Below are some helpful notes that I’ve been making for a brief review:
1. If they give you a cash duration use it
2. Treynor = Beta = Well Diversified
Sharpe = Std. Dev = Not Well Diversified
If a manager ranks highest in Treynor but lowest in Sharpe this indicates they are not well diversified and are taking on nonsystematic risk that is not being captured by Beta
3. “For the pound against the dollar” - The pound is the subject, the pound is the base currency.
- Immunization assumes no default and requires liquid bonds when rebalancing. While corporate bonds would theoretically would reduce the cost of immunization due to higher coupons, immunization requires that there is no default and corporate bonds would theoretically increase the cost of rebalance. For these reasons corporate bonds would increase the cost of immunization as you would need more in assets (surplus) to invest in corporate bonds.
5. FRA Mark to Market
( (Locked in FRA Rate - Current Libor) * Notional * (Loan Day)/360 ) * (1/(1+Current Libor * (Loan Day/360))) * (1/(1+rf)^(FRA Day/365))
FRA Day = Day Underlying Loan Starts - Today
Loan Day = Days in underlying loan
6. Symmetric Cash Flow Match = Cash Flow Match + Assumption you borrow short term to fund liability and don’t need perfect matching
7. Immunization Risk Equations = M^2 is immunization risk
STDDEV(Tgt) = M^2 * STDDEV(Slope change) * n
M^2 = Size of Liability and Dispersion between asset and liability date
Confidence Interval = Tgt Return ± (K * STDDEV(Tgt))
n = horizon length
8. Common K Values
1% VAR = 98% Confidence = 2.33
2.5% VAR = 95% Confidence = 2
5% VAR = 90% Confidence = 1.65
9. 3 Requirements for Multiple Liability Immunization
A. PV Asset = PV Liab
B. Weight Avg Asset Dur = Weight Avg Liab Dur
C. [___Liab Dur____]
Asset Dur Range Exceeds Liab Dur Range
* Requires constant rebalancing, only immunizes for a small (due to convexity) parralel (if you want paralell must be keyrate/functional duration match or linear program)
10. Stale Price Bias = Serially Correlated Returns = Smoothing.
Mostly a concern in Direct Real Estate, Distressed Debt and Private Equity.
Causes correlation to be lower and STDDEV to be lower. Makes diversification appear higher. Biases Sharpe upward. Used to game Sharpe Ratio. Not concerning for hedge funds due to monthly reporting.