Helpful Notes

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.

  1. 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_______}

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.

11. Flat and Heavy favorable to interest

12. Wealth tax FVIF = ((1 + R) ( 1 - Tax))^n

Tax Drag % > Tax Rate

As Time increases tax drag increases

As Return increases tax drag DECREASES

13. Tax Drag % = Tax Rate in deferral

Value fo Deferral increases as time and return increase

14. Taxable STDDEV = STDDEV (1 - Tax) - therefore all else government absorbs some std dev in taxable acct. Also noteworthy is that if you have a period of negative returns you will have a better return in a taxable account due to value of offsetting gains. If you have a period of positive returns you will do best in a tax exempt/tax deferred account

15. TAE can be lower than Tcg if gains are large & deferred for a long time with little dividends/interest. TAE can be larger than Tcg if low basis

16. FVIF(total) = (((1+Rart)^n) - 1) * (1 - Tecg) + 1 - (1 - B) * Tcg

Rart = Return (1 - Realized Tax)

Realized Tax = Pi * Ti + Pd * Td + Prg * Trg

Tecg = ((1 - Realized Tax) / (% Unrealized)) * Tcg

B = PV/Cost Basis

RAE = FVIF(Total) ^ (1/n) -1

Tax Drag % = r - RAE

TAE = 1 - (RAE/r)

Tax Drag $ = (FV No Tax - PV) - (FV Tax - PV)

% Value of deferral = Tax Drag% Accrual - Tcg

17. Deemed Disposition = Immediate tax on unrealized gains at death or upon leaving country, generally no estate tax, thus its best to gift low basis assets before death.

  1. Taxable Gift (IF GIVER PAYS) = (1 + aftertaxreturn)^n * (1 - Tg + Tg*Te)

Tg*Te represents the reduction in estate tax due to the tax bill being paid by the giver. Example: Estate size is 100k. Gives 20k gift. Estate size is 80k Pays 5k tax on gift, Estate size is now 75k. If estate tax is 50% there is a 0.5* 5k = 2.5k reduction in estate tax from the gift giver paying the tax.

19. PIE - Three principles of central Bank

P = Political Influence - independent of it

I = Inflation target to guide expectations

E = Economic Control of economy using monetary policy to prevent overheat/cooling

20. Vintage Effect only important if timeframe is less than 5 years

21. Rolling returns show cyclility and consistency

  1. Historical VAR and Monte Carlo VAR are nonparamentric (they assume no return distribution). Historical VAR uses simulated returns for options/bonds based upon current characteristics. Analytical VAR can be used for non-normal returns but must be supplemented with scenario analysis. VAR focuses on Left Tail. CVAR focuses on right tail. CVAR (credit Var) is hard to estimate and cannot be separated from VAR. CVAR is also hard to project as defaults occur infrequently and data is limited.

23. Tail VAR = VAR + Avg of Worst X% outcomes

Gives insight into magnitude of loss which is a weakness of VAR that can be overcome with TailVAR or Scenario analysis. VAR should not be used in isolation because of this.

24. Cons of VAR

Different methods give different results, generates false sense of security (output only as good as input), ignores upside, ignores magnitude of worst case, does not account for liquidity of positions, historical relationships may not hold, some methods difficult and expensive

25. Pro of Analytical VAR allows modeling of correlations

26. 8% expected return, Std dev of 10%, Port Size = 833,333.33

0.08 - 2 * 0.10 = -12%

-0.12 * 833,333.33 = 100k

2.5% annual VAR of 100k

97.5% chance loss will be no more than 100k in a year

2.5% chance loss will be at least 100k in a year

27. You can expect a loss of _________ for _____ months in 5 years (use above info)

0.08/12 = 0.00667

0.10 / (SQRT(12)) = 0.02887

(0.0067 - 2 * 0.02887)*833,333.33 = 42,529.19

0.025 VAR * 12 months in a year * 5 years = 1.5 months

You can expect a loss of 42,529.19 for 1.5 months in the next 5 years

VAR can only be time scaled using SQRT (Periods) if and only if expected return = 0%

28. Special Purpose Vehicle = Enhanced Derivatives Product Company

Separately collateralized subsidiary to improve your own counterparty risk. If you are trading with someone elses Enhanced Derivatives Product company there will likely be much less credit risk/counterparty risk

