The All Weather Strategy
Ray Dalio had a problem. He was the founder of a successful money management firm for institutional investors, such as pension fUnds. He had established plans and trust funds for his loved ones, and he was managing the assets. But he worried what would happen to these funds in the future. Dalio had seen and heard of too many cases in which inherited funds were taken over by new trustees or money managers who subsequently lost a large share of the wealth. He sought a way of ensuring that the...
Eliminating Distortion Caused By Large Cash Flows
An expedient solution to calculating an estimated TWR using the MWR and removing the error associated with large cash flows is to calculate a special valuation when there are large cash flows and to calculate subpe-riod returns for the periods flanking the large cash flow date. To do this, analysts monitor the portfolio for cash flows and identify situations where the MWR is being materially influenced by the cash flows. This is usually done using some threshold net transaction value, such as...
Financial Engineering And Interest Rate Derivatives
New financial instruments created through financial engineering can have highly unusual risk and return characteristics that offer both opportunities and challenges for fixed-income portfolio managers. To illustrate the possibilities opened up by financial engineering, consider the inverse floater, which is a bond that pays a lower coupon payment when a reference interest rate rises. For example, an inverse floater may pay a coupon rate equal to 10 minus the rate on one-year Treasury bills....
Probability Theory
It is a vast oversimplification, but not an overstatement, to say that the stock market is an uncertain universe. In this universe are hundreds, even thousands of single forces that combine to set prices, all of which are constantly in motion, any one of which can have a drastic impact, and none of which is predictable to an absolute certainty. The task for investors, then, is to narrow the field, to identify and remove that which is the most unknown, and to focus on the least unknown. And that...
The Way Ahead
Financial planning has always been a blend of art and science. This chapter demonstrates that the art of financial planning is enhanced by taking a sequential, scientific approach to a particular psychological attribute the client's risk tolerance. Use basic research to distill an understanding of the construct being considered. Use the appropriate disciplines to build a test instrument. Use large numbers of test results to fine-tune the understanding of the construct and the instrument. Seek a...
Example 121
An investor intends to construct a portfolio consisting entirely of the shares of Company A and Company B. Short-selling is not allowed. The prospects for the shares are as follows Share A Share B Expected return E 10 20 Standard deviation of return a 20 30 a Assuming that the objective is the minimisation of ap, what proportion of available funds should be invested in A and what proportion in B if the returns of A and B are i perfectly positively correlated rAB 1 iii perfectly negatively...
The Market Index
In what has become known as Roll's critique, Richard Roll3 pointed out that 1. There is a single testable hypothesis associated with the CAPM The market portfolio is mean-variance efficient. 2. All the other implications of the model, the best-known being the linear relation between expected return and beta, follow from the market portfolio's efficiency and therefore are not independently testable. There is an if and only if' relation between the expected return-beta relationship and the...
Reading Japanese Candlesticks
Candlesticks measure price fluctuations within a certain time frame. CapyrW 2N5 hy Martat Tiadws Intitula, Inc. Trading is a financial game involving two opponents the bulls and bears. We all know that there are not actual bulls and bears trading in the market, but investors and traders who have invested either in a bullish direction or a bearish direction. Both sides have clear objectives and want the market to move in their direction bulls want the market to go up, or rally, to make higher...
Return Concepts
LOS 36.a Distinguish among the following return concepts holding period return, realized return and expected return, required return, discount rate, the return from convergence of price to intrinsic value given that price does not equal value , and internal rate of return. Holding period return is he increase in price of an asset plus any cash flow received from that asset, divided by the initial price of the asset. The measurement or holding period can be a day, a month, a year, ere. In most...
Partnerships and Equity Sharing
The guy with the experience approaches the guy with the money. When the deal is complete, the guy with the experience has the money, and the guy who had the money has experience. If you are low on cash or have cash and are low on time, a partnership or equity-sharing arrangement may be for you. Using partners to finance real estate transactions is the classic form of using other people's money OPM . Experienced investors are always willing to put up money to be a partner in a profitable real...
