Points to remember

#
1
2
3

9
10

11

12

13

14

15

16

17
18

19
20
21
22

23

24

25
26

27

28

29

30

31

32

33

34

35
36

37

38

39

40

41

42

43

44

45

46
47

48

49

50
51

52

53

54

55

56

57

58

59

60

61

62
63
64
65
66
67
68
69

70

71
72

73

74

75

76
77

78

79

80

81
82

83

84

85
86
87
 Points to remember
Details
Equities tend to perform well during periods of rising prices and inflation. Real estate also performs well during inflationary tim
during periods of inflation and rising interest rates.
Capital mobility approach to exchange rate forecasting
The capital mobility approach expands on uncovered interest rate parity by adding terms related to risk premiums for term, cr
those premiums, the capital mobility approach reduces to uncovered interest rate parity.
Expected repricing return = change in P/E ratio
Expected income return =  dividend yield − increase in shares outstanding
Expected nominal earnings growth =  real earnings growth + inflation
Seven-step process for formulating capital-market expectations
Low inflation can be beneficial for equities if there are prospects for economic growth free of central bank interference. Declin
declining economic growth and asset prices. The firms most affected are those that are highly levered because they are most s
Low inflation does NOT affect the return on cash instruments.

In the early expansion phase of the business cycle, stock prices are increasing. This is due to the fact that sales are increasing b
Labor will not ask for wage increases because unemployment is still high. Idle plant and equipment will be pushed into service
usually emerge from recession leaner because they have shed their wasteful projects and excessive spending. Later on in the e
and stock returns slows because input costs start to increase. Interest rates will also increase during late expansion, which is a

Degree of segmentation of zero indicates complete integration. In that case, the Singer-Terhaar approach would yield a risk p
RP = ρ(i,M) × σ(i) × SR
6% = 0.85 × 15% × SR
Solving for the Sharpe Ratio results in a 0.471 Sharpe Raio.

E(RRE) = Cap rate + nominal NOI growth rate − %ΔCap rate =

Grinold-Kroner model
The econometric models approach can result in models that are quite reliable that include numerous variables that mimic rea
The economic models approach is more likely to result in models that are complicated and time intensive to create. It very inf
with accuracy.
UIP states that exchange rate changes between countries should equal the differences in their nominal interest rates. Success
A carry trade involves borrowing in a low interest rate currency and lending in a high interest rate currency.
Deflation reduces the value of investments financed with debt. In the case of real estate, if the property is levered with debt, l
declines in the investor's equity position. As a result, investors flee in an attempt to preserve their equity and prices fall furthe
deflationary periods when inflation and interest rates are declining.
In general, inflation rises in the latter stages of an expansion and falls during a recession and the initial recovery. Bond yields p
during a recession, however, they bottom out during the initial recovery stage.
Low inflation can be beneficial for equities if there are prospects for economic growth free of central bank interference. Declin
declining economic growth and asset prices. The firms most affected are those that are highly levered because they are most s
Low inflation does NOT affect the return on cash instruments.
In the fifth step of the formulation of capital market expectations, the analyst should use a consistent set of assumptions when
conclusions.

The OPEC meeting and probable outcomes could be anticipated and already factored into current oil prices leading to the leas
choices. Exogenous shocks usually lead to economic slowdowns, as in the case of an oil shock leading to higher prices, inflation
increased unemployment, and a slowing economy. A reduction in oil prices could be caused by a weak global economy with w
of oil in the global market. This would reduce the price of oil and boost the economy, potentially overheating it in which cause
interest rates that ultimately slow the economy down. In a financial crisis the result is usually characterized by banks becomin
the central bank to stabilize the banking system and economy by increasing liquidity and lowering interest rates.
The inflation index forecast suggests that deflation is expected. Nominal rate bonds should perform the best under that scena
the coupon payments would increase. Given the high-quality nature of the bonds, concerns about default are unlikely to dom
benefit.
The late expansion phase of the business cycle is characterized by high confidence and employment, increases in inflation, risi
prices. Investor nervousness increases risk during this period. The central bank also limits the growth of the money supply
Consistency over various time horizons is referred to as intertemporal consistency. Cross-sectional consistency refers to consis
Economic indicators are actually easy to understand and interpret.
A checklist approach actually allows for changes in the model over time.

The Singer-Terhaar model adjusts the CAPM for market imperfections, specifically segmentation. When markets are segmente
across borders.

If markets are segmented, two assets with the same risk can have different expected returns because capital cannot flow to th
calculating the risk premium under full segmentation, the Singer-Terhaar uses the local market as the reference market instea
correlation between the local market and itself is 1.0.

The portfolio's Macaulay duration is 7.97 (= 7.5 × 1.062). The Macaulay duration represents the investment horizon at which t
immunized against interest rate risk. Given that the manager's investment horizon of 7.5 years is shorter than Macaulay durati
yields will result in a return that is lower than the YTM, since the loss on the bond price will outweigh the increase in reinvestm
capitalization (cap) rates are positively related to both vacancy rates and they are inversely related to the availability of debt fi
U.S. Treasury Inflation Protected Securities (TIPS) are protected against increases in inflation. They would be needed the least
initial recovery phase of the business cycle, inflation is falling.
The manager should invest in equities or real estate. Equities tend to perform well during periods of rising prices and inflation.
during inflationary times. Bonds tend to underperform during periods of inflation and rising interest rates.
Equities tend to do well from a point when the economy is at a trough because future economic expansion positively impacts
will reduce the risk of the equity market, thus reducing required returns. The reduction in required returns will increase equity
over the period of increased integration.
Less developed and smaller financial markets, and wealth concentration are both signs that an emerging market is more susce
of cyclical industries, including commodities, is also a sign of increased risk.

At the trough of the business cycle, analysts should recommend an increase to equity exposure since equities tend to perform
improve. With interest rates expected to rise, an analyst should recommend reducing portfolios' bond exposures and duration
when interest rates rise. Analysts may recommend a barbell strategy (increase short-term and long-term bond exposure and r

The analyst can use the sample VCV matrix because the sample size of 52 × 3 = 156 sufficiently exceeds the number of asset cl
rule of thumb, the analyst needs more than 12 × 10 = 120 observations for the sample VCV matrix to be reliable and not subje
these conditions are satisfied.
The capital mobility approach expands on uncovered interest rate parity by adding terms related to risk premiums for term, cr
those premiums, the capital mobility approach reduces to uncovered interest rate parity.
Shortening maturity is the correct strategy since credit premiums have been shown to be especially generous at the short end
maturities of credit risky bonds would go against the empirical evidence about term and credit premiums. Moving from AA to
effective way to take on increasing credit risk because that would be a move towards safer investments and away from the ex

Combining information in the sample VCV matrix and the factor-based VCV matrix will result in more precise data and therefo
based VCV matrices are both biased (their expected values do not equal the true matrix returns, not even on average) and inc
increases in the factor-based VCV matrix, the model does not converge to the true matrix).

Investment strategies with a narrow investment focus (e.g., country-specific or sector-specific) are more likely to be passively
opportunities to generate alpha. Key person risk is more relevant for active managers, particularly if the ability to achieve supe
small number of individuals.
Considering investments relative to both style and size factors presents the opportunity for investors to target exposure to me
classifications (i.e., medium-cap, large-cap, value, growth, etc.) can change over time. This is a dynamic process. Categorization
customized beyond the standard S&P 500 Index. A small-cap growth stock should be benchmarked to something other than th

A major disadvantage of segmenting by size and style is that categories may be defined differently by different investors.

When segmenting by geography, a major disadvantage is that investing in a foreign market may offer lower exposure to that m
example, a domestic investor from a developed market buys shares in large companies in a foreign market to diversify. Howev
already diversified their business internationally and may even derive much of their income from the investor's country.

Shareholder engagement benefits all shareholders of the firm. Some investors incur the direct costs of engagement, while free
Active managers are most likely to be involved with engagement efforts, while passive investors typically avoid the associated
engagement involves uncovering information that is potentially both material and nonpublic, it does increase the risk of inside

Cash drag can have a positive effect on the value of the fund.

Packeting and buffering can be used to smooth stock migration between indexes and improve the investability of an equity ind
A free-float weighting adjusts a stock's outstanding shares for closely held shares that are not usually available for trading by m
Factor-based weighting strategies allow an investor to choose indexes with a high exposure to out-of-favor risk factors to incre
capitalization index. Because factor-based weighting includes elements of an active strategy, it should have higher operating c
transparent.
Optimization seeks to maximize desired results (e.g., returns) or minimize undesirable characteristics (e.g., variance).
The optimization process may result in a style tilt if the underlying index has a style tilt. That is not necessarily an undesirable o
Minimizing tracking error will not always minimize variance per unit of return (i.e., it will not always be mean-variance efficien
ETFs are traded throughout the day on an exchange.
An authorized participant acts as the market maker for an ETF's shares. It is also the intermediary between investors and the E
and redemption of the ETF's shares.
Intraday trading of the constituents of an indexed portfolio can have a positive or negative effect on the portfolio's returns rel
The same is true of cash drag, which has a positive (negative) effect on the indexed portfolio's returns when the market is falli

The passive managers may have a greater obligation than active managers to engage in activist actions.

