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Study Session 8-9: Asset Allocation and Related Decisions in Portfolio Management

Reverse Optimization and Beta of an Asset Class


Is Beta of an Asset Class used during reverse-optimization process ?

According to curriculum: 

“Reverse optimization takes as its inputs a set of asset allocation weights that are assumed to be optimal and, with the additional inputs of covariances and the risk aversion coefficient, solves for expected returns.” and then

Minimum expected return in Constructing Sub-Portfolios using Goals-Based approach


I have a question regarding the subject.

How Minimum expected returns for a given investment horizons and at specific probabilities are calculated ? It looks like the calc process is out the scope of the curriculum but I would like to get a general idea at least.

In the Reading 13, Exhibit 36 we’ve got “Annualized Minimum Expectation Returns” for each Time Horizons (5,10,15…) and at Required Success (Probabilities: 99,95…).

Cross-Currency Basis Swap

Referring to reading 16 example 7 cross currency basis swap. can someone confirm whether the exchange rate is fixed for the duration of the swap, or the exchange of loan principal depends of the exchange rate at the time of exchange. In the CFAI material, it says the exchange rate is assumed to be fixed but can it differ in practice? Thanks in advance.

Yield curve

“In terms of the business cycle, the yield curve is typically steep at the bottom of the cycle. As the cycle moves toward expansion, the curve tends to flatten. At the top of the cycle, the yield curve will likely be flat to inverted. During contraction, the curve will begin to re-steepen.”

I literally understand nothing from this. Could you please help me to breakdown what is meant in here?

VIX question

A volatility trader observes that the VIX term structure is upward sloping. In particular, the VIX is at 13.50, the front- month futures contract trades at 14.10, and the second- month futures contract trades at 15.40. Assuming the shape of the VIX term structure will remain constant over the next three- month period, the trader decides to implement a trade that would profit from the VIX carryroll down. She will most likely purchase the:

The answer is:

C VIX front- month futures and sell the VIX second- month futures.

FTSE RAFI US 1000 Index

Hi - Does anybody know where you can get the daily returns for this index ?  If not, can anybody please suggest an alternative fundamental index ?

Thanks very muc.

liability-relative approach: modeling liabilities

I cannot wrap my head around this one - could someone pls explain why inthe liability-driven approach, modeling liabilities can be done by shorting bonds that match the duration and present value of liabilities?

Thank you :)

Asset allocation - taxable portfolio

A taxable portfolio should be less frequently rebalanced. Due to: 

1. Frequent rebalancing leads to realizing gains, hence you pay more in taxes (higher taxable income)

2. A tighter corridor involve higher transaction costs, therefore it is better to have a wider range/corridor. Also, due to the lower volatility after-tax, you need larger movements to change the volatility/risk level. 

Why would you want to increase the risk level in this case? Because higher risk leads to better returns, OK, but is there any kind of aspect I´m missing here? 

optimal asset allocation - MTCR and Sharpe

Excess Return over MTCR’s formula is equivalent to a Sharpe Ratio.
The calculation is: (Rp -Rf) / MCTR
The Sharpe ratio adjusts for risk, and can help you determine the investment choice that will deliver the highest returns
while considering risk.

However, I still cannot understand why an optimal asset allocation involves the fact that ALL assets have MCTR and hence equal Sharpe ratios? Why is not an optimal asset allocation involving assets with highest Sharpe ratios? (but not necessarily equal?)