COMMODITY OliYWIl lDi
The Commodity Channel Index CCI , invented by Donald Lambert in 1980, was originally designed to solve engineering problems regarding signals. The indicator was adapted for trading of commodities and later popularized by Ken Wood, who used it to trade a variety of financial instruments, including currency futures. Donald Lambert's intent in developing the CCI was to manufacture an indicator that would try to normalize momentum readings. Like sto-chastics and RSI, the prime focus of the CCI is...
macd histogram
Subtracting the slow line signal line from the fast line MACD line creates the MACD histogram. Plot the difference in the form of histogram bars. When the fast line is above the slow line, the histogram bar is plotted above the zero line. When the fast line is beneath the slow line, the bar is beneath the zero line. The slope of the histogram depends on the difference between the fast line and the slow line. Stronger bull action will cause the fast line to be farther above the slow line thus...
The Internet Investments Online Yhw
Fixed-income management analytics and software are typically proprietary. The sites listed below offer some additional information about the techniques discussed in the text and will give you insight into the use of various analytical and portfolio management techniques. http www.ryanlabs.com Ryan Labs is a leader in the construction and analysis of fixed-income indexes. Their site offers information on its research, data, indexing, consulting, and asset liability management skills this latter...
private equity valuation
This is a new topic review this year and has a great deal of testable material, both conceptual and quantitative. For the exam, know the three sources of value creation in private equity. Know that, relative to buyout firms, venture capital concerns firms that are immature and generally more risky. Understand that the drivers of return for buyouts are earnings growth, the increase in multiple upon exit, and the reduction in the debt whereas for venture capital firms, it is the pre-money...
Lightweight Remoting Hessian and Burlap
An RMI environment can be cumbersome to set up, and uses arbitrary network ports that are not firewall-friendly. WSDL SOAP-based web services are hard to export in a portable fashion, and waste bandwidth because of their verbose protocol. Lightweight HTTP-based remoting protocols address both these issues They can be run on top of any standard Servlet container, and will work across any firewall. While there has been much talk about HTTP-based web services, it has focused on WSDL and SOAP with...
Investing Case Study 1
Imagine yourself in midtown Manhattan walking down the most fashionable part of 5th Avenue. When you get to 56th Street your breath is taken away by a towering, modern, distinctive building with a unique jagged facade of black glass. As you look up, your eye catches a grove of 16 full-size trees planted on six floors of terraces the lowest of which is 50 feet above the level of the sidewalk. Upon entering the 68-story tower, you are flanked by attractive show windows of renowned retail stores....
Using the market cycle model
How can you put this into practice My favorite method is to plot three smoothed momentum indicators to mimic the three trends. An example can be seen in Figure 8 using the Kst indicator, originally introduced in Stocks amp Commodities in the early 1990s. The formulas for the three trends can be seen in the sidebar, The Kst. It's also possible to substitute other smoothed momentum indicators. For example, three suggested sets of parameters are displayed in Figure 9 for the stochastic indicator....
The Index Model and Diversification
The index model, first suggested by Sharpe,6 also offers insight into portfolio diversification. Suppose that we choose an equally weighted portfolio of n securities. The excess rate of return on each security is given by Similarly, we can write the excess return on the portfolio of stocks as We now show that, as the number of stocks included in this portfolio increases, the part of the portfolio risk attributable to nonmarket factors becomes ever smaller. This part of the risk is diversified...
Fallacies of longterm portfolio choice
Although the conditions for myopic portfolio choice are simple, and their logic can be understood without resort to advanced mathematics, there has been much confusion about these issues over the years. One source of confusion is the common tendency to measure risk in units of standard deviation rather than variance, and to work with mean-standard deviation diagrams like Figure 1.1 rather than mean-variance diagrams. With IID returns the variance of a cumulative risky return is proportional to...
Spot And Forward Yields
The spreadsheet entitled SPOTYA.XLS, found on the Online Learning Center www.mhhe.com bkm , can be used to estimate spot rates from coupon bonds and to calculate the forward rates for both single-year and multiyear bonds. The spreadsheet demonstrates a methodology to bootstrap spot rates from coupon bonds. The model sequentially solves for the spot rates that are associated with each of the periods. The methodology is similar to but slightly different from the regression methodology described...
