Source:
http://www.analystforum.com/phorums/read.php?13,967038
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If our Human Capital is Bond-like, we should invest more aggressively (equity) and our demand for life insurance increases.
A short position in an option is either out-of-the-money and no payment is due, or it is in-the-money and the short owes payment to the long. Therefore the short position bears NO CREDIT RISK.
Honour willingness as long as it is below or equal to ability – except for the wealthy independent!
Additional compensation arrangement requires both clients and employer give the written approval.
Box Spread: combo of a Bull Call and Bear Put Spread; a non-directional strategy… seeks to exploit arbitrage opportunities between options prices of the same underlying.
Taylor Rule: gives an estimate for central bank interest rate decisions:
R target = R Neutral + 0.5*(GDP expected - GDP trend) + 0.5*(Inflation expected - Inflation target)
When distinguishing between Type I and Type II errors, remember “Type I HORN.”
Type I HO (Null Hypothesis) RN (Reject Null)
Null = Manager adds no value; Reject and conclude that manager adds value when he actually does not.
SAMURAI (For properties of a valid benchmark):
Specified in advance, Appropriate, Measurable, Unambiguous, Reflective of manager’s current opinions, Accountable (Manager), Investable.
Types of benchmarks - MBS FRAC!
Manager Universe - Broad Mrkt indices - Style indices
Factor model - Returns based - Absoute - Custom
If only defense - lack of action or inaction
Ceteris paribus - because of unexpected action/event, all else same
Legal / Regulatory Constraints for Endowments and Foundations: UMIFA and Prudent Investor
ERISA prohibits investment of more than 10% of DB plan assets in the company stock, but NO such law applies to DC plans
Durations: Dfixed-Dfloating>0. To shorten duration take floating Asset (i.e. receive floating and pay fixed)
Claw back provision: If PE sponsor received early distribution but failed to deliver the expected profit; he has to give back money.
Private equity has low liquidity and allocation to this class should be 5% or less with a plan to keep the money invested for 7-10 yrs
Adding REITs to stock / bond –> higher return –> marginally lower sd –> higher sharpe ratio
Adding direct real estate investment to stock / bond –> lower return –> significantly lower sd –> higher sharpe ratio
Going long a pay-fixed swap will lower your portfolio duration, while going long a pay-floating swap will increase your portfolio duration.
For a domestic investor, currency risk is about half the risk of foreign stocks and about twice the risk of foreign bonds.
There are four main reasons not to trade bonds - “please stop bothering susan”
please = Portfolio constraints (biggest cause of inefficiency in bond markets)
stop = story disagreements
bothering = buy and hold
susan = seasonality
There are eight main reasons to trade bonds - “really can cook, no salt you say?”
really = relative value pick up (biggest reason)
can = credit upside
cook = credit defence
no = new issue trades
salt = secot-rotation trades
you = yield curve pickups
say? = structure trades
Distressed Debt Arbitrage = long debt and short equity of the same company.
Total Active Return = True active return + Misfit active return
true = Manager return - Normal port return
misfit = Normal port return - Benchmark
Increase in Age -> Lower demand for life insurance
Higher risk aversion -> Higher demand for life insurance
Greater initial wealth -> Lower demand for life insurance
Stronger Bequest Motive -> Higher demand for life insurance
Stock-based compensation and bonuses: Complements
Explicit Incentives and Implicit Incentives: Substitutes
In a non-trending market, Constant Mix outperforms Buy-and-Hold outperforms CPPI
In a trending market, CPPI outperforms Buy-and-Hold outperforms Constant Mix
Investor’s Utility Adjusted Return = Expected Return Portfolio - 0.005 * Risk Aversion Score * Portfolio Variance
“(Insert name of firm) has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®).”
Total commodity return = collateral return + roll return + spot return
*For roll return it is the futures differential minus the spot return
Without rebalancing, classical immunization only works for a 1-time instaneneous change in i-rates. We cease to be immunized when (1) i-rates change and (2) Time passes
Currency Management Strategies:
Balanced Mandate - Asset Manager also manages currency
Currency Overlay - Currency managed within IPS by another currency manager
Seperate Asset Class - Currency managed under its own seperate guidelines
(Note - CFAI says it’s a suboptimal strategy if managed in two-steps. Simultaneous management would be better.)
For Grinold/Kroener: always look for real or nominal g! - real should be used, as inflation is a separate component; thus, do not sum nominal g and i
Beta of A = standard deviation of A / standard deviation of market * correlation
Covariance of A and B = Beta of A * beta of B * square of standard devation of market
Jensen’s Alpha: Portfolio Return - Expected Portfolio Return based on SML
IR: Active Return / Standard Deviation of Active Returns
* Note: IR doesn’t capture all portfolio variability, just the variability of excess returns *
Sharpe: (Return Portfolio - Rf) / (Standard Deviation Portfolio)
Treynor: (Return Portfolio - Rf) / Beta Portfolio
M2: Rf + Sharpe * Standard Deviation Market
Implication of cyclical and secular changes in the corporate bond market include:
1. securities with embedded options will command a premium due to their scarcity
2. the percentage of long-term issues will decline - effective duration and aggregate interest rate risk sensitivity will also decline.