Generally, the larger the number of index constituents, the higher the tracking error. This is because a full replication approac
costly for larger indexes.
Liability funding is more accurately controlled.
Tactical asset analysis often operates on the assumption that the market overreacts to information.
Tactical asset analysis is typically performed routinely as part of a continuing asset management, attempts to take advantage o
relative prices of securities in different asset classes, and assumes that investor's risk tolerance is unaffected by changes in we

Multifactor models can be used to isolate systematic risk exposures.

Because the consultant only takes into account the investor's risk and return preferences, he is using the asset only approach
Strategic asset allocation reflects the investor's desired systematic risk exposure. Strategic asset allocation employs a long-term

The most appropriate asset allocation strategy is the tactical strategy. This strategy assumes that the investor's risk tolerance i
expectations are subject to frequent change. The tactical strategy assumes that investment allocation decisions are based on c
risk tolerances do not change with changes in wealth levels. For example, when the market conditions are bearish, the investo
respect to capital commitments to stocks and will allocate a consistent level of his portfolio to cash or bonds. In bull market or
risk tolerance will not change and would continue to allocate consistent amounts to stocks and cash or bonds.

The location of the market portfolio on the efficient frontier is found by drawing a line from the risk free asset that is tangent t
tangency is known as the global market portfolio.
ALM and asset-only approaches are used for strategic not tactical asset allocation. With ALM an investor's optimal asset alloc
liability modeling. Allen is incorrect: with asset-only strategies, liabilities only indirectly impact the return objective. Asset-only
ALM for controlling risk. Immunization and cash management are ALM approaches.

Positive economic net worth. This implies that the: value of economic assets exceeds the value of economic liabilities.

A taxable portfolio must pay taxes when the portfolio is profitable (or receive a tax loss carryforward when the portfolio has a
in profitable periods and reduced losses in loss periods demonstrates that after-tax volatility is lower than pre-tax volatility.
Carry in currencies (as well as commodities and fixed income) is an example of systematic TAA; systematic TAA uses strategies
predicable and persistent. In the specific case of currencies, TAA determines which currencies should be overweighted or und
interest rate expectations.
Prior to a sale, when the cost basis of an asset exceeds its market value, the asset has an unrealized loss. The primary reason f
losses is to engage in tax loss harvesting. Tax loss harvesting involves realizing capital losses against current or future realized c
overall tax liability.
The risk-adjusted TAA portfolio's effectiveness is best assessed by plotting its realized risk and return against the risk and retur
portfolio's efficient portfolio. Even if the TAA portfolio had better Sharpe and information ratios than the SAA portfolio, it could
portfolios along the SAA's efficient frontier.

With the additional donation, the endowment's size increased materially (i.e. 60%). Therefore, it allows the portfolio manager
portfolio by exploring new asset classes that may have been unavailable under the previous portfolio size as well as to re-evalu
liquidity and time horizon.
Investing the donation simply using the existing asset allocation ignores the potential for new asset classes and the revised ass
Investing the donation simply in riskier assets ignores the existing assets and fails to take a holistic view of the portfolio.

Reduce the allocation to alternative investments and equities and increase the allocation to fixed income with a shorter durati

POV algorithms are also known as participation algorithms

Arrival price algorithms are used when the order is not outsized. This means the sized should be less than 15% of the expecte
TWAP algorithms executes the trades by slicing it in small time periods. These orders are then executed within a given time
Small currency trades and small exchange-traded derivatives trades are typically implemented using the direct market access
The negative coefficient on SMB indicates that the manager had a slight large-cap bias relative to the benchmark.
Sortino ratio is more relevant when return distributions are not symmetrical, as with option writing. The Sortino ratio is also p
objectives is capital preservation.
this ratio allows an investor to evaluate whether excess returns warrant the additional non-systematic risk in actively manage
A capture ratio greater than 1 indicates positive asymmetry of returns, or a convex return profile.
A is correct. Maximum drawdown is the cumulative peak-to-trough loss during a continuous period. Drawdown duration is the
drawdown until the cumulative drawdown recovers to zero, which can be segmented into the drawdown phase (start to troug
to zero cumulative return). The maximum drawdown was –24.00%, with a drawdown period of four months. Given the 10-yea
recovered quickly from its maximum loss.
A critical element of manager selection is to assess if the investment process is superior, repeatable, and can be consistently a
Experienced investment personnel is a key aspect of investment due diligence. A strong back office and suitable investment ve
operational due diligence.
The focus of the initial screening process is on building a universe of managers that could potentially satisfy the identified portf
historical performance. Identifying a benchmark is a key component of defining the manager’s role in the portfolio, and third-p
way to build an initial universe which can then be further refined.
Type I errors are more easily measured than Type II errors. In addition, Type I errors may be linked to the compensation of the
errors of commission, whereas Type II are errors in omission. Firing a skilled manager is less transparent to the investor.
With regard to RBSA, if the portfolio contains illiquid securities, the lack of current prices on those positions may lead to an un
volatility in a returns-based style analysis. Longer return series generally provide a more accurate estimate of the manager’s u
return.
Availability bias is the tendency to be overly influenced by events that have left a strong impression and/or for which it is easy
A factor-based VCV matrix approach may result in some portfolios that erroneously appear to be riskless if any asset returns c
common factors or some of the factors are redundant.

The factors commonly used in the factor-based approach generally have low correlations with the market and with each other
factors typically represent what is referred to as a zero (dollar) investment or self-financing investment, in which the underper
finance an offsetting long position in the better-performing attribute. Constructing factors in this manner removes most marke
(because of the offsetting short and long positions); as a result, the factors generally have low correlations with the market an
commonly used in the factor-based approach are typically similar to the fundamental or structural factors used in multifactor

Collateral Support Annexes—CSAs—in which margin can be posted. Posting additional margin would typically not be a daily ev
extreme market moves.) in the context of FORWARDS
The three requirements for an index to become the basis for an equity investment strategy are that the index be (a) rules base
investable. Buffering makes index benchmarks more investable (Statement 2) by making index transitions a more gradual and
Compared with broad-market-cap weighting, passive factor-based strategies tend to concentrate risk exposure, leaving invest
the risk factor (e.g., momentum) is out of favor.
sector and industry rotation is a top-down strategy, consistent with the fund’s top-down approach
The first step in creating a quantitative, active strategy is to define the market opportunity or investment thesis. Then, relevan
transformed into a usable format. This step is followed by back-testing the strategy, which involves identifying the factors to in
Finally, the strategy performance should be evaluated using an out-of-sample back-test.
Shrinkage estimation involves taking a weighted average of a historical estimate of a parameter and some other parameter es
the analyst’s relative belief in the estimates. A shrinkage estimator of the covariance matrix is a weighted average of the histo
alternative estimator of the covariance matrix.
Checklist assessments are time consuming because they require looking at the widest possible range of data and may require
Availability bias is a bias towards allowing expectations to be unduly influenced by a previous event that left a significant impr
Status quo bias is a bias toward recent observations as being predictive of the future.
 Potential Questions

Suppose that an equity market has a degree of segmentation of zero, a standard deviation of 15%, and a 0.85 correlation with
Suppose that the equity market has a risk premium of 6%, the Sharpe Ratio of the global market is closest to:

Which asset would perform the worst during deflationary periods?

In initial recovery inflation and bond yields tend to be low

Which of the following regarding the formulation of capital market expectations is least accurate? An analyst should:
Checklist approach to economic forecasting

A coupon-paying bond will have a Macauley duration less than the term. Therefore, the duration in this case is less than the in
When duration is less than investment horizon, an increase in interest rates will benefit the portfolio due to reinvestment at th
resulting in a realized return that is greater than initially expected.
When markets are falling, it is better to hold cash and therefore, cash drag actually benefits the fund. The benchmark is assum
invested, therefore, it is not subject to cash drag. The use of futures contracts is an example of a derivatives strategy that can
equity exposure to a portfolio. That will avoid or reduce cash drag compared to if the portfolio were simply invested in cash.

If a stock is always included in the benchmark and the passive managers are tracking that benchmark, then the passive manag
permanent shareholders. In such a case, the passive managers may have a greater obligation than active managers to engage
because the latter can easily sell their shares if desired.
For passive managers who are trying to match the performance of a benchmark, it is not as easy to sell the underlying shares i
compared to active managers who are trying to outperform the benchmark.
Both active and passive managers have a fiduciary duty to vote proxy shares in the best interests of their investors. The active
usually do so directly. Due to the expense and time, however, most passive investors will usually do so indirectly through prox
In both cases, however, the duty to vote proxy shares for their investors has been performed.