29. Herstatt/Settlement/Counterparty Risk can be reduced by:


posting margin

netting (noncurrency)

continuously-linked-settlement (for currency) and Closeout netting (for currency)

Credit Analysis on counterparty

Have minimum credit standards

Counterparty issuer limits

30. Performance Netting Risk - Requires multiple managers with an asymetric performance fees (not ad valorem). Risk of one guy doing great and everyone else doing terrible and the company still having pay bases to everyone that sucked and pay base + incentive payments to the good guy. The company won’t receive good revenue because most of their revenue arrangements are performance fees which wont be paid as nearly everyone sucked except that one good guy.

31. Effective Beta

Port End Value + Gain/Loss on Contract = Overall End Value

Overall End Value / Begin Value - 1 = % Overall Change

% Overall Change / % Index Change = Effective Beta

Gain/Loss on Contract = # contracts bought (negative if sold) * (Futures Price Now - Futures Price Begin) * Multiplier if any

32. Put + Straddle = Strip. Puts benefit if price goes down and straddle benefits if volatile. If a womans clothes go down shit will get volatile. Strap is a strip but with a call instead of a put

33. Box Spread = (Strike Spread / (1 + rf)^n) - Net Premium = Arbitrage Profit

Bear Put Spread combined with Bull Call Spread used for arbitrage based upon put/call parity relationship

34. Insurance Need

Lower Post Death Objectives

Better family health history and lower risk aversion

Larger FC/Less HC/Aka you’re old

More correlated HC is to FC (market)

—Since HC is PV of future income and the discount rate is based upon inflation + risk of HC a higher correlation to FC the greater the risk of HC thus a greater discount rate applied to value HC, thus HC will be lower as a result thus refer to the “Larger FC/Less HC” rule

35. Hedge

Hedge market but not currency = foreign Rf

Hedge currency but not market (assuming perfect hedge) = (1 + Roll Yield) * (1 + local return) - 1

Hedge none = (1 + local return) * (1 + Currency Return) - 1

Hedge both market and currency = Domestic Rf

36. Currency Hedge Foreign Bond Assuming IRP Holds and no change in rates, and same maturity/quality

Return = Domestic Rf + (Bond Rate - Local Rf)

Thus when comparing hedged foreign bonds, the largest spread between the bond rate and the bonds respective local rf rate will have highest return assuming IRP holds and no changes in rates/credit spreads

37. Source/Territory Conflict

Exemption - Pay Source

Credit - Pay higher of source or residence

Deduction - Pay Source then pay part of residence = Source Rate + (1 - Source Rate) * Residence Rate

Deduction only a partial resolution

38. Forward Conversion with Options

Buy Put and sell call at same price, identical to a short forward and will earn rf

39. Completeness Port combines port and concentration to minimize correlation with the concentration. Uses tax loss harvesting to reduce the concentration which causes rest of port to become low basis. Still retains risk of downside due to specific factors. Reduces mismatch return?

40. Primary Capital = Personal + Mkt Risk buckets ------basically it is networth excluding concentrations

Implied Assets = Human Capital

Implied Liabilities = PV future spending needs

Excess Capital = PV Assets including implied - PV Liab including Implied

Always note that a safety reserve is highly recommended as mortality rates are based upon average figures and to provide a psychological buffer against volatility. Use Rf rate to calc PV of spending needs because spending risk is unrelated to the risk of the assets used to fund spending.

Prob Joint Survival = 1 - Chance they Both Die

Chance They Both Die = Prob one dies * Prob other dies

As time passes implied liabilities decline as they have a finite lifespan assuming the same annual spending needs (IF THEY ARE PRESENTLY SPENDING). If they are not presently spending and spending is in future their implied liabilities will rise as time passes because they are being discounted less.

41. Yardeni - Forward Earnings Yield vs. Corp A Debt - (Import of earn * 5 year earn growth)

Premise Since D1/(R-G) = P then R - G = D1/P. It is assumed that D1 = E1.