Duration
To deal with the ambiguity of the maturity of a bond making many payments, we need a measure of the average maturity of the bond's promised cash flows to serve as a useful summary statistic of the effective maturity of the bond. We would like also to use the Figure 16.2 Cash flows paid by 9 coupon, annual payment bond with 8-year maturity. The height of each bar is the total of interest and principal. The lower portion of each bar is the present value of that total cash flow. The fulcrum point...
Capital Requirements Actuarial Risk Management
The capital requirements for equity-linked insurance differ by jurisdiction. Although many contracts in the United States have minimum requirements based on simple deterministic projection, some actuaries have recognized the potential inadequacy of this method and have moved to stochastic simulation to determine the requirements. In Canada, regulations permitting the determination of capital requirements by stochastic simulation of the liabilities are due to come into full effect by 2004 the...
Trade Chart Patterns Like The Pros
Don't read this book - MAKE MONEY WITH IT Trade Chart Patterns Like The Pros by Suri Dud-della is one of those rare opportunities to build a base of knowledge that can take you further each time you trade. Suri has laid out an indispensable tome on trading chart patterns based upon his real-life experiences in a format that will work well for the spectrum cf investors - from novice to expert. Trade Chart Patterns Like The Pros stays focused and does not overwhelm you with mathematical...
Neuroticism versus Emotional Stability
Neuroticism is on the opposite pole from emotional stability. Those who score high on neuroticism experience more negative feelings such as anxiety, anger, or depression and are more emotionally reactive than others. They are more likely to identify with the phrase Panic easily. Their difficulty in emotion regulation when under stress can impair their ability to think clearly, make decisions, and cope. In one fMRI experiment, the degree of participants' insula activation when threatened was...
Stress
Stress is the condition that results when personenvironment transactions lead the individual to perceive a discrepancy whether real or not between the demands of a situation and the resources of the person's biological, psychological or social systems. Stress arises out of the discrepancy between where one is and where one imagines they should be - a conflict between their expectations and reality. If that difference is too large, for too long, chronic stress will physically wear them down,...
Actual Returns versus Expected Returns
The CAPM is an elegant model. The question is whether it has real-world value whether its implications are borne out by experience. Chapter 13 provides a range of empirical evidence on this point, but for now we focus briefly on a more basic issue Is the CAPM testable even in principle For starters, one central prediction of the CAPM is that the market portfolio is a mean-variance efficient portfolio. Consider that the CAPM treats all traded risky assets. To test the efficiency of the CAPM...
Contribution To Return
Suppose we had a portfolio comprised of four stocks, each held with an equal 25 weight, and each earned 10 during the period. We can see in Exhibit 17.1 that the contribution to return made by each security to the total fund return is 2.50 . The 2.5 contribution for each security was calculated by multiplying the beginning of period weight by the return during the period. Contribution to return Security begin weight x Security return 17.1 EXHIBIT 17.2 Single Period Contribution EXHIBIT 17.2...
The Curse of the Quote Machine or Tickeritis
A constant resort to price quotations clouds judgment. Uncontrolled tape watching or quote gathering is a sure way of losing perspective. Just after I began trading futures in 1980,1 remember renting a very expensive quote machine that also plotted real-time charts. At the beginning of the trading day, the screen was blank. As the day wore on, it gradually filled up as each tick or trade was plotted on the screen. This seemed to be a good idea at the time, because my approach to speculation had...
Why We Eat Dessert First
Our favorite holding period is forever. Warren Buffet in Letter to Berkshire Hathaway How many people actually complete their New Year's resolutions It shouldn't be difficult, but year after year, whether it is to maintain their ideal weight, save adequately for retirement, or otherwise accept short-term pain for a long-term benefit, very few people can stick to the plan. They simply cannot defer gratification. The difficulty people have in delaying pleasure is a result of time discounting.1...