The asset-liability approach to strategic asset allocation is desirable because liabilities are more accurately controlled.

Multifactor models can be used for asset allocation by creating factor portfolios, which isolate systematic risk exposures (i.e., n
risks). Risk factors can be used as units of analysis in asset allocation. But one problem is that it is not always easy to determin
those identified risk factors. Some may be investable and others may not. Asset classes are by definition assets that are owned
though the cost and ease of investing varies.
Strategic asset allocation establishes a portfolio's long-term asset class exposures by integrating each element of investment p
market expectations. It affords an investor the ability to control systematic risk exposures by aligning their risk and return obje
actual portfolio of investments. Tactical asset allocation involves adjustments away from the strategic mix to take advantage o
projections of relative asset class performance

According to modern portfolio theory, only systematic risk is rewarded. Total risk (may be measured by standard deviation) is
systematic and unsystematic risk.

Desirable asset classes would explain a high proportion of portfolio returns and thus have a high R-squared. The asset mix pro
manager should be easily measured.

A positive economic net worth implies that the value of the organization's economic assets exceeds the value of economic liab
Economic assets and liabilities includes the traditional accounting balance sheet assets and liabilities as well as extended portf
liabilities that are not included on traditional balance sheets. Therefore, extended portfolio assets and liabilities alone do not c
net worth. Although it would be unusual in practice, the economic net worth could be positive in theory even if the accounting
negative.

Although the pension plan is currently fully funded, it has a high exposure to potentially illiquid alternative investments. In add
of its fixed income portfolio is too high and exceeds the average time until retirement (7 years, assuming age 62 retirement ag
the reduction in the average retirement age to 58 will result in increased liquidly needs. The fund needs to reduce its allocatio
(alternative investments and equity) and increase its allocation to less risky assets (fixed income with a lower duration).
 During economic disastors, the positive point is that the old inefficinent production can be replac
A financial system allows an economy to channel resources to their most efficient use and crisis a
The long-term real government yields converge to the long-term economic growth rate of a coun
Aggregate MV of equity = Nominal GDP x share profits in an economy x P/E ratio

Econometric Indicators
Lagging 0.67% 12
Coincident
Leading

Value of equity = GDP x E/GDP x P/E

CAPE of PSX

using LEI for time series model

financial model designed to capture cyclical turning points
secular forces in an economy
black-litterman model
Grinold-Kroner model

Grinold Kroner model D/P + (%E - %S) + Inf + %P/E

Singer-Terhaar Model RP(i) ΦRP(G) + (1 - Φ)RP(S)

Φ Correlation of global market with the portfolio R(B) = σ(B) x ρ(i,M) x SR(m
RP(G) Sharpe ratio R(e) = σ(e) x ρ(i,M) x SR(m
ρ(i,M)σ(i)*SR 6.0053%
Integration of local market with the global

Overshooting relationship

Objective function E(Rm) - 0.005ʎσ^2

ʎ willingness and capacity to take risk

safety first ratio (ER - Threshhold amount) /SD

Asset allocation from risk budgeting perspective

It is optimal when the Excess return to MCTR is equal for every assets classs and that is equal to the SR of the tangency portfol
MCTR B(1) x STD (P)

Funding ratio = value of assets / value of liabialities [underfunded or overfunded]

Discount rate in DBP is the yield on the high quality corporate bond
Surplus optimization

Seven-step process for formulating capital-market expectations

Revise all formulas including the Taylor rule
Phases of Expansion Inflation Bonds Equities
Initial Recovery Falling low yields Perform better
Early Expansion Start to increase
Late Expansion
Slowdown Does not perform better
Contraction Does not perform better

Taylor rule Neutral = Neutral rate + Expected Inflation + 0.5(Expected Inflation - target Inflation+ 0.5(Expecte
A popular order management system is Charles River

Derivatives
Stock Long call short put
Short position on a stock Shart call long put

In order to exploit arbitrage opportunity, we create a synthetic position

The behavior of the fixed income futures is dependent on the underlying bond that is
CTD
Cross-currency basis swap
In this context, the basis is the difference between interest rates in the cross-currency
basis swap and those used to determine the forward exchange rate

Fixed Income
Butterfly Spread 2 x Body - (Wings) Curve Trade (3 ways) In t
If curvature is going to rise, then it means butterfly spread is going to increase. 1) In the upward sloping
In the above scenario, the active fixed income manager is going to execute Barbell strategy 2) Buy T-Bond futures
Long Barbell and short bullet is called leveraged barbell strategy 3) Intersest rate swap (Re

When we are bullish on the Bond market then there can be a "Bull steepner"
In this case D(P) > D(B) as the yields are expected to fall and the bond prices are expected to rise and the key rate exposure sh
if we buy call option on bonds, then the duration is expected to rise on the bond portfolio
In the event interest rates fall, we will buy call option on bonds as we want to increase the duration and convexity of the bond
Buying T-Bond futures is also expected to increase the duration of the bond portfolio and it is a intra-carry trade.

Trading, Performance Evaluation, and Manager Selection

The most common intra-day price benchmarks are: TWAP and VWAP. Portfolio managers choose TWAP when they wish to exc
Pre-trade benchmarks include decision price, previous close, opening price, and arrival price. A pre-trade benchmark is often s
t production can be replaced with the efficinent production
st efficient use and crisis arise when the participants lose their confidence in other fulfilling their obligations
omic growth rate of a country

0.0804

Model
1 Major Issues/ Key Drivers
Hard to forecast and control by the management
Therefore, multiple options

3% 2% 1% 0.5% 2.0%
8.50%

R(B) = σ(B) x ρ(i,M) x SR(m)

R(e) = σ(e) x ρ(i,M) x SR(m)

52 3 156

factor exposures
asset allocation
risk budgeting

SR of the tangency portfolio

ded or overfunded]

3.9
1.10 46.10

3.88
rget Inflation+ 0.5(Expected GDP - GDP long-term trend

Curve Trade (3 ways) In this we are expecting the yield curve will remain the same
 1) In the upward sloping curve, we borrow at lower interest rate bonds and invest in the higher interest rate bonds
2) Buy T-Bond futures
3) Intersest rate swap (Receive Fixed)

d the key rate exposure should more towards the short-end of the yield curve

and convexity of the bond portfolio

a-carry trade.

WAP when they wish to exclude potential trade outliers

trade benchmark is often specified by portfolio managers who are buying or selling securities on the basis of decision prices.
rate bonds

of decision prices.
 Phases of Business Cycle

Diffusion Index
A diffusion index is a cross-sectional method to analyze common tendencies among multiple time-series.

A diffusion index is a statistical measure often used to detect economic turning points. It aggregates multiple indica
examining whether they are trending upward or downward, but ignores the magnitude of the movement.

Active Equity portfolio management Strategies

1 Top-Down Strategies
2 Bottom-up Strategies
3 Factor-based Strategies
4 Activist Strategies
5 Other Strategies

1 Top-Down Strategies
Country and geographical allocation to equities
Sector and Industry Rotation
Volatility-based strategies
Thematic Investment Strategies

2 Bottom-up Strategies
Value and Growth Based Strategies
 3 Factor-based Strategies

4 Activist Strategies

5 Other Strategies
Strategies based on statistical arbitrage and market microstructure
Event-driven Strategies

Reserve Portfolio

The component of an insurer’s general account that is subject to specific

regulatory requirements and is intended to ensure the company’s ability to
meet its policy liabilities. The assets in the reserve portfolio are managed
conservatively and must be highly liquid and low risk.

Surplus Portfolio

The component of an insurer’s general account that is intended to realize

higher expected returns than the reserve portfolio and so can assume some
liquidity risk. Surplus portfolio assets are often managed aggressively with
exposure to alternative assets.
The component of an insurer’s general account that is intended to realize
higher expected returns than the reserve portfolio and so can assume some
liquidity risk. Surplus portfolio assets are often managed aggressively with
exposure to alternative assets.

Equitization

Temporarily investing cash using futures or ETFs to gain the desired equity
exposure before investing in the underlying securities longer term.
Equitization may be required if large inflows into a portfolio are hindered by
lack of liquidity in the underlying securities

Execution risk

Execution risk is often proxied by price volatility. Securities with higher

levels of price volatility have greater exposure to execution risk than
securities with lower price volatility.