Thus Yardeni can be compared to R - G where Corp A Debt is R and the (Import of earn * 5 year growth) is G

Obvious Con is that Corp A Debt is not a good approximation of the risk of equity

Additionally the importance of earnings changes depending upon where the cycle is and is not static

42. Fed - Forward Earnings Yield vs. 10 year T Bond

Con of Fed is doesn’t consider earnings growth

Another Con compares nominal figure (Bond Yield) to real figure (earn yield)

TBond Yield not a good approximation fo equity risk

Pro - It captures the relationship when rates fall earnings are more valuable which is true as earnings become more real as inflation falls

43. More Frequent Rebalance

Pro - Potentially less market impact as the portfolio will require smaller trades to rebalance back to target

Con - Higher transaction costs relative to the benefits of rebalancing and more monitoring

44. % of port rebalancing vs. Calendar Year

% of port - if one is outside of band then rebalance ALL to target

Con - Requires more monitoring

Pro - related to market activity

45. Bond Equivalent Yield = If given for immunization be sure to compound semi-annually

Bond Equivalent Yield = ((1 + Annual Return)^(1/2)-1) * 2

46. If plan freezes inflation indexed benefits for new retirees, current AND DEFERRED will retain inflation benefits. Also it is important to note that even if a plan does not index benefits for inflation there will need to be SOME real bonds in the portfolio to account for the % of salary increases related to inflation.

Equity = Real salary increases

Real Bonds = Benefits indexed for inflation + Inflation part of salary increases

Nominal Bonds = Benefits not indexed for inflation

47. Asset Only Approach - Low risk asset is asset with low correlation with other assets. In ALM low risk asset is the asset with the highest correlation to the liabilities.

48. Tax Efficient = Buy and hold

Dont want cash drag = not buy and hold

Floor = CPPI or buy and hold

risk tolerance increases 20% for every 20% increase in wealth = constant mix

Believe moderately increasing to flat market with low volatility = Buy and hold

49. Do nothing if trending, rebalance if expect correction = Discretionary hedge

50. Duration of Call = Dur of underlying * Delta * (Price of Underlying / Price of Option)

51. Port turned over twice a year and cost to trade is 50 bps

Cost to trade = 50bps * (1 time bought + 1 time sold) * 2 times turned over = 2%

52. Benchmarks and Validity Check

Absolute - Not Investable

Broad Index - Only appropriate if semi-active approach vs broad index

Mgr Universe - Fail everything except measurable

Style - Ambiguous and may not match manager process

Factor - Ambiguous and not intuitive

Return-Based - SATISFIES - con is requires many months to get reliable pattern

Custom Security - SATISFIES - Arguably the best but con is expensive to construct and maintain and have transparency concerns

53. Type 1 Error - Keeping bad manager

54. Inputs to Maco Attribution

Policy Allocation, Bench Returns, Fund Returns/Cash Flows/Valuations

55. Macro Steps

  1. Net Contributions - No Impact

  2. Rf Rate

  3. Category @ Neutral - Passive Return in excess of rf

  4. Style @ Neutral - Misfit Return

  5. Fund @ Neutral - Active Return excluding Tactical Asset Allocation

  6. Fund @ Actual Weight - Tactical Asset Allocation

0 + rf + Passive + Misfit + Active excl TAA + TAA = Total Return

56. 3 Assumptions of Quality Control - VAN

V - Volatility of Alpha Constant (doesn’t change styles)

A - Alpha independent

N - No Skill is null

57. GIPS - Bring over past performance from new firm

Must have same decision makers, same process, and have records to support performance that you obviously didn’t steal or take from your previous employer without permission


Must disclose your role in the performance (co-manager, etc) or just disclose the performance you were responsible. Again you can’t find the shit in your computer from your previous employer and use it without permission.

58. Within Sector (SELECTION) Bench Sector Weight * (Port Sector Return - Bench Sector Return)

Pure Sector Allocation =(Port Sector Weight - Bench Sector Weight) * (Bench Sector Return - Bench Return)

Interaction = (Port Sector Weight - Bench Sector Weight) * (Port Sector Return - Bench Sector Return)

59. Short Collar = Risk Reversal.

Short Seagull Spread = Collar + Sale of OTM Put = Put Spread + Sale of OTM Call

Short Seagull Spread = Short Risk Reversal + Sale of OTM Call

Long Seagull Spread = Call Spread + Sale of OTM Put

Short Butterfly Spread = Sandwich Spread

Bear Put Spread + Bull Call Spread = Box Spread

Money Spread = Spread with more options on one side than other

Time Spread = Spread with differing maturities on one side than other

60. 4 Core GIPS Principles

  1. Adhere to Law

  2. Properly Define Firm

  3. Provide Compliant presentations to all prospects

  4. Ensure not false or misleading

Common Pros and Cons

Including microcaps increase completeness and decrease investability

Floating Bond increases cash flow risk and decreases market risk.