DeltaHedging for Portfolio Insurance
Portfolio insurance, the high-tech hedging strategy that helped grease the slide in the 1987 stock market crash, is alive and well. And just as in 1987, it doesn't always work out as planned, as some financial institutions found out in the recent European bond market turmoil. Banks, securities firms, and other big traders rely heavily on portfolio insurance to contain their potential losses when they buy and sell options. But since portfolio insurance got a bad name after it backfired on...
Beliefs Not Prejudices
The character and psychological makeup of each individual is unique. This means that some of us come to the marketplace with more biases than others. In this respect, it is important to note that many of our prejudices are shaped and influenced by our experiences. Someone who has suffered a great deal from financial insecurity through bankruptcy or a recent job loss, for example, is much less likely to take risks when investing. A given piece of bad news will send this person scurrying to his...
How to Be Objective
There are no certainties in this investment world, and where there are no certainties, you should begin by understanding yourself. .s soon as money is committed to a financial asset, so too is emotion. Any biases that were present before the money was placed on the table are greatly increased once the investment has actually been made. If none were present before, they certainly will appear now. However hard we may try, certain prejudices are bound to creep in. A successful investor realizes...
Holy Grail
Nothing is more frequently overlooked than the obvious. JLOU probably bought this book hoping that it would provide some easy answers in your quest to get rieh quickly in the financial markets. If you did, you will be disappointed. There is no such Holy Grail. On the other hand, this book can certainly point you in the right direction if you are willing to recognize that hard work, common sense, patience, and discipline are valuable attributes to take with you on the road to smart investing....
TwoWay Swing Area
The next concept is the two-way swing aiea. Let's say that on a chart you can see crude oil futures are rangebound between 24 and 25. The market just keeps bouncing like a pinball between the 24 area of support and the 25 area of resistance. Then some random event causes the market to gap down to, say, 23 below the prior low at 24. Now, let's say that, after some time, the market comes back and tests this 24 area. This prior low of 24 now acts as resistance. Furthermore, the 24 area becomes a...
Which Stocks Rebound
The big question we have been asking is Which stocks By studying stock tables closely during this period you can determine which stocks are rebounding strongly and which are not responding. Many of the strong rebounders are likely to become the market leaders. For that reason it is important to identify those stocks and their characteristics. After reviewing the monthly Security Charts of 1,105 leading stocks published by the Securities Research Company, I was able to determine quickly the...
Jerry Toepke Why Seasonals Work
The seasonal approach to markets is designed to anticipate future price movement rather than constantly react to an endless stream of often contradictory news. Although numerous factors affect the markets, certain conditions and events recur at annual intervals. Perhaps the most obvious is the annual cycle of weather from Warm to cold and back to warm. However, the calendar also marks the annual passing of important events, such as the due date for U.S. income taxes every April 15. Such annual...
Chapter 5 Turtle Soup Plus One
The Turtle Soup Plus One setup is almost identical to the Turtle Soup setup, except it occurs one day later. It too, can be traded in all markets and in all time frames. We are looking for the market to make a new intermediate-term high low and then reverse the following day With so many trend-following breakout players in the investment arena, the rewards are large when a breakout fails and reverses. This is especially true if the market has given players a chance to add on to existing...
Questions And Problems Muq
6.1. Explain why brokers require margins from clients when they write options, but not when they buy options. 6.2. A stock option is on a February, May, August, November cycle. What options trade on a April 1 and b May 30 6.3. A company declares a 3-for-l stock split. Explain how the terms of a call option with a strike price of 60 change. 6.4. Explain the difference between the specialist system and the market maker order book official system for the organization of trading at an exchange....
Too Much of a Good Thing
The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities that is, continuing to speculate in companies that have gigantic valuations relative to the...
Dividend Recapitalization
While not a true exit strategy, a dividend recapitalization dividend recap provides the sponsor with a viable option for monetizing a sizeable portion of its investment prior to exit. In a dividend recap, the target raises proceeds through the issuance of additional debt to pay shareholders a dividend. The incremental indebtedness may be issued in the form of an add-on to the target's existing credit facilities and or bonds, a new security at the HoldCo level,27 or as part of a complete...