Scheduled algorithms
No adverse price movement
Scheduled algorithms are appropriate for orders in which portfolio Size: 5% - 10% of Vol.
managers or traders do not have expectations for adverse price movement
during the trade horizon. Scheduled algorithms are often appropriate when Liquid
the order size is relatively small (e.g., no more than 5%–10% of expected
volume), the security is relatively liquid, or the orders are part of a risk-
balanced basket and trading all orders at a similar pace will maintain the
risk balance.

Effective performance attribution

Performance attribution helps explain how performance was achieved; it

breaks apart the return or risk into different explanatory components.
Effective performance attribution must account for all of the portfolio’s
return or risk exposure, reflect the investment decision-making process,
quantify the active decisions of the portfolio manager, and provide a
complete understanding of the excess return/risk of the portfolio.
multiple time-series.

s. It aggregates multiple indicators by

de of the movement.
Condor Strategy
The dollar smile is a theory th
currencies when the U.S. eco
spectrum, just like the smile

Why ?
“The dollar is a safe haven; it

Previous Data
Φ
(1-Φ)

New Data
Φ
(1-Φ)
The dollar smile is a theory that says the U.S. currency tends to increase in value against other
currencies when the U.S. economy is extremely weak or very strong. It goes up at either end of the
spectrum, just like the smile on your face.

“The dollar is a safe haven; it has the biggest economy, the strongest bonds, and the largest military.”

Singer-Terhaar Model

ΦRP(g) + (1-Φ)x RP(s)

Previous Data
0.55 0.033 0.018 4.79% Net Change 0.60%
0.45 0.066 0.030

0.75 0.0378 0.028 4.19%

0.25 0.054 0.014
 lessons from COVID-19
The risk of the financial instruments have become dynamic in nature
Stocks offering less than 10% might get shot off the market
Young firms with less fixed capital did much better than capital intensive firms

Eliminating the effect of forex movements

1QFY21 1QFY20 Change
Net income 12,302 2,515 389%
Forex G/L (3,631) 3,221
Adj. net income 8,671 5,736 51%

Growth is not always good as it may eat the valuation of the company through capital investment .
This is because higher growth demands higher reinvestment in terms of capital
REV phenomena Drivers of silver prices
Redistribution policies Bullish market : Governments spending on lower income household that will create
Environmental policies Solar panel demand or green capex
Varitility in supply chains Biden administration approving its solar program

Risk tolerance of the define benefit plan is determined by:

1 The overfunded status tells us that the plan can withstand higher level of volatility
2 The size of the plan relative to the size of the company
3 The age of the workforce implies higher duration of the plan
4 Higher turnover means that there will be less vesting of the plan
5 The debt ratio of the company
6 The correlation of the plan's returns to the operating result of the company

The performance of tech stocks in the inflationary environment

Tech stock are the longer duration assets in which an investor is not paid well into the
future and the investors should instead rather own parts of the market that are highly
correlated with the nominal GDP.
nvestment .

e household that will create demand for a commodity cyclical economic backdrop
1 CFA designation should always be used as an adjective

2 Free to solicit his former employer’s clients using public information.

3 One way the independence and objectivity of the candidate is threatened is through influence of material benefits

4
fluence of material benefits
Focusing on a specific sector, such as clean energy or climate change, is thematic investing.. Impact investing m
environmental objectives but additionally influences measurable financial returns through engagement with a compa
investment.

Disadvantages of using ETFs include the need to buy at the offer and sell at the bid price, paying commissions, an
illiquid markets at either purchase or sale. It is to be noted that ETFs can expereince the peiods of increased market

Using stratified sampling alone will increase the tracking error of that particular portfolio.

Momentum is a return-oriented approach whereas low volatility is a risk reduction approach.

Overlay using equity index futures. This approach can get the equity exposure up to at least the guideline range w
the active managers. Equity index futures will very likely have less tracking error than the active managers.

Buffering involves establishing ranges around breakpoints that define whether a stock belongs in one index or anot
providers have adopted policies intended to limit stock migration problems and keep trading costs low for investors w
indexes. Size rankings may change daily with market price movements, so buffering makes index transitions a more
orderly process. 

Securities lending is typically used to offset the costs associated with portfolio management. By lending stocks, ho
investor is exposed to the credit quality of the stocks’ borrower (counterparty or credit risk) and to risks involved with
collateral (market risk).

Merger arbitrage is a good uncorrelated source of alpha. Diversifying across a variety of mergers, deals, and indus
help hedge the risk of any one deal failing. Merger arbitrage does not exploit capital structure divergence in a single
relatively liquid strategy.

Systematic risk-factor approaches typically explain most or all of the risk and return patterns of public assets but fa
patterns for private assets

EMN managers are more useful for portfolio allocation during periods of non-trending or declining markets. EMN he
strategies take opposite (long and short) positions in similar or related equities having divergent valuations while atte
maintain a near net zero portfolio exposure to the market. EMN managers neutralize market risk by constructing the
that the expected portfolio beta is approximately equal to zero. Moreover, EMN managers often choose to set the be
industries as well as for common risk factors (e.g., market size, price-to-earnings ratio, and book-to-market ratio) equ
these portfolios do not take beta risk and attempt to neutralize many other factor risks, they typically must apply leve
and short positions to achieve a meaningful return profile from their individual stock selections.

Opportunistic strategies do have risk exposure to market directionality, also called trendiness. Opportunistic strate
macro themes and multi-asset relationships on a global basis; therefore, broad themes, global relationships, market
affect their returns. Generally, the key source of returns in global macro strategies revolves around correctly d
capitalizing on trends in global markets.
 When projecting expected returns, the order of returns from highest to lowest is typically regarded as priva
hedge funds, bonds. Therefore, the probability of achieving the highest portfolio return while maintaining the funde
plan would require the use of private equities in conjunction with public equities.

A traditional approach has been used to define the opportunity set based on different macroeconomic cond
primary limitations of traditional approaches are that they overestimate the portfolio diversification and obscure the p
risk.

The pension plan’s investment in private equities via a blind pool presents the prospect that less than perfect tr
be associated with the underlying holdings of the alternative asset manager. Capital is committed for an investment
assets that are not specified in advance. In addition, reporting for alternative funds is often less transparent than inv
accustomed to seeing on their stock and bond portfolios.

An absolute return hedge fund has a greater potential to diversify the fund’s dominant public equity risk than eithe
private real estate. Absolute return hedge funds exhibit an equity beta that is often less than that of private eq
real estate. Also, absolute return hedge funds tend to exhibit a high potential to diversify public equities, whereas eq
hedge funds exhibit a moderate potential to fulfill this role.

Public real estate as an asset class would likely offer less opportunity for capital growth and lower diversification be
equity long/short hedge funds as an asset class would provide a moderate degree of risk diversification in Pua’s all-
do not carry significant capital growth potential
investing.. Impact investing may target When using security lending, the voting rights are transferred to the
ough engagement with a company or by direct borrower of the securities

d price, paying commissions, and possibly facing  ETFs have smaller taxable events than mutual funds because of the in-
the peiods of increased market illiquidity. securities between an authorized participant and the fund when redempt

rtfolio. Relative to broad-market-cap-weighting, passive factor-based strategies

concentrate risk exposures, leaving investors exposed during periods wh
approach. factor is out of favor.

The total contribution to the return caused by active factor weightin

to at least the guideline range without impacting
n the active managers. (Underweighting of the Growth factor + Overweighting of the Quality fact

Packeting involves splitting stock positions into multiple parts. For exam
ock belongs in one index or another. Some index stock’s capitalization increases and breaches the breakpoint between th
trading costs low for investors who replicate large-cap indexes, a portion of the total holding is transferred to the large
makes index transitions a more gradual and rest stays in the mid-cap index.

agement. By lending stocks, however, the Activist short-selling funds take short positions and publicly share their n
it risk) and to risks involved with the posted fundamental views

ety of mergers, deals, and industries can further Equities and volatility is negatively correlated
structure divergence in a single company and is a

 Replacing investment-grade fixed-income securities with private equity

expected return but also increase portfolio return volatility
n patterns of public assets but far less of those
Convertible arbitrage strategies have performed best when convertible

ng or declining markets. EMN hedge fund

Equity market-neutral strategies do use a relative value approach. Equi
g divergent valuations while attempting to
strategies hold balanced long and short equity exposures to maintain ze
zero) net exposure to the equity market and such factors as sector and
market risk by constructing their portfolios such
cap). 
agers often choose to set the betas for sectors or
o, and book-to-market ratio) equal to zero. Since
s, they typically must apply leverage to the long
selections. Dedicated short selling and short-biased strategies have return goals th
less than those for most other hedge fund strategies but with a negativ
benefit. In addition, they are more volatile than a typical long/short equ
because of their short beta exposure
trendiness. Opportunistic strategies are based on
es, global relationships, market trends, and cycles
es revolves around correctly discerning and
 Cross-sectional momentum strategies generally result in holding a net z
neutral position. In contrast, positions for assets in time-series moment
determined in isolation, independent of the performance of the other a
strategy and can be net long or net short depending on the current pric
asset.
  Cross-sectional momentum strategies generally result in holding a net z
neutral position. In contrast, positions for assets in time-series moment
determined in isolation, independent of the performance of the other a
strategy and can be net long or net short depending on the current pric
is typically regarded as private equities, asset.
urn while maintaining the funded status of the