Cash Flow Matching has no immunization risk but requires more cash to fund as there is rarely perfect matching and need to assume conservative rates for cash balances which can be large sometimes

OTC Derivatives more customized/useful for currency but are more difficult to exit as difficult to find offsetting so may have to negotiate early termination fee. Thus not as liquid as exchange traded.

Calendar Year Rebalancing is simple, provides discipline, and requires less monitoring, but is unrelated to market activity

Using Min Var Ratio (Beta) for a proxy hedge decreases basis risk/tracking error but is very unstable and requires constant montioring and rebalancing

Buyout funds are more stable, have earlier cash flows, higher avg returns, and less failures BUT have less upside potential than Venture Capital

Integration causes more liquidity and lower risk but at the tradeoff of lower return and less diversification benefits

Optimization (vs. Strat Sampling) minimizes tracking error but at the cost of higher turnover. Also risk of overfitting/sampling error.

Ad Valorem (AUM) Fee is simple & predictable but does not align port mgr interests as well as a performance fee

Pooled Accts have lower mgmt costs for small funds that cant afford dedicated mgr but may hold excess cash to provide liquidity and it is difficult to differentiate pooled performance

Stock Index futures have lower transaction costs and can leave underlying manager underdisturbed to facilitate risk mgmt transactions but must be rolled over and have uptick rule that only allows sales at a price higher than last trans cost for shorts

Holdings analysis captures changes in style more quickly and can tell you what a manager holds but it cannot detect style drift like Returns based analysis can and it also is more complicated than returns based analysis

Implementation shortfall algorithm has less opportunity cost but more market impact than VWAP algorithm. If you are risk averse and consider MVO or are doing portfolio trades or believe in an uptrending market if buying and a downtrending market if selling you will want implementation shortfall as it frontloads trades on in day and considers missed trade opp cost.

61. Min Var Ratio = Cov (Asset, Hedge) / VAR (Hedge)

Similar to Beta except Var of Mkt = Var of Hedge

This is only used for a proxy hedge due to basis risk

62. European Call has 0 Jump to Default Risk (AKA Current Credit Risk) but has potential credit risk equal to the price of the option (NOT THE OPTION PAYOFF)

63. American Call option has current credit risk equal to the price of the option (NOT THE OPTION PAYOFF)

64. Measure the potential credit risk of a currency forward:

A. Current Spot * ((1 + rf domestic)^n / (1 + rf foreign)^n) = New Forward Rate

B. ((New Forward Rate - Locked In Forward Rate at purchase) * Foreign Notional) / (1 + rf domestic)^n = PV Domestic Gain to the LONG

PV Domestic Gain to the Long = -PV Domestic Gain to the short

SPOT = Domestic/Foreign

65. Info Ratio = Info Coeff * SQRT (Breadth)

66. (Asset MV * Asset Dur - Liab MV * Liab Dur) / Equity MV = Equity Dur

67. Spread over mean / STDDEV Spread = Highest will exhibit fastest mean reversion

68. Utility = Port Return - 0.5 * K * VAR (Asset)

69. Last Years Expenses - check and see if you need to increase for inflation

70. Friedman Savage Double Inflection Utility Function: People must be paid a premium to take moderate risks. People maximize expected wealth subject to a safety constraint. Low income/wealth individuals either chose no or low risk with current wealth (buy insurance) or a high risk with a low probability payout to acquire future wealth (gambling/lottery). High Income /wealth individuals are risk averse with current assets. Middle Income/individuals prefer small more fair gambles?

Traditional Finance assumes Risk Averse have concave utility curves and convex indifference curve. It assumes individuals maximize utility subject to a budget constraint.

