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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...
Global Macro Strategies
Managers pursuing global macro strategies form expectations regarding price changes in global capital markets and take long and short positions in interest rates, equities, currencies, and commodities based on the capital market outlook. Risk control with downside protection and stable returns is generally a goal of global macro managers. However, managers differ in their use of discretionary and systematic trading methods. Highly discretionary managers use many trading strategies sometimes...
Regulation D Strategies
Regulation D of the U.S. Securities Act of 1933 allows public companies to raise capital through private placements of unregistered securities. Private placements are cheaper and less time consuming than public issuances of securities and are thus an attractive alternative. In a Regulation D strategy, a hedge fund manager takes a long position in privately placed unregistered securities stocks, convertibles, options, or warrants issued by a publicly traded small or micro capitalization company....
FixedWeight and RollingWindow Clones
AIM 77.5 Distinguish between fixed-weight and rolling-window clones, explain their construction and compare the differences between these strategies. Two versions of the multifactor model are used to create linear clones that replicate the factor exposures of hedge funds. The first version is the fixed-weight methodology, which uses the whole sample and has the portfolio weights constant through time. The second version is the rolling-window methodology, which is used to reduce the look-ahead...
Capital Structure Arbitrage Strategies
Capital structure arbitrage strategies attempt to capitalize on relative price-movement discrepancies observed between the debt and equity securities of an individual company. Bond and equity prices of an individual company do not always move together as predicted by financial theory. Through long and short positions on different securities, managers attempt to exploit these time lags. Managers begin by analyzing the following relationships underlying an individual company's securities stock...
Concept Checkers Mts
1. Which of the following is the best synonym for diversified VAR 2. When computing individual VAR, it is proper to I. use the absolute value of the portfolio weight. III. use only negative weights. 3. A portfolio consists of two positions. The VAR of the two positions are 10 million and 20 million. If the returns of the two positions are not correlated, the VAR of the portfolio would be closest to 4. Which of the following is TRUE with respect to computing incremental VAR Compared to using...
Hedge Fund Replication Using Hypothetical Strategies
AIM 77-1. Explain and distinguish between the strategies followed by Capital Decimation Partners and Capital Multiplication Partners. Capital Decimation Partners CDP is a hypothetical strategy of shorting out-of-the-money put options on the S amp P 500 with strike prices that are 7 above the current price and expire in three months or less. Selling the put option generates income in a matter similar to that received by insurance companies. That is, the investor writing or selling puts is...
Concept Checkers
1. For a given portfolio, having a Treynor measure greater than the market but a Sharpe measure that is less than the market would most likely indicate that the portfolio is B. generating a negative alpha. C. borrowing at the risk-free rate. D. not borrowing at the risk-free rate. 2. In the CAPM, the beta for an asset is also referred to as its 3. The derivation of the CAPM implicitly assumes that the level of market efficiency is 4. With respect to performance measures, the use of the standard...
Managing Portfolios Using VAR
AIM 74.8 Demonstrate how a manager can manage risk by using marginal VARs to make decisions to lower portfolio VAR. A manager can lower a portfolio VAR by lowering allocations to the positions with the highest marginal VAR. If the manager keeps the total invested capital constant, this would mean increasing allocations to positions with lower marginal VAR. Portfolio risk will be at a global minimum where all the marginal VARs are equal for all i and ' We can use our earlier example to see how...
Hedge Fund Incentive Structures
AIM 76.3 Analyze the implications the incentive structure of hedge funds have on the risk and performance of the funds. Strict regulations govern the compensation contracts of mutual fund managers. For one thing, the compensation must be symmetric. Symmetric compensation means the negative and positive effects on compensation from losses and gains, respectively, must be equal in absolute value terms. The easiest and most often used symmetric compensation method is to make a manager's...
Budgeting Risk
AIM 75.13 Explain how to budget risk across asset classes and active managers. Risk budgeting should be a top down process. The first step is to determine the total amount of risk, as measured by VAR, that the firm is willing to accept. The next step is to choose the optimal allocation of assets for that risk exposure. As an example, a firm's management might set a return volatility target equal to 20 . If the firm has 100 million in assets under management and assuming the returns are normally...
Component VAR
AIM 74.6 Compute component VAR in a portfolio with a large number of positions and use it to decompose VAR. Component VAR for position i, denoted CVAR , is the amount a portfolio VAR would change from deleting that position in that portfolio. In a large portfolio with many positions, the approximation is simply the marginal VAR multiplied by the dollar weight in position i CVAR MVARj X wj x P VAR x . x w Using CVAR , we can express the total VAR of the portfolio as Given the way the betas were...
Absolute vs Relative Risk and Policy Mix vs Active Risk
AIM 75.7 Explain absolute versus relative risk and distinguish between policy mix and active risk for investment managers. Absolute or asset risk refers to the total possible losses over a horizon. It is simply measured by the return over the horizon. Relative risk is measured by tracking error, which is the dollar loss relative to a benchmark. The shortfall is measured as the difference between the fund return and that of a benchmark in dollar terms. VAR techniques can apply to tracking error...
Active Systematic Returns
Active returns are defined as the difference between the manager's portfolio returns and the benchmark returns. As described in AIM 73.5, total active returns can be defined as having two components a systematic portion and a specific or residual portion. 3pA x Rg , remember, is the active systematic portion. This portion can be further decomposed into the following three components for further analysis. Expected active beta return is the return that results from the product of average active...
Objectives of Performance Analysis
Performance analysis refers to return-based performance analysis basic and advanced and portfolio-based performance analysis. Return-based performance analysis is a method of assessing both risk and returns of an investment. The advanced method adds statistical and theoretical refinements to the basic models. Portfolio-based performance analysis attributes single period realized returns to various sources and then tests these attributed returns for statistical significance in order to draw...