Risk factor-based approaches to asset allocation produce more robus

proposals.
ifferent macroeconomic conditions. The
diversification and obscure the primary drivers of

Short-biased equity strategies help reduce an equity-dominated portfo

Short-biased strategies are believed to deliver equity-like returns with le
exposure to the equity premium but with an additional source of return
ospect that less than perfect transparency will from the manager’s shorting of individual stocks.
is committed for an investment in a portfolio of
s often less transparent than investors are

nant public equity risk than either private equity or Short-biased strategies are expected to provide some measure of alph
ten less than that of private equity or private lowering a portfolio’s overall equity beta.
ersify public equities, whereas equity long/short

owth and lower diversification benefits. Also,

f risk diversification in Pua’s all-equity portfolio but
are transferred to the

l funds because of the in-kind transfer of

nd the fund when redemptions occur.

ve factor-based strategies tend to

exposed during periods when a chosen risk

by active factor weighting is

eighting of the Quality factor) ÷ Total effect

to multiple parts. For example, if a mid-cap

he breakpoint between the mid-cap and
g is transferred to the large-cap index but the

and publicly share their negative

urities with private equity will increase

urn volatility

ed best when convertible issuance is high 

tive value approach. Equity market-neutral

exposures to maintain zero (or close to
uch factors as sector and size (i.e., market

egies have return goals that are typically

tegies but with a negative correlation
n a typical long/short equity hedge fund

ly result in holding a net zero or market-

ts in time-series momentum strategies are
erformance of the other assets in the
nding on the current price trend of an
 ly result in holding a net zero or market-
ts in time-series momentum strategies are
erformance of the other assets in the
nding on the current price trend of an

ation produce more robust asset allocation

equity-dominated portfolio’s overall beta.

equity-like returns with less-than-full
dditional source of return that might come
ks.

ide some measure of alpha in addition to

1 Plan and design a model
2 Ask the right question
3 Keep the assumptions upfront
4 Make Data inputs blue - Never hardcode data into formulas
5 Build scenarios page to avoid multiple versions
6 Build financial statements vertically
7 Don't work on financial statements
8 Do all calculations on schedules
9 Build very simple formulas on the schedules
10 Repeat the data, then use it in formulas

1 Cover page
- makes it feel like a financial presentation
- Include: logos, company names, dates
-Automate the date
11/5/2022

2 Executive Summary
-This is the first thing you client will want to know "what's the answer ??"
-Can be customized for every model
- Include whatever youe client need to see to make their decision
- Rev fcst, EBITDA, valuation outputs, IRRs, Credit Stats, ect
Financing companies that accumulate such assets as loans as a result of their underlying business use
ADIs to structure their liabilities in a way that matches the maturities of the assets. In this manner,
the debt manager is seeking to minimize interest rate risk by better matching the duration of assets
and liabilities. With LDI, the liabilities are given and the assets are managed in a way that considers the
structure of the liabilities, as Shrewsbury correctly states in Point 1. An LDI strategy requires that the
liabilities be modeled to measure their interest rate sensitivity, as he correctly states in Point 3.

Bear Steepener
A bear steepener is the widening of the yield curve caused by long-term interest rates increasing at a
faster rate than short-term rates. A bear steepener is usually suggestive of rising inflationary
expectations–or a widespread rise in prices throughout the economy.

For parallel changes, the equal money durations and PV01 imply that assets and liabilities would move
in tandem

Given that the assets have lower convexity and dispersion than the liabilities, they will underperform; that is, the
liabilities would change by a greater amount than the assets.

The liabilities are estimated—that is, calculation of the PBO—using high-quality corporate bonds. The typically
wider spreads of lower-quality bonds may underperform the spreads of higher-quality bonds in a market sell-off.
Conversely, hedging the liabilities with swaps may not provide enough of a spread risk hedge relative to using
corporate bonds such that if spreads tighten, high-quality corporate bonds (used to discount liabilities) may
outperform swaps. Model risk refers to making incorrect assumptions regarding future liabilities or
approximations being inaccurate. Liquidity risk is associated with exhausting available collateral funds to meet
margin calls on derivative positions or to pay benefits.

Swaptions are a contingent security on interest rate swaps. A receiver swaption would allow the plan to receive a
fixed (higher) rate if rates rally, but at the cost of the swaption premium. To finance this receiver swaption, the DB
plan can sell a payer swaption to collect a premium that finances the receiver swaption. If rates rise above some
level, the plan would increase its duration by virtue of being put a swap. The plan may have anticipated closing the
duration gap at higher interest rate levels, so being put a swap is in line with an LDI program.
Swaptions are a contingent security on interest rate swaps. A receiver swaption would allow the plan to receive a
fixed (higher) rate if rates rally, but at the cost of the swaption premium. To finance this receiver swaption, the DB
plan can sell a payer swaption to collect a premium that finances the receiver swaption. If rates rise above some
level, the plan would increase its duration by virtue of being put a swap. The plan may have anticipated closing the
duration gap at higher interest rate levels, so being put a swap is in line with an LDI program.

A total return swap (TRS) is an over-the-counter portfolio derivative strategy that combines elements of interest
rate swaps and credit derivatives. There is an exchange of cash flows between the two parties over the tenure of
the contract, based on a reference obligation that is an underlying equity, commodity, or bond index. In this case,
the reference obligation would be a corporate bond index. Creation units are large blocks of exchange-traded
fund (ETF) shares traded against a basket of underlying securities; this transaction typically occurs between the
ETF distributor and a broker/dealer. Entering into a creation unit transaction is done to facilitate trading but does
not establish a passive bond position. The DB plan could use also use the actual ETF as an alternate passive
instrument.

Counterparty credit risk is essentially absent from exchange-traded derivatives, such as futures contracts, and can
be essentially eliminated from over-the-counter derivatives, such as swaps, through inclusion of a Credit Support
Annex. In contrast, model risk is implicit in the management of a defined-benefit pension plan, which is made up
of Type IV liabilities (uncertain amount and uncertain timing). Further, most fixed-income derivatives contracts
trade on credit risk–free government securities, and the pension plan’s assets consist of both investment-grade
and speculative-grade corporate securities, making spread risk difficult to eliminate from the management of the
portfolio.

Given that bonds typically trade in large blocks (in excess of USD1 million), attempting to build a bond index fund,
even with a stratified sampling approach, would be difficult given the small size of the portfolio. Although mutual
funds require payment of expenses, index funds benefit from economies of scale that are passed on to investors.
A synthetic approach using a total return swap and holding cash would work. Although it would require finding a
counterparty for a relatively small swap, conducting due diligence to control counterparty risk, and dealing with
occasional rollover risk, it would still have lower costs than building the portfolio directly.

The roll down return is equal to the bond’s percentage price change assuming an unchanged yield curve over the
strategy horizon. The roll down return results from the bond “rolling down” the yield curve as the time to maturity
decreases. As time passes, a bond’s price typically moves closer to par.

Duration matching approach

Compared with other weighting schemes, such as equally weighted, value-weighted indexes are tilted toward
issuers with higher levels of debt. The more an issuer or sector borrows, the greater the tilt toward that issuer in
the index. Leverage and creditworthiness are negatively correlated, so a value-weighted index will be more
susceptible to credit quality deterioration than an equally weighted index will be. BSCA is an equally weighted
index, whereas the others are value weighted.

Equity securities typically trade much more frequently than debt securities, so current market valuations are
available. Many fixed-income securities are very illiquid, trading very infrequently. Therefore, pricing and valuation
are difficult, and such estimations as matrix pricing, which are subject to error, must be used.

 the bullet portfolio would have the lowest convexity and the barbell portfolio would have the highest. The
laddered portfolio would have a convexity in between the two.
Floating-coupon bonds provide inflation protection for a bond’s coupon but not for its principal.

Horizon matching is a hybrid approach to liability-based mandates that combines cash flow matching and
duration matching. Cash flow matching intends to match a short- to medium-term liability stream (charity
donations for the first five years) to a stream of bond portfolio cash inflows. Duration matching further considers
that the bond portfolio’s reinvestment risk and market price risk offset each other as it relates to the charity
donations during Years 6 through 10.

An inverse floater is a bond or other type of debt instrument that has a coupon rate that varies inversely with a
benchmark interest rate.