Thanks can you email them to me? ill private msg u my email addy

71. Ways to reduce turnover/transaction costs for indexes:

Overlap between categories, buffering rules, less index breadth, multiple variables to measure style, clear and transparent rules that allow indexes to anticipate changes

72. Y = TFP + ALPHA * K + (1 - ALPHA) * L

Incentivizing Savings increases K and may increase TFP

One time changes don’t affect long term growth

More Wealth Redistribution = Lower TFP due to inefficiencies in asset prices

Regulations cause one time change

More technology = Higher TFP

73. Contingent Immun

PV Asset * (1 + (Min or Safety Return / 2))(^n*2) = Required Terminal

Required Terminal / (1 + Available Immun / 2)^(n*2) = PV Liab

PV Asset - PV Liab = Cushion Spread

74. Traders should not monitor risk it should be independent group that reports to CEO/Board.

75. Don’t add two VARs together as there is a diversification benefit

76. Mkt Val Asset / Replace Val Asset = Tobin Q

Mkt Val Asset - Mkt Val Liab / (Replace Val Asset - Mkt/Replace Val Liab) = Equity Q

Mkt Val Equity / Replace Val Equity = Equity Q

Exhibits mean reversion over long term to 1. Difficult to value the intangible assets is a con. Lower = underpriced

77. Singer Tehrar ICAPM

  1. Global Sharpe * STDDEV(asset) * Correl (Asset, global mkt) = Risk Premium Perfect Integration

  2. Local Sharpe * STDDEV(asset) * 1 = Risk premium Perfect Segmentation

  3. (% Integrate * RP Integrate + % Segment * RP Segment) + Illiquidity Premium (if any) = Risk Premium

  4. Risk Premium + rf = Expected Return

Many questions assume Local Sharpe = Global Sharpe so if not given two use Global Sharpe in Place of Local.

78. Calculate the covariance/correlation of 2 assets using nothing but their betas and variance of mkt

1. Memorize following 3 equations

A. Cov(x,y) = BetaX * BetaY * VAR(MKT)

B. Beta X = Cov(x,mkt) / VAR(MKT)

C. Cov(x,mkt) = Correl(x,mkt) * STDDEV(X) * STDDEV(MKT)

2. Apply simple algebra and combine A, B, and C

Cov(x,y) = (Correl(x,mkt) * STDDEV(X)) / STDDEV(MKT) * (Correl(Y,mkt) * STDDEV(Y)) / STDDEV(MKT) * VAR(MKT)

3. VAR(MKT) terms cancel out with 2 STDDEV(MKT) terms

Cov(x,y) = Correl(x,mkt) * STDDEV(X) * Correl(Y,mkt) * STDDEV(Y)

Term will be in %^2

79. Asset Manager Code Principles : Ethical Manner, Benefit of clients, independence/objectivity, skill/comp/dilligence, timely and accurate communication with client, uphold capital mkt rules

80. Black Litterman/Resampling address unstable efficient frontier. Constrained Black Litterman uses reverse optimization starting at the global equilibrium portfolio and allows an individual to express views. It is based upon theory and it dampens extreme investor views while being diversified. It does not lie on the efficient frontier if investor adjusts for views but will be close. It assumes all mkt in equilibrium unless adjusted. It causes the expected returns (input) to have less effect on the output which are the most volatile component. Resampling has same benefits but doesn’t use complicated math (pro or con depending) and isn’t backed by theory (con). As far as I know resampling doesn’t allow for investor to adjust views.

Unconstrained is the same as constrained black litterman it just does not use reverse optimization for some odd reason.

More to come tomorrow. I have 500 ish bullets.

cool of you to put your notes down, much appreciated. Good points off some of the previous year tests.

1 Like


Axioms of Utility Theory

Indifference Curves - Continuous

Preferences Well Defined

Order of preferences can be combined if C > D, then C + A > D + A

Decide consistently

BAYES - Apply Bayes formula to incorporate new info

MADE - Maximize utility subject to budget constraint

A - Adhere to Axioms of Utility Theory (IPOD)

PIE - Probability assigned to possible events

82. Bayes Formula - New Prob A = Old Prob A * (New Prob of B after new info / Old Prob of B)

83. Isolation Effect - When process of editing in prospect theory leads to inconsistent preferences/choices due to framing.