Moral Hazard Problems (Corporate Governance):
a) Insufficent effort results when company execs are too occupied with various non work related interests (i.e. golf game, buying expensive art, etc.) instead of focusing and putting enough effort to get the job done
b) Exravagant projects is when management continue to invest in high profile or pet projects even though the return on the investments is not in the best interest of the company and its shareholders
c) Entrechement – when managers invest in bad projects but in projects where they have a strong understanding so that they become more valuable to the company
d) Self-Dealing – I am not 100% sure, but I think when they funel business to companies they own or family and friends.
Corridor Widths
Factor…………………..(Value - effect on corridor widths)
Transaction Costs……………………………(higher-higher)
Risk tolerance………………………………..(higher-higher)
Correlation……………………………………(higher-higher)
Volatility………………………………………..(higher-lower)
Volatility of the rest of the portfolio……….(higher-lower)
A contango commodity market occurs when the lease rate is less than the risk free rate.
Cross Default Provision: issue considered in default if defaulted on another credit agreements
Jump to Default: AKA current credit risk
Grinold and Kroner:
R(i) = Div1/P0 + i + g - (DELTA) S + (DELTA) P/E
Ri = expected return on stock i
Div1 = dividend next period
P0 = current stock price
i = expected inflation rate
g = real growth rate in total earnings
(DELTA) S = change in shares outstanding
(DELTA) P/E = change in P/E ratio
Market Neutral Strategy has a Beta of Zero. Manager can add Beta exposure using futures, swaps, etc.
Short Extension Strategy: Net Portfolio beta=Beta Long+Beta Short, hence can outperform long only strategy as it exploits benefits of short-selling
Payer’s Swaption–gives the buyer of the option the right to enter into a swap where the option buyer pays the fixed rate . Converts a future FRN into fixed rate obligation.
Receiver’s Swaption–gives the buyer of the option the right to enter into a swap where the option buyer receives the fixed rate. Converts a future fixed rate obligation into floating rate obligation.
http://www.analystforum.com/phorums/read.php?13,967038
——————————————————————————-
If our Human Capital is Bond-like, we should invest more aggressively (equity) and our demand for life insurance increases.
A short position in an option is either out-of-the-money and no payment is due, or it is in-the-money and the short owes payment to the long. Therefore the short position bears NO CREDIT RISK.
Honour willingness as long as it is below or equal to ability – except for the wealthy independent!
Additional compensation arrangement requires both clients and employer give the written approval.
Box Spread: combo of a Bull Call and Bear Put Spread; a non-directional strategy… seeks to exploit arbitrage opportunities between options prices of the same underlying.
Taylor Rule: gives an estimate for central bank interest rate decisions:
R target = R Neutral + 0.5*(GDP expected - GDP trend) + 0.5*(Inflation expected - Inflation target)
When distinguishing between Type I and Type II errors, remember “Type I HORN.”
Type I HO (Null Hypothesis) RN (Reject Null)
Null = Manager adds no value; Reject and conclude that manager adds value when he actually does not.
SAMURAI (For properties of a valid benchmark):
Specified in advance, Appropriate, Measurable, Unambiguous, Reflective of manager’s current opinions, Accountable (Manager), Investable.
Types of benchmarks - MBS FRAC!
Manager Universe - Broad Mrkt indices - Style indices
Factor model - Returns based - Absoute - Custom
If only defense - lack of action or inaction
Ceteris paribus - because of unexpected action/event, all else same
Legal / Regulatory Constraints for Endowments and Foundations: UMIFA and Prudent Investor
ERISA prohibits investment of more than 10% of DB plan assets in the company stock, but NO such law applies to DC plans
Durations: Dfixed-Dfloating>0. To shorten duration take floating Asset (i.e. receive floating and pay fixed)
Claw back provision: If PE sponsor received early distribution but failed to deliver the expected profit; he has to give back money.
Private equity has low liquidity and allocation to this class should be 5% or less with a plan to keep the money invested for 7-10 yrs
Adding REITs to stock / bond –> higher return –> marginally lower sd –> higher sharpe ratio
Adding direct real estate investment to stock / bond –> lower return –> significantly lower sd –> higher sharpe ratio
Going long a pay-fixed swap will lower your portfolio duration, while going long a pay-floating swap will increase your portfolio duration.
For a domestic investor, currency risk is about half the risk of foreign stocks and about twice the risk of foreign bonds.
There are four main reasons not to trade bonds - “please stop bothering susan”
please = Portfolio constraints (biggest cause of inefficiency in bond markets)
stop = story disagreements
bothering = buy and hold
susan = seasonality
There are eight main reasons to trade bonds - “really can cook, no salt you say?”
really = relative value pick up (biggest reason)
can = credit upside
cook = credit defence
no = new issue trades
salt = secot-rotation trades
you = yield curve pickups
say? = structure trades
Distressed Debt Arbitrage = long debt and short equity of the same company.
Total Active Return = True active return + Misfit active return
true = Manager return - Normal port return
misfit = Normal port return - Benchmark
Increase in Age -> Lower demand for life insurance
Higher risk aversion -> Higher demand for life insurance
Greater initial wealth -> Lower demand for life insurance
Stronger Bequest Motive -> Higher demand for life insurance
Stock-based compensation and bonuses: Complements
Explicit Incentives and Implicit Incentives: Substitutes
In a non-trending market, Constant Mix outperforms Buy-and-Hold outperforms CPPI
In a trending market, CPPI outperforms Buy-and-Hold outperforms Constant Mix
Investor’s Utility Adjusted Return = Expected Return Portfolio - 0.005 * Risk Aversion Score * Portfolio Variance
“(Insert name of firm) has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®).”
Total commodity return = collateral return + roll return + spot return
*For roll return it is the futures differential minus the spot return
Without rebalancing, classical immunization only works for a 1-time instaneneous change in i-rates. We cease to be immunized when (1) i-rates change and (2) Time passes
Currency Management Strategies:
Balanced Mandate - Asset Manager also manages currency
Currency Overlay - Currency managed within IPS by another currency manager
Seperate Asset Class - Currency managed under its own seperate guidelines
(Note - CFAI says it’s a suboptimal strategy if managed in two-steps. Simultaneous management would be better.)
For Grinold/Kroener: always look for real or nominal g! - real should be used, as inflation is a separate component; thus, do not sum nominal g and i
Beta of A = standard deviation of A / standard deviation of market * correlation
Covariance of A and B = Beta of A * beta of B * square of standard devation of market
Jensen’s Alpha: Portfolio Return - Expected Portfolio Return based on SML
IR: Active Return / Standard Deviation of Active Returns
* Note: IR doesn’t capture all portfolio variability, just the variability of excess returns *
Sharpe: (Return Portfolio - Rf) / (Standard Deviation Portfolio)
Treynor: (Return Portfolio - Rf) / Beta Portfolio
M2: Rf + Sharpe * Standard Deviation Market
Implication of cyclical and secular changes in the corporate bond market include:
1. securities with embedded options will command a premium due to their scarcity
2. the percentage of long-term issues will decline - effective duration and aggregate interest rate risk sensitivity will also decline.
Moral Hazard Problems (Corporate Governance):
a) Insufficent effort results when company execs are too occupied with various non work related interests (i.e. golf game, buying expensive art, etc.) instead of focusing and putting enough effort to get the job done
b) Exravagant projects is when management continue to invest in high profile or pet projects even though the return on the investments is not in the best interest of the company and its shareholders
c) Entrechement – when managers invest in bad projects but in projects where they have a strong understanding so that they become more valuable to the company
d) Self-Dealing – I am not 100% sure, but I think when they funel business to companies they own or family and friends.
Corridor Widths
Factor…………………..(Value - effect on corridor widths)
Transaction Costs……………………………(higher-higher)
Risk tolerance………………………………..(higher-higher)
Correlation……………………………………(higher-higher)
Volatility………………………………………..(higher-lower)
Volatility of the rest of the portfolio……….(higher-lower)
A contango commodity market occurs when the lease rate is less than the risk free rate.
Cross Default Provision: issue considered in default if defaulted on another credit agreements
Jump to Default: AKA current credit risk
Grinold and Kroner:
R(i) = Div1/P0 + i + g - (DELTA) S + (DELTA) P/E
Ri = expected return on stock i
Div1 = dividend next period
P0 = current stock price
i = expected inflation rate
g = real growth rate in total earnings
(DELTA) S = change in shares outstanding
(DELTA) P/E = change in P/E ratio
Market Neutral Strategy has a Beta of Zero. Manager can add Beta exposure using futures, swaps, etc.
Short Extension Strategy: Net Portfolio beta=Beta Long+Beta Short, hence can outperform long only strategy as it exploits benefits of short-selling
Payer’s Swaption–gives the buyer of the option the right to enter into a swap where the option buyer pays the fixed rate . Converts a future FRN into fixed rate obligation.
Receiver’s Swaption–gives the buyer of the option the right to enter into a swap where the option buyer receives the fixed rate. Converts a future fixed rate obligation into floating rate obligation.