Surrender Charges
Finally, annuities will have some sort of sales or surrender charge. This can be an up-front sales charge or a back-end load. If the insurer deducts a charge when the premium is paid, thus resulting in a lower amount of money being invested, this is a front-end load. However, insurers generally impose a surrender charge, rather than charge the investor up front. Surrender charges are generally charged only if the owner takes more than 10 percent of the annuity value out during a calendar year...
Trading Tip No 6 Mirror Image Foldback Patterns
In theory, time moves both forwards and backwards. The word cycle implies that time returns again to a starting point. This means time does indeed go both forwards and backwards. This is a difficult concept for human beings but philosophers have debated it for years and found that it is possibly true. Einstein's Theory of Relativity hypothesizes that time most certainly is a variable depending on the speed or relative motion of the observer. So, it is not unusual to think that human beings, who...
Doji And Nr 4 With Orb
To test for profitability of an ORB trade after a Doji NR 4 Day. A day when theopen and the closing price are approximately the same. A day with a narrower daily range than any of the previous 3 day's daily ranges. A trade taken with entry at a predetermined level above or below the open. Displays the results of these tests. The information provided is as follows 1 The maximum difference between the open and close on the Doji Day. 2 The entry level above or below the open. 3 Whether the trade...
Exit Strategies Using Fibonacci Expansions
So much time is spent on entering a trade, however we also need to focus on some exit strategies. This is not a full Fibonacci course, so if you don't understand the basics I suggest that you visit my website for help with those aspects. Human nature makes trading very challenging. Sometimes you want to exit a trade too quickly when it goes against you, and to cling on to a winner too long. Too often a winning trade will reverse, taking back most of your profits, or even going into a loss. On...
xMb 2PPA XRb MB 26f3pAtx6RBt t t t t
The following example illustrates the calculation of expected active beta return, active beta surprise, and benchmark timing return given portfolio return information. Data for the active portfolio beta and the benchmark returns for one year over 12 consecutive months is given in Figure 3. Long-term expected excess benchmark returns are selected to be 6 . All other values are calculated, as described as follows. Performance Analysis Examining Active Systematic Returns Figure 3 Column 1 t 12...
Rating Trend Strength
Here's a simple indicator of trend strength. It goes like this A value of 10 signals an uptrend a value of-10 signals a downtrend. Stocks amp Commodities Contributing Editor Tushar Chande uses this simple rating system to help answer the eternal traders' question Is the market trending ls you may have noticed, a number of rather complicated indicators are available to measure trend strength. None of these indicators, unfortunately, is perfect. You could use J. Welles Wilder's average...
Linear Regression Channel
A Linear Regression Channel LRC is created by drawing an equal Standard Deviation SD distance from the Linear Regression based trend line. A Linear regression trend line shows equilibrium prices, where as Linear regression channels show the deviation of prices from the equilibrium or center line. A Linear regression channel is plotted on the price chart using the least squares method. In a LRC, the bottom channel indicates support and the top trend line indicates resistance. Prices trade within...
Bands And Channels
Thus far, modifications have been based on a simple moving average or trendline. The plot can be adjusted forward or backward, the position can be reversed, or the entry or exit delayed in an attempt to begin the new trade at the time when the trend has decidedly taken a new direction. Even if prices have begun what will become a major downtrend, an entry into a short position too soon may be subjected to sharp reversals caused by conflicting fundamental and technical elements at these turning...
Selections from CFG Newsletters
PERIPHERAL TRADING IN THE FOREX MARKET Often traders, especially neophytes, allow emotions to take over and rule the rules of trading. This usually produces failure, and the trader leaves the forex industry with losses, never to come back. Some will come to their senses and begin following strict rules for selective entries while using tight stops. After all, I have said many times, The greatest distance to travel in the forex is found between the ears. I have seen over and over in the lives of...
Semideviation
Downside risk statistics are based on the concept of partial, or semideviation. Semideviation is the standard deviation of the returns that fall below the mean return. Semideviation is the square root of semivari-ance, and below mean semivariance is the variance of the returns below the mean return. We calculate the semideviation in the same way as standard deviation, except that we modify the formula to use only those returns that fell below the mean return for the period. To calculate the...