Adding bonds of highly leveraged companies does not involve the use of leverage. The following methods of
leverage may be used to increase portfolio returns relative to an unleveraged portfolio: (1) futures contracts, (2)
swap agreements, (3) structured financial instruments, (4) repurchase agreements, and (5) securities lending.
Each of these methods adds leverage to an unleveraged portfolio, including, as in this example, an unleveraged
portfolio of bonds from highly leveraged companies.

Repurchase agreements and securities lending transactions are leveraged methods to increase portfolio returns
relative to an unleveraged portfolio.
A fixed-rate receive swap and an inverse floater are leveraged methods to increase portfolio returns relative to
an unleveraged portfolio.

Tax loss harvesting involves the timing of investment sales and thus the realization of gains and losses. Controlling
the timing of realizing gains and losses can be valuable for a taxable investor because it may be optimal to delay
realizing gains and related tax payments and to realize losses as soon as possible. Among the important
considerations of tax loss harvesting is a comparison of short-term and long-term capital gains rates.

When compared with the single liability due in four years, the portfolio has the same return and duration
characteristics of a single zero-coupon bond maturing in four years. The interest rate risk has been immunized,
which is known as zero replication.

Measurement error for Asset BPV can arise even in the classic passive immunization strategy for Type I cash
flows, which have set amounts and dates. Asset liquidity can become a risk factor in strategies that add active
investing to otherwise passive fixed-income portfolios and would not be applicable here.

Contingent immunization allows for active bond portfolio management until a minimum threshold in the surplus is
reached

A laddered portfolio has lower convexity and dispersion than a barbell portfolio but more than a bullet portfolio,
given comparable duration and cash flow yields. Lower convexity and dispersion are desirable aspects in liquidity
management. In a laddered portfolio, there is always a bond close to redemption enhancing liquidity. As bonds
mature, the final coupon and principal are available for distribution or can be reinvested in a long-term bond at
the back of the ladder. The Wharton portfolio is more of a barbell, has higher convexity than the Lawson portfolio,
and would see a larger reduction in cash flow reinvestment risk with the reduction of convexity.
A laddered portfolio has lower convexity and dispersion than a barbell portfolio but more than a bullet portfolio,
given comparable duration and cash flow yields. Lower convexity and dispersion are desirable aspects in liquidity
management. In a laddered portfolio, there is always a bond close to redemption enhancing liquidity. As bonds
mature, the final coupon and principal are available for distribution or can be reinvested in a long-term bond at
the back of the ladder. The Wharton portfolio is more of a barbell, has higher convexity than the Lawson portfolio,
and would see a larger reduction in cash flow reinvestment risk with the reduction of convexity.

Structural risk arises from the design of the duration-matching portfolio. It is reduced by minimizing the
dispersion of the bond positions, going from a barbell structure to more of a bullet portfolio that concentrates the
component bonds’ durations around the investment horizon

The two requirements to achieve immunization for multiple liabilities are for the money duration (or BPV) of the
asset and liability to match and for the asset convexity to exceed the convexity of the liability.

“bums” problem, which arises as a result of a market-cap-weighted portfolio increasing the weight of a particular
issuer or sector that has increasing borrowings.

Low tracking error requires an indexing approach. A pure indexing approach for a broadly diversified bond index
would be extremely costly because it requires purchasing all the constituent securities in the index. A more
efficient and cost-effective way to track the index is an enhanced indexing strategy, whereby Soto would purchase
fewer securities than the index but would match primary risk factors reflected in the index. Closely matching these
risk factors could provide low tracking error.

Although a significant spread between the market price of the underlying fixed-income securities portfolio and an
ETF’s NAV should drive an authorized participant to engage in arbitrage, many fixed-income securities are either
thinly traded or not traded at all. This situation might allow such a divergence to persist.

In immunization we have to lock-in the cashflow yield (IRR) of the bond portfolio.

 Non-parallel shifts as well as twists in the yield curve can change the cash flow yield on the immunizing portfolio;
however, minimizing the dispersion of cash flows in the asset portfolio mitigates this risk. 

Structural risk to immunization arises from twists and non-parallel shifts in the yield curve. Structural risk is
reduced by minimizing the dispersion of cash flows in the portfolio, which can be accomplished by minimizing the
convexity for a given cash flow duration level

The use of an index as a widely accepted benchmark requires clear, transparent rules for security inclusion and
weighting, investability, daily valuation, availability of past returns, and turnover. 

An investor having an investment horizon equal to the bond’s Macaulay duration is effectively protected, or
immunized, from the first change in interest rates, because price and coupon reinvestment effects offset for either
higher or lower rates.

 An upward shift in the yield curve reduces the bond’s value but increases the reinvestment rate, with these two
effects offsetting one another. The price effect and the coupon reinvestment effect cancel each other in the case
of an upward shift in the yield curve for an immunized liability.
 An upward shift in the yield curve reduces the bond’s value but increases the reinvestment rate, with these two
effects offsetting one another. The price effect and the coupon reinvestment effect cancel each other in the case
of an upward shift in the yield curve for an immunized liability.

Minimizing the convexity of the bond portfolio minimizes the dispersion of the bond portfolio. A non-parallel shift
in the yield curve may result in changes in the bond portfolio’s cash flow yield. In summary, the characteristics of a
bond portfolio structured to immunize a single liability are that it (1) has an initial market value that equals or
exceeds the present value of the liability, (2) has a portfolio Macaulay duration that matches the liability’s due
date, and (3) minimizes the portfolio convexity statistic.

Under an enhanced indexing strategy, the index is replicated with fewer than the full set of index constituents but
still matches the original index’s primary risk factors. This strategy replicates the index performance under
different market scenarios more efficiently than the full replication of a pure indexing approach.

Investment-grade bonds have lower credit and default risks than high-yield bonds and are more sensitive to
interest rate changes and credit migration, which cause credit spread volatility. The much higher credit loss
rate experienced with high-yield bonds results in an emphasis on credit risk and the market value of the position to
evaluate high-yield risk.

 G-spread, which uses a linear interpolation of the yields of two on-the-run government bonds as the benchmark
rate, weighted so that their weighted average duration matches the duration of the credit security. The most
appropriate measure for a portfolio-level spread is the OAS because it is challenging to apply the G-spread, I-
spread, or Z-spread to a diversified portfolio of credit securities because none of these spread measures would
reflect optionality in the relevant bonds.

 Hedging tail risks through portfolio diversification is not difficult to implement and only has modest incremental
cost. Hedging with derivatives, such as credit default swaps, is effective but costly.

Emerging market credit is characterized by a concentration in commodities and banking and government
ownership of some entities

The correlation of expected defaults on the collateral of a CDO affects the relative value between the senior and
subordinated tranches; as default correlations increase, the value of mezzanine tranches usually increases relative
to the value of senior tranches. Therefore, an investor is going to short Class A and long Class B tranche.

The benefit of roll down comes from riding the yield curve in a stable interest rate environment with an upward-
sloping yield curve. As bonds mature, they have shorter maturities and, therefore, lower required yields. As the
required yields decrease, the value of the bonds increase. If the portfolio’s holdings are concentrated at the
steeper parts of the yield curve, the roll down benefit is increased.

Typically, calls would be sold on bonds held by the portfolio, but puts could also be sold on bonds the portfolio
would want to own, such as the bonds that will be needed when the portfolio is rebalanced at the end of the
year. If volatility is lower than the level priced into the options, the portfolio will still benefit from selling options.
Typically, calls would be sold on bonds held by the portfolio, but puts could also be sold on bonds the portfolio
would want to own, such as the bonds that will be needed when the portfolio is rebalanced at the end of the
year. If volatility is lower than the level priced into the options, the portfolio will still benefit from selling options.

Under a flattening yield curve, a barbell portfolio (one with higher weights at the shortest and longest maturities)
will outperform bullet portfolios (higher weights at the middle of the yield curve) or laddered portfolios (relatively
even weights across the yield curve).

Spread risk is a function of credit migration. For investment-grade bonds, the risk of credit rating migration (credit
deterioration) is greater than the risk of actual credit loss. Accordingly, credit spread volatility, as opposed to
outright credit default loss, is a more relevant consideration as it relates to investment-grade bonds. Spread
duration measures the credit spread volatility risk in a portfolio of investment-grade bonds.

Bond B is most likely callable because of the difference between its option-adjusted spread (OAS) and its Z-spread.
The Z-spread is the yield spread that must be added to each point of the implied spot yield curve in order for the
present value of the bond’s cash flows to equal its market price. The OAS considers the value of optionality in a
bond’s cash flows. The theoretical value of a callable bond is less than that for an otherwise equivalent non-
callable bond because of the value of the call option (the issuer’s right to retire the bond prior to maturity) being
sold by the investor. The OAS is the constant spread that when added to all the one-period forward rates makes
the arbitrage-free value of the bond equal to its market price

Determining the timing and location of credit cycle weakening is an important top-down relative value
consideration for global credit portfolio managers. Regional differences exist in credit cycles, credit quality, sector
composition, and market factors.

