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Study Session 17: Portfolio Management: Economic Analysis, Active Management, and Trading

Portfolio Management-Active Returns

To calculate Active Returns, 2 formulas are given in the curriculum- (pg 473)

1. Value added is the sum product of the active weights and asset returns: ie summation (ΔwiRi) and

2. Value added as the sum product of active weights and active security returns: ie summation ΔwiRAi. Now RAi is Ri-RB. I am not able to understand this part. 

Can someone pls help.

EOC Q24 Active PM reading: IR vs IC to choose a better portfolio manager

The question asks to choose the candidate with greatest skill at achieving active returns and in the answer the choice is based on the highest IR. However, in the text it is stated that IC is the measure of the manager’s skill (which would lead to a different answer). Can someone please clarify? 

Sharpe Ratio Annualized

In the CFAI reading 3.1 of Portfolio Management, Analysis of Active Retrun. the book takes a monthly return and make it to an annual return by multiplying by 12. I would have thought they would have raised it to the power of 12 to account for compounding. Any insight into why the did this, and if that was a mistake? 

Sharpe and Information Ratio

“A fund with zero systematic risk (e.g., a market-neutral long-short equity fund) that uses the risk-free rate as its benchmark would have an information ratio that is equal to its Sharpe ratio. This is because active return will be equal to the portfolio’s return minus the risk-free rate, and active risk will be equal to total risk.”

Analysis of active portfolio management example 3

In example 3, Q1, it states that the fund with the highest information ratio would add more value to the Sharpe ratio. So it chooses IR =0.05 over IR = -0.23

But we have,

SRp2 = SRb2 + IR2

So, should the sign of IR matter? Shouldn’t we look at the absolute value of IR.

Why is there negative covariance between future bond price and intertemporal rate of substitition?

Given bonds are a good consumption hedge, I would think that a higher intertemporal rate of substition (i.e., higher marginal utility from future consumption, i.e., lower incomes in the future) would correspond to a higher bond price. 

I understand why the covariance would be negative for equities, which are a bad consumption hedge - I don’t understand why it would be negative for a default-free bond.

nominal risk-free rate

A risky asset offers high positive returns during business downturns. A colleague argues that the nominal required rate of return on the asset may be less than the nominal risk-free rate. Is the colleague correct?

  1. Yes.

  2. No, the return must be higher than the nominal risk-free rate.

  3. No, the relationship between the asset’s nominal return and the nominal risk-free rate is indeterminate.

Reading 50 EOC Q2

Would someone help me to understand how the solution got the 2%, 3%, 0%, -4%, and -2%? I literally pulled my hair out for the past two hours. THANK YOU!

[question removed by moderator]

Active risk doubt

I had a doubt from reading 50 portfolio mgmt level 2. 

When we find expected returns, we use product of weights and returns of individual security in portfolio. But such product of weight and risk are not used to calculate risk. so why in example 5 solution3 , do we use - active risk of portfolio is square root of sum of active weights squared times the active volatility squared for each security.