RPj - RBj). Bj = benchmark weight RPj = portfolio return RBj = benchmark return |
| pure sector allocation return | Multiply the weighting differences between portfolio and the benchmark for each sector by the difference in returns between the benchmark sector and overall benchmark return or ∑(wPj - wBj)(RBj - RB). |
| m squared ratio | m2 = stddev of benchmark *(rp-rf)/stddev(port)+ rf |
| currency allocation effect | 1. Calculate diff between U.S. dollar return and local currency return for portfolio and benchmark in each country 2.SUM(wp Cp) - (wb Cb) wp: port wght cp: diff between US and port. local return wb: bench. wght cb: diff between US and bench local re |
| market allocation effect | SUM(Wp - Wb)x (blr) blr = local benchmark return |
| semivariance | Measures the dispersion of all observations that fall below the mean or target value of a data set. Semivariance is an average of the squared deviations of values that are less than the mean. |
| # of contracts needed to change port. beta | (New beta - Old beta) x (port value/(future beta x contract price)) |
| fixed for fixed swaps | 1. determine notional principal 2. Translate it into second currency 3. determine interest payments |
| bull spread | buy the lower strike price, sell the higher strike price |
Created by:
fongholio