 In order to take duration-neutral positions that will profit from an increase in the curvature of the yield curve,
Hirji should structure a condor. This condor structure has the following positions: long the 2-year bonds, short the
5-year bonds, short the 10-year bonds, and long the long-term bonds. Hirji’s allocation to the 2-year bond
position is calculated as follows:

If the forecast is correct and the yield curve loses curvature, the rates at either end of the curve will rise or the
intermediate yields will drop. As a result, bonds at the ends of the yield curve will lose value or the intermediate
bonds will increase in value. In either case, the bullet portfolio will outperform relative to a more diverse maturity
index portfolio like the benchmark.

 A bond’s empirical duration is often estimated by running a regression of its price returns on changes in a
benchmark interest rate.

Spread sensitivity is the effect on credit spreads of large withdrawals by investors from credit funds. Spread
sensitivity can be measured as the spread widening (in basis points) divided by the percentage outflow from high-
yield funds (funds withdrawn divided by assets under management). A decrease in the spread sensitivity to fund
outflows would most likely indicate an increase in liquidity.
The G-spread is the spread over an actual or interpolated benchmark (usually government) bond. A benefit of the
G-spread is that when the maturity of the credit security differs from that of the benchmark bond, the yields of
two government bonds can be weighted so that their weighted average maturity matches the credit security’s
maturity.

When an issuer announces a new corporate bond issue, the issuer’s existing bonds often decline in value and
their spreads widen. This dynamic is often explained by market participants as an effect of increased supply. A
related reason is that because demand is not perfectly elastic, new issues are often given a price concession to
entice borrowers to buy the new bonds. This price concession may result in all of an issuer’s existing bonds
repricing based on the new issue’s relatively wider spread. A third reason is that more debt issuance may signal an
increase in an issuer’s credit risk.

Bond Z has the lowest spread duration because it has the lowest credit rating. Credit spreads tend to be
negatively correlated with risk-free interest rates. One important reason for this phenomenon is that key macro
factors, such as economic growth, default rates, and monetary policy, usually have opposite simultaneous effects
on risk-free rates and spreads

An individual bond’s liquidity tends to be positively correlated with both the bond’s issue size and the size of the
market in which the bond is traded.

Bond dealers are another factor in bond market liquidity because liquidity tends to be positively correlated with
inventory size (bonds that are held in larger size in dealers’ inventories are usually more liquid).

Charateristics of Emerging market bonds

1) Many emerging market bonds benefit from implicit or explicit government support.
2)The emerging market credit universe has a high concentration in both the lower portion of the investment-grade
rating spectrum and the upper portion of high yield.
erlying business use
ets. In this manner,
duration of assets
ay that considers the
gy requires that the
tes in Point 3.

Only Type I clients can measure the interest rate sensitivity of liabilities using yield statistics
Macaulay, modified duration, money durations, and the present value of a basis point (PVBP)
Those with Type II, III, and IV liabilities must use a curve duration statistic, such as effective
duration, to estimate interest rate sensitivity.”

ates increasing at a
nflationary

iabilities would move

y will underperform; that is, the

orporate bonds. The typically

quality bonds in a market sell-off.
d risk hedge relative to using
to discount liabilities) may
uture liabilities or
able collateral funds to meet

would allow the plan to receive a

ce this receiver swaption, the DB
aption. If rates rise above some
may have anticipated closing the
DI program.
would allow the plan to receive a
ce this receiver swaption, the DB
aption. If rates rise above some
may have anticipated closing the
DI program.

combines elements of interest

e two parties over the tenure of
dity, or bond index. In this case,
ge blocks of exchange-traded
typically occurs between the
one to facilitate trading but does
TF as an alternate passive

uch as futures contracts, and can

gh inclusion of a Credit Support
pension plan, which is made up
d-income derivatives contracts
sist of both investment-grade
te from the management of the

pting to build a bond index fund,

of the portfolio. Although mutual
that are passed on to investors.
ough it would require finding a
terparty risk, and dealing with
directly.

unchanged yield curve over the

eld curve as the time to maturity

ted indexes are tilted toward

er the tilt toward that issuer in
ighted index will be more
BSCA is an equally weighted

rent market valuations are

. Therefore, pricing and valuation
ust be used.

ould have the highest. The

or its principal.

s cash flow matching and

m liability stream (charity
tion matching further considers
er as it relates to the charity

ate that varies inversely with a

. The following methods of

tfolio: (1) futures contracts, (2)
nts, and (5) securities lending.
this example, an unleveraged

ds to increase portfolio returns

ase portfolio returns relative to

n of gains and losses. Controlling

use it may be optimal to delay
e. Among the important
capital gains rates.

me return and duration

ate risk has been immunized,

tion strategy for Type I cash

in strategies that add active
e here.

nimum threshold in the surplus is

but more than a bullet portfolio,

are desirable aspects in liquidity
enhancing liquidity. As bonds
vested in a long-term bond at
vexity than the Lawson portfolio,
n of convexity.
but more than a bullet portfolio,
are desirable aspects in liquidity
enhancing liquidity. As bonds
vested in a long-term bond at
vexity than the Lawson portfolio,
n of convexity.

uced by minimizing the

t portfolio that concentrates the

money duration (or BPV) of the

the liability.

reasing the weight of a particular

a broadly diversified bond index

rities in the index. A more
gy, whereby Soto would purchase
he index. Closely matching these

come securities portfolio and an

ed-income securities are either
persist.

ield on the immunizing portfolio;

this risk. 

eld curve. Structural risk is

e accomplished by minimizing the

ules for security inclusion and

A bond portfolio structured to immunize a single liability must have an initial market value th
exceeds the present value of the liability. And lower convexity caters for the structural risk.

is effectively protected, or
vestment effects offset for either The immunizing portfolio needs to be greater than the convexity (and dispersion) of the outf
But, the convexity of the immunizing portfolio should be minimized in order to minimize disp
reduce structural risk.
nvestment rate, with these two
ect cancel each other in the case
In both the above strategies, any change in the movement of yield curve is going to result in
cancelling the coupon reinvestment effect as both the strategies are immunized.
 nvestment rate, with these two
ect cancel each other in the case
In both the above strategies, any change in the movement of yield curve is going to result in
cancelling the coupon reinvestment effect as both the strategies are immunized.

ond portfolio. A non-parallel shift

summary, the characteristics of a
market value that equals or
at matches the liability’s due

full set of index constituents but

ndex performance under
xing approach.

s and are more sensitive to

ty. The much higher credit loss
e market value of the position to

ment bonds as the benchmark

credit security. The most
ing to apply the G-spread, I-
ese spread measures would

d only has modest incremental

y.

anking and government

e value between the senior and

ranches usually increases relative
d long Class B tranche.

Portfolio convexity can be reduced by selling options, either puts or calls. 

e environment with an upward-
, lower required yields. As the
gs are concentrated at the

The rolling hedge will generate a profit (loss) if the spread between the short-term German y
be sold on bonds the portfolio short-term Australian or British yield increases (decreases) over time.”The rolling hedge is sim
ebalanced at the end of the borrowing short term in the Australian or British market and lending short term in the Germa
till benefit from selling options. spread between short-term German and short-term Australian or British rates increases, earn
lending will increase relative to costs from borrowing.
 The rolling hedge will generate a profit (loss) if the spread between the short-term German y
be sold on bonds the portfolio short-term Australian or British yield increases (decreases) over time.”The rolling hedge is sim
ebalanced at the end of the borrowing short term in the Australian or British market and lending short term in the Germa
till benefit from selling options. spread between short-term German and short-term Australian or British rates increases, earn
lending will increase relative to costs from borrowing.

shortest and longest maturities) In order to properly account for the cost/benefit of eliminating currency exposure, hedge gai
or laddered portfolios (relatively should be measured relative to forward foreign exchange rates.