84. Mental Accounting and Framing relate to:

Layer of investments, spending current income first, spending current assets second, spending future income last.

Money/assets can fall into any of the three buckets depending upon how they are framed

85. Appropriate benchmark for a market neutral strategy is a hurdle rate/risk free rate due to lack of systematic risk despite the fact that another reading states that these are invalid benchmarks as they are not investable.

86. 5 Factors that lower repo rate

High Quality Collateral, High Demand relative to Supply collateral, Shorter length of repo agreement, collateral is physically delivered to lender, fed funds rate is low

Maturity of collateral affects the quality of collateral it is not a separate factor

87. Synthetic Investing - Want to convert 100k cash temporarily to equity for a year

(100k * (1 + rf)^1) / ((Contract Price/Conversion Factor) * Multiplier) = # of contracts (WHOLE NUMBER)

If you have 100k you are expecting to receive in 1 year and want to preinvest it

100k / ((Contract Price/Conversion Factor) * Multiplier) = # of contracts (WHOLE NUMBER)

88. Taylor Rule Calculates the target fed funds rate. If you want to find the CHANGE in the fed funds rate using the taylor rule you need to use the taylor rule using the CURRENT data to find the fed funds rate NOW and then use the taylor rule again using FORECAST data to find the fed funds rate IN FUTURE

Then Subtract FUTURE FED FUNDS - CURRENT FED FUNDS to get the expected CHANGE.

Taylor = Neutral + 0.5 (Inflation Fcst - Inflation Tgt) + 0.5 (GDP Fcst - GDP Tgt)

If either inflation or GDP are growing above tgt the economy is overheating and the fed will raise rates to cool the economy.

89. 6 Categories that Affect Pension Risk

Sponsor Profitability - Debt/Equity Ratio and net income margin

Workforce Characteristics - % Active Lives, Avg age of workforce, avg age of retirees

Plan Features - Lump Sum/Early Retirement

Funded Status

Contribution Outflow Ratio

Correlation of sponsors earnings with pension asset returns

90. Noise = Chance of actuarial assumptions differing from reality

More participants = Less Noise

Older Participants = Less Noise

Frozen Plan = Less Noise

You need to go to work for Schweser or Wiley. Or maybe Edupristine, they could seriously use the help.

91. High Quoted Spread and High Trade Volume / Avg Daily Trade Volume - Best suited for a crossing network, Electronic communication network, or broker or principal trade with dealer

If Low Spread and Low % Avg daily trade volume then use logical participation.

92. Global Min Var Port for ALM is cash flow match which is costly and not optimal however it is good to measure the risk taken vs this portfolio.

93. Soritino is beta based and will only apply to equities

94. A. Quarterly Foreign Cash Flow * 4 / Foreign Swap Rate = Foreign Notional

B. Convert Foreign Notional to Domestic at Spot

C. Domestic Notional * Domestic Swap Rate / 4 = Quarterly Domestic Cash Flow

95. Systematic Trading = Rules Based and can be contrarian or trend following rules

Discretionary Trading = Judgement and manager’s expertise

96. Positive Roll Yield = Backwardation for long = Downward sloping curve for long

Reverse relationships if short.

97. Using mining stocks as an indirect way to gain exposure to commodities is inefficient as most commodity companies hedge their own commodity exposure.

98. Implementation shortfall can be positive (costly) or negative (benefit) if delay causes trader to get a better price.

99. Algorithmic trading can cause concentration problems as liquid securities are bought and sold first

100. Loans + Bank Treasury Port = Bank Assets

Deposits = Bank Liabilities

If loans become more risky, use treasury port to offset and become less risky

If deposits become more risky, can take on more risk in port

Performance Measures

Net Interest Rate Margin = (Interest Income - Interest Expense) / Avg. Earn Assets

Interest Spread = Avg Yield on earn assets (port and loans) - Avg yield on interest bearing liab (deposits)

Risk Measures

Credit Risk Metrics (general)


Leverage Adjusted Duration Gap = Asset Dur - Liab Dur * (Liab/Asset)

