IPMIA 2023

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• What does the Face value for bonds mean? value that must be repaid when the bond reaches maturity = par value
• what does n stand for? maturity
• what is meant with coupon? interest payments
• r n+t interest rate (yield), per maturity and time
• why are bonds issued? issued as debt by institutions to finance expenses
• what does a zero-coupon bond entail? pays no coupons, issued at a discount (price<face value)
• what is the main difference between governmental bonds and corporate bonds? corporate bonds are riskier as they have default risk attached
• what is benchmark comparison? direct comparison to a benchmark, commonly using cumulative returns
• what is style comparison? direct comparison to a benchmark of similar "style"
• what is risk-adjusted methods for valuation? takes into account the risk level of the managed portfolio (relative to the benchmark)
• why do continouos compounding? investors earn continuous growth, the face value is reinvested very single millisecond, and not just annually for example
• what is e? Exponential (continuous compounding for example) (2nd ln on calculator)
• why does the expecations hypothesis fail to explain the behaviour of interest rates? because short-term interest rates are not predictable to any significant degree, & it sometimes overestimates future short-term rates, making it easy for investors to end up with an inaccurate prediction of a bond's yield curve
• why has the expectations hypothesis failed? The Expectations Hypothesis has faced challenges because it oversimplifies the real-world factors influencing interest rates. It doesn't consider risk premiums, market frictions, liquidity preferences, central bank interventions, time-varying risk preferences, term premiums, and the non-stationarity of interest rates, all of which can cause long-term interest rates to deviate from the theory's predictions. As a result, the Expectations Hypothesis is considered to have limitations in explaining actual interest rate movements.
• what is the liquidity preference theory? interest rate on a security is primarily influenced by investors' preference for liquidity. People demand a premium for holding less liquid assets (i.e. long term bonds) than more liquid assets (i.e. short-term bonds)
• explain the market segmentation theory interest rates are determined by demand and supply for bonds within specific maturity segments of the market. investors have preference for certain maturities, which then influences the interest rates
• explain the preferred habitat theory closely linked to market segmentation theory. investors are only willing to move to different segments (habitats) of the bond market if they are compensated by higher interest rates or another premium
• Name factors that affect the return distributions curve Standard deviation (variance, volatility), skewness, kurtosis, value at risk (VaR), mean, range
• How does standard deviation (variance) affect the return distributions curve? how wide the distribution is - wider = more risk as more potential returns
• how does skewness affect the return distribution curve? more skewness to one side indicates more extreme returns. downside investment=negative (to right) skewness
• how does kurtosis affect the return distribution curve? fatter tails mean higher likelihood of extreme returns
• characteristics: dislikes risks of extreme negative outcomes (highly risk-averse), has the expected shortfall as its risk measure, disregards risks above the left tail of returns conditional sharpe ratio (expected shortfall as risk measure)
• characteristics: dislikes below the mean or negative returns (highly risk averse), has semi-deviation as its risk measure, disregards risks of positive outcomes Sortino ratio (uses semideivation as the risk measure)
• characteristics: mean-variance optimizer, has variance as its risk measure, disregards risks as extreme outcomes Sharpe ratio (volatility as risk measure)
• characteristics: large portfolop that is sufficiently diversified and that the portfolio manager believes the only risk factor is the market Treynor ratio (beta as risk measure)
• how does value-at-risk (VaR) affect the return distribution curve? estimates the maximum potential loss within a specified confidence interval over a given time horizon
• how does the mean affect the return distributions curve? location of the distribution
• how does variance affect the return distribution curve? low variance = tighter curve (higher)
• Why would VaR be a good risk-measure for a highly-risk-averse investor? it quantifies the maximum potential loss a portfolio might experience over a specific time horizon. It allows the investor to set a threshold for the maximum acceptable loss and assess whether the portfolio's risk alignes with their risk tolerance. investor can see worst case scenarios.
• why would conditional sharpe ratio suit a highly-risk-averse investor well? it puts more emphasis on downside risk and aligns more closely with the goals of the investor
• where does the prior derive from in Black-Litterman? market equilibrium returns (generated from CAPM)
• where does the likelihood derive from in Black-Litterman? from investor's knowledge
• where does the posterior derived from in Black-Litterman? from the prior and likelihood
• posterior =mean
• what is the main difference between the sharpe ratio and the sortino ratio? the Sortino Ratio takes into account only the downside risk of an investment, while the Sharpe Ratio takes into account both the upside and downside risk
• beta= a measure of an asset's sensitivity to market movements. It provides valuable insights into the asset's risk characteristics and helps investors make informed decisions about diversification, risk management, and portfolio construction
• what is Jensen's alpha? is a risk-adjusted performance measure that represents the average return on a portfolio or investment, above or below that predicted by the capital asset pricing model (CAPM), given the portfolio's or investment's beta and the average market return
• characteristics of common stock represent voting rights, residual claim, limited liability, shareholders elect a board of directors, commonly traded in stock exchanges, can pay dividends
• characteristics of preferred stock cumulative dividends, dividends are paid prior to common stockholders, no voting rights (most often)
• characteristics of general bond issued as debt by institutions which wish to finance their expenses, usually pays coupons, issued with different maturities, when it matures the issuer repays the face value
• characteristics of zero coupon bond issued at discount price (price below face value), no coupons
• characteristics of nominal government bonds issued as debt by the government to finance expenses, typically considered risk-free
• characteristics of corporate bonds issued as debt by companies, default risk is present (higher interest rates than government bonds), can be callable, typically traded at lower prices than government bonds
• characteristics of mortgage bonds secured by a mortgage and backed by real estate holdings, pay fixed coupons, typically safer than corporate bonds -> trade at higher prices
• characteristics of money market securities short-term securities (most often zero-coupon bond)
• what is e(rm)-rf market risk premium
• what is TP? term premium = is the excess yield that investors require to commit to holding a long-term bond instead of a series of shorter-term bonds
• what is a company's market cap? the value of its outstanding shares of stock
• when is the value of the company overvalued? if value < company's market cap or fair stock price < market price
• when is the value of the company fairly priced? if value = company's market cap or stock price = market price
• when is the value of the company undervalued? if value > company's market cap or fair price > market price
• why are typically government bonds considered risk free? government can raise taxes to repay its debt
• what does it mean if, for example, a bond is real? its tied to inflation (value increases in proportion to the price level)
• what is ytm? interest rate that makes the present value of a bond's payment equal to its price
• what impact does continuous compouding have (e) on bond price? will deliver a higher bond price than annual compounding. face value reinvested every single millisecond
• what is x(nt) another premium connected to various types of risk (credit, liquidity risks etc)
• what does a positively shaped yield curve signal? expectations that policy rates will rise in the future, plus a positive term premia that increase with maturities (n)
• what does a flat yield curve signal? investors have lost confidence in the economy's growth outlook, rates kept constant
• what does an inverted yield curve signal? inform about an upcoming recession in the near term, with a reaction of the central bank to lower policy rates
• term structure of inflation expectations Nominal - real
• R(nt)? total bond return
• what impacts the riskiness (bond price sensitivity) of a bond? maturity, YTM (interest rate) level, coupon size or rate
• which is more price-sensitive: long term or short term bonds? long term
• which are the 2 sources of return in active bond investing? yield curve predication and miss-pricing (arbitrage)
• what is a Model for yield curve prediction and detