Three components of return for a commodities futures contract:
Spot return - Return on the futures caused by the change in the underlying commodity’s spot price.
Collateral reurn - Assumed to be the risk-free rate.
Roll return - Usually the result of backwardation. Backwardation produces a downward sloping structure o futures prices.
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3 types of managing currency exposure:
Balanced mandate - Under this approach, the investment manager is given total responsibility for managing the portfolio, including the currency exposure.
Currency overlay - The portfolio manager is not responsible for currency exposure. Instead, a separate manager (an expert in foreign currency management) is hired to manage the currency exposure within the guidelines of the IPS.
Separate asset allocation - If currency is considered a separate asset, it is managed as if it were a totally separate allocation given to a separate manager and managed under its own guidelines.
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Investor circumstances subject to change:
RRTTLLU = Risk, return, time horizon, taxes, liquidity, legal, and unique.
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Properties of a valid benchmark:
SAMURAI = Specified in advance, Appropriate to the investment approach, Measurable, Unambiguous, Reflective of the manager’s current investment opinions, Accountable, Investible.
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5 types of investment risks:
Specific Risk - The risk of the individual security - can be reduced or eliminated by holding the security in a diversified portfolio.
Residual Risk - This risk is related to the trading strategies employed, how they are carried out, and how they are interpreted by taxing authorities. Includes counterparty and regulatory risk.
Counterparty Risk - The probability that a counterparty will not correctly complete the transaction as expected.
Regulatory Risk - The possibility that tax authorities will not accept the tax treatment applied to a transaction.
Herstatt Risk - Alternate name for “settlement risk”, which is the risk that one side is paying while the other side is defaulting. It has historically been a problem in foreign exchange markets. Has been mitigated since 2002 by “continuously linked settlements”.
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3 examples of behavioral biases:
Representativeness - Investors perceptions are based upon current of historical information rather than unbiased expectations. This can result in temporary mispricing of stocks. An example could be assuming a stock will do well in the future because it just announced a surprise good earnings.
Conservatism - The inability of analysts to fully incorporate the impact of new information on their projections.
Frame dependence - Investors’ tendency to change (frame) their risk tolerance according to the direction of the market.