For investment-grade corporate bonds, the correlation between credit spreads and the risk-f
of credit rating migration (credit is negative, not positive.
ad volatility, as opposed to
ment-grade bonds. Spread
de bonds.

ed spread (OAS) and its Z-spread.

pot yield curve in order for the
rs the value of optionality in a
otherwise equivalent non-
e bond prior to maturity) being
ne-period forward rates makes

p-down relative value

edit cycles, credit quality, sector The butterfly trade consists of a long (short) barbell and a short
(long) bullet

e curvature of the yield curve,

long the 2-year bonds, short the The C$150 million long-term bonds have a money duration of
cation to the 2-year bond C$150 × 1,960 = C$294,000

nd of the curve will rise or the

l lose value or the intermediate
ative to a more diverse maturity

e returns on changes in a  Global credit managers do use currency swaps and invest in
pegged currencies to hedge foreign exchange exposures.

from credit funds. Spread EM indexes have a higher proportion of commodity producers
he percentage outflow from high- and banks than developed market indexes have.
n the spread sensitivity to fund

When default losses are low and credit spreads are relatively
tight, high-yield bonds tend to perform more like investment-
grade bonds.
 When default losses are low and credit spreads are relatively
ernment) bond. A benefit of the tight, high-yield bonds tend to perform more like investment-
enchmark bond, the yields of grade bonds.
matches the credit security’s

Investment-grade corporate bonds have meaningful interest rate

sensitivity, and therefore, investment-grade portfolio managers
ds often decline in value and usually manage their portfolio durations and yield curve
effect of increased supply. A exposures closely. In contrast, high-yield portfolio managers are
n given a price concession to more likely to focus on credit risk and less likely to focus on
an issuer’s existing bonds interest rate and yield curve dynamics.
more debt issuance may signal an

edit spreads tend to be

henomenon is that key macro
e opposite simultaneous effects

d’s issue size and the size of the

to be positively correlated with

more liquid).

port.
r portion of the investment-grade
ng yield statistics
asis point (PVBP)
uch as effective
ve an initial market value that equals or
ers for the structural risk. Single liability Immunization

(and dispersion) of the outflow portfolio.

ed in order to minimize dispersion and Multiple liability Immunization

d curve is going to result in price effect

are immunized.
d curve is going to result in price effect
are immunized.

er puts or calls. 

n the short-term German yield and the

me.”The rolling hedge is similar to
ng short term in the German market. If the
British rates increases, earnings from
n the short-term German yield and the
me.”The rolling hedge is similar to
ng short term in the German market. If the
British rates increases, earnings from

rrency exposure, hedge gains or losses

redit spreads and the risk-free interest rate

Guardians are cautious and concerned about the future, particularly as they approach retirement. They are concern
seek advice from those they perceive as being more knowledgeable than themselves.

individualists are independent and confident investors who like to make their own decisions. They are unlikely to ea
analysis.

celebrities hold opinions about some things but may be willing to take advice about investing. They only recognize t
extent.

 naive diversification strategy (i.e., dividing assets equally among available funds irrespective of the underlying co

Social proof is the result of a deeply rooted psychological bias. It implies trust in other people. The forms of this t
better and that the best way to make a decision is to look at the decisions other people have made.

Institutions that maximize their Sharpe ratio for an acceptable level of volatility would be following an asset-only
they would not be concerned with modeling their liabilities.

Asset-segmentation approach is an asset-only approach that does not consider liabilities.

Dynamic asset allocation is a long-term active strategy

The endowment bias is the bias that individuals ascribe more value to things merely because they already own the

The Sharpe ratio is the slope of the line drawn from the risk-free rate to a particular portfolio.

 The lower the volatility of an asset class relative to the rest of the portfolio, the wider the optimal rebalancing corr

 Private equity indexes do not capture the risk and return attributes of private equity accurately. In addition, owing t
indexes do not accurately measure their true volatility.

The higher the correlation of an asset class with the rest of the portfolio, the wider the optimal corridor. When
divergence from target weights is less likely.

Black–Litterman starts with the excess returns produced from reverse optimization, which commonly uses the ob
assets or asset classes of the global opportunity set. It then alters the reverse-optimized expected returns that reflec
behaves well in an optimizer.

The 60/40 stock/bond heuristic allocates 60% of assets to equities, supplying a long-term growth foundation, an
reduction benefits.

The Norway model passively invests in publicly traded securities subject to environmental, social, and governanc
endowment model asset allocation emphasizes active management of large allocations to non-traditional investm

A risk parity asset allocation is based on the notion that each asset class should contribute equally to the total ri
A risk parity asset allocation is based on the notion that each asset class should contribute equally to the total ri

 a private wealth manager requires a thorough understanding of asset class risks and returns, correlation among a
vehicles, managers, products, and implementation strategies.

The goals do demonstrate specification, in that they identify both the time frame and amounts. Stratification is n
methodology used in equity indexing.

The Monte Carlo simulation analyzes the likelihood of the client’s actual portfolio meeting anticipated retirement ne
include the probability of achieving the Benetton’s goal, it would not guarantee that their goal is achieved, nor would
magnitude” to achieving their goal. Thus, they run the risk of outliving their assets and may need to reduce their an

A mortality table illustrates an individual’s life expectancy at any given age. A potential problem with using mortality
Benetton’s retirement goal is the probability that either one or both of them live to an age that exceeds the life expec
run the risk of outliving their assets and may need to reduce their annual income (spending) goal at some point.

Risk tolerance is the level of risk an individual is willing and able to bear and relates to one’s attitude toward risk. Ri
of the risk involved. Unlike risk tolerance, how a client perceives the riskiness of an investment depends on the circu
a client’s risk perception, but doing so will not increase the client’s risk tolerance.

Risk perception is the subjective assessment of the risk involved, and how a client perceives the riskiness of an inv
wealth manager can help shape a client’s risk perception.

Monte Carlo models can incorporate customized input data, such as life expectancy, taxes, inflation, and investmen

The Monte Carlo model assumes a simple average return and a standard deviation of returns for the portfolio, wh
linear portfolio growth. Both models should use forward-looking capital market assumption.Monte Carlo model ca
deterministic model does not have that capability.

Asset allocation and selection are much more difficult when managing portfolios for individuals compared with insti
must consider such constraints as time horizon, scale, taxes, and unique circumstances—for example, preferred or r
interfere with the optimization of the investor’s portfolio. Such situations are less likely to arise in an institutional setti

Risk aversion—how the individual behaves when faced with negative outcomes.

Risk capacity is the investor’s ability to accept financial risk. It is determined by the client’s net worth, income, inve
on.. Risk tolerance refers to the level of risk that an individual is willing and able to bear; its inverse is risk aversion

Straight-line growth is not a feature of goal-based investing; it is a component of the deterministic forecasting me
which a given return is assumed to compound until the investment horizon is reached.

Probability of success is not a feature of goal-based investing; it is an outcome of the Monte Carlo method for det

Premiums paid by the policyholder are not considered part of the policyholder’s estate at the time of death.
 Deduction method

Credit method, which uses the higher tax rate alone

The “annuity puzzle” describes the phenomenon that retirees tend to avoid annuity investments, which may be app
financial goals. An annuity provides a series of fixed payments, either for life or for a specified period, in exchange fo

13500 607500
1,200,000
14,400,000 1,872,000
156,000
468,000
ch retirement. They are concerned about protecting their assets and may
s.

ecisions. They are unlikely to easily take advice without doing their own

nvesting. They only recognize their investment limitations to a certain

rrespective of the underlying composition of the funds). 

other people. The forms of this trust include the belief that the majority knows
le have made.

uld be following an asset-only asset allocation approach, and, as such,

bilities.

because they already own them.

portfolio.

der the optimal rebalancing corridor.

accurately. In addition, owing to the illiquid nature of the constituents, these

der the optimal corridor. When asset classes move in sync, further

n, which commonly uses the observed market-capitalization value of the

zed expected returns that reflect an investor’s own distinctive views yet still

g-term growth foundation, and 40% to fixed income, supplying risk

mental, social, and governance concerns. In comparison, the

ations to non-traditional investments, seeking to earn illiquidity premiums

ontribute equally to the total risk of the portfolio.

ontribute equally to the total risk of the portfolio.

nd returns, correlation among asset classes, and knowledge of investment

nd amounts. Stratification is not a characteristic of goals but is a

eeting anticipated retirement needs. Although the Monte Carlo output would
heir goal is achieved, nor would it necessarily measure the “shortfall
nd may need to reduce their annual income (spending) goal at some point.

tial problem with using mortality tables as the sole method to analyze the
age that exceeds the life expectancy of the general population. Thus, they
ending) goal at some point.

to one’s attitude toward risk. Risk perception is the subjective assessment

vestment depends on the circumstances. A wealth manager can help shape

perceives the riskiness of an investment depends on the circumstances. A

, taxes, inflation, and investment management fees.

n of returns for the portfolio, whereas the deterministic model assumes

umption.Monte Carlo model can include tax assumptions, but the

individuals compared with institutions. Wealth management for individuals

ces—for example, preferred or restricted security holdings—all of which may
y to arise in an institutional setting.

lient’s net worth, income, investment time horizon, liquidity needs, and so
bear; its inverse is risk aversion.

e deterministic forecasting method for determining capital sufficiency in

ed.

he Monte Carlo method for determining capital sufficiency.

ate at the time of death.

nvestments, which may be appropriate to best help them reach their
specified period, in exchange for a lump sum payment. 
130