Since Asset = Liab + Equity

Thus Asset Dur = (Liab/Asset) * Liab Dur + (Equity/Asset) * Equity Dur

(Liab/Asset) * Liab Dur + (Equity/Asset) * Equity Dur - (Liab/Asset) * Liab Dur

Equation simplifies to Equity/Asset * Equity Dur

because if she’s flat and heavy, i’ve got no interest in her

these notes are great, thanks for posting

101. Duration Foreign Bond = Duration * Yield Beta

102. The actuarial rate assumed to meet claims of insurance is generally not taxed.

103. Shrinkage estimator is the weighted avg of 2 correlation matrices which is done to reduce the impact of a forecast and generally blends forecast with historical data to mute impact of extreme forecasts. ANY CHOICE OF the target covariance matrix will not decrease the efficiency of the covariance estimate. Good for small/medium data sets.

104. ALM Benchmark is the liability itself

105. Market Risk = Financial Risk = interest rate risk, exchange risk, commodity risk, econ risk, etc.

Liquidity Risk = Financial Risk = high bid-ask spread/mkt impact

Credit Risk = Financial Risk = Counterparty Risk

106. Prudence trap - overly cautious forecast to manage client expectations. Data mining is adding variables to model that have no predictive merit. Time period bias is short term relationships that will not hold in the long run

107. If trying to assess whether a fixed income strategy is active, semiactive or passive focus on the duration first. IF the duration is not perfectly matched it is active. If the duration is a large mismatch then it is “FULL BLOWN active” Just a plain “active” strategy will never have a large duration mismatch. A semi-active strategy will have a goal of reducing expenses with small alpha.

108. When Both Monetary and Fiscal Policy are expansive - strong upward slope

When Both are restrictive = Inverted curve

When Monetary is restrictive but fiscal is expansive = FLAT

When Monetary is expansive and fiscal is restrictive = Slight slope

109. Key rate duration holds all other key rates constant except for one and repeats this with all key rates to simulate effect of twists

110. If you are concerned about risk , it is a credit defense trade regardless if you are doing it with individual bonds or with sectors. Do not confuse this with a sector trade.

111. Optimal ALM strategy is to use interest rate swaps to mimic liability exposure and free up capital to invest in equities

112. If given CTD bond price & conversion factor and you are using the CTD duration to calc # of contracts then use the CTD Price & the conversion factor.

Whatever Duration you are given is the price you will use.

(TGT Exposure - Current Exposure) / (Contract Exposure) * ((Market Value of port) / (Price of Contract / conversion factor)) * Yield Beta

If Yield Beta is not given input 1

If conversion factor is not given input 1

If given cash duration use it.

If you are asked to simultaneously decrease the amount in stocks and change the beta you will need to do the following steps:

A. Calculate the # of contracts as if you were decreasing the amount in stocks and not changing the beta

B. Calculate the change in beta as if you had made the cash trades in step A and changed the amount in stocks and bonds. So you will want to use the new stock $ amount not the current.

C. Add contract amounts together.

113. Emerging markets have access to secondary sources of liquidity (IMF and World Bank)

114. If doing an OLS regression assuming correlation of 0.1 between factor 1 and factor 2 and you want to find out what the volatility would have been had you had a correlation of 0.5 between factor 1 and factor 2 you need to follow the following steps:

A. Calculate VAR(Error) using following equation and inputting info from the regression.

VAR (X) = VAR(Factor 1) * Beta(F1)^2 + VAR(F2) * Beta(F2)^2 + 2 * Beta(F1) * Beta(F2) * Correl (F1,F2) + VAR (Error)

B. Enter new correl (F1,F2) and enter the VAR(Error) calculated in A and solve for VAR(X)

C. Take SQRT of VAR(X) to get STDDEV(X)

115. Misfit Return = Normal (style) bench - Investor (broad) Bench

True Return = Port Return - Normal (style) bench

Total Return = True return + Misfit Return

Total STDDEV = (True VAR + Misfit VAR)^(1/2)

116. Bond Yield + Premium Approach = 10 Year T Bond + Equity Risk Premium

Buildup Approach = Short Real Rf + Inflation Premium + Maturity Premium + Liquidity Premium + Equity Risk Premium

117. Holdings Data required for style box. Return based analysis can detect style drift and but can’t specifically say what they have been invested in. Returns based analysis is simple and only requires return data.

118. Fair Dealing = Favoring one client over another (client front running other clients)

Priority of Transactions = Employee front running a client

119. Issuer paid research must disclose total comp and only accept flat fee not based upon result and must disclose that its issuer paid.

120. Misconduct = purposeful ommission

Misrepresentation = either accidental or purposeful ommission

121. Swaption Rate = Coupon Rate - Credit Premium

Add a call option to fixed debt if you are the issuer by buying a fixed receiver which will give you the option to pay a floating rate should rates fall. If you would issue a callable bond you would similarly be able to call the debt and pay a floating rate if rates would fall.

122. Behavioural Life Cycle - Framing/Mental Acct of wealth as current income, future income or current assets

123. Behavioral Asset Pricing (Stochastic Discount Factor) - Forecast dispersion is an additional risk factor that is added to the traditional discount rate. This is also called sentiment risk.

124. Behavioral Port Theory - Maximize wealth subject to a safety constraint. Large # of assets per layer suggests risk aversion. Greater cash holdings suggest loss aversion and represents the safety constraint. Asset concentration suggests belief of info advantage

125. Adapative Market Hypothesis is a revised version of EMH that adds in bounded rationality and satisfice. It assumes risk premiums change over time, active manage can add value via arbitrage, strategies will have periods of outperformance and underperformance. People apply hueristics until they fail then adjust with ultimate goal being SURVIVAL.

126. Prospect Theory = Loss aversion when making a decision. Loss Aversion = disposition effect.

127. When using dealer bid ask spreads use the bid/ask that lowers your gain the most or increases your loss the most.

128. FX Swap - This is NOT a currency swap. This is a rollover of a maturity foward contract buy doing the opposite spot transaction as the forward transaction. And then entering in to a new forward contract that was same as the previous.


A. Sell 10M Zar 3 month forward

B. 2 days prior to expiry will Buy 10M ZAR in spot

C. Enter new contract to Sell 10M Zar 3 month forward

If doing the SAME notional in step A and Step C then:

Spot transaction will be the (bid + Ask) / 2 known as the MID SPOT

Forward Rate will be MID SPOT + Adjusted SIDE Forward Point

If changing the notional in step A and step C for whatever reason then:

Spot transaction will be the SIDE SPOT

Forward Rate will be SIDE Spot + Adjusted SIDE Forward Point

Adjust the forward point based upon number of decimals in quotes.

Spot = 1.42 Forward points = 9 Forward rate will equal 1.42 + 9/100 = 1.51

Spot = 1.423 Forward Points = 20 Forward rate will equal 1.423 + 20/1000 = 1.443

129. Active Accum Adventure and Spontaneous Friendly Celebrity are ACTIVE and EMOTIONAL

Cautious Preservers are PASSIVE and EMOTIONAL

Independent Individuals are ACTIVE and COGNITIVE

Methodical are PASSIVE and COGNITIVE

Straight Arrow = middle of road on everything

Will want to take control with Active accum Adventurers, Provide big picture items for cautious preserves based upon goals, provide detailed rationale for methodical and independent individuals and educate spontaneous friendly celebrities.

130. Sample Size Neglect = I read the CEO was good so the stock must be good

Common Bias Mixups

Conservatism - Cognitive - Too complex to analyze so don’t change

Status Quo - Emotional - Inertia and don’t like feeling of change

Illusion of control - Cognitive - Believe they influence when they don’t

Illusion of knowledge - Emotional - Believe they are a genius

Hindsight Bias - Cognitive - Fill in memory gaps with what they prefer to believe. think easy to predict the past

Self Attribution - Emotional - A subset of overconfidence where they blame others for failure

Availability Bias - Cognitive Processing - putting more weight on info because it resonates with them

Representative - Cognitive Belief - Categorization problem

Loss Aversion - Emotional - Selling winners to lock in gains, holding losers to avoid losses. Taking extra risk to make up for losses. Leads to disposition effect. Results in excess turnover. Would rather take a risky gamble to get a small gain vs. large loss than a fair gamble that would result in a small loss vs. smaller loss

Regret Aversion - Emotional - Past memory that caused them regret is causing them to act a certain way or they are doing something solely to avoid the regret of not doing it and missing out and regretting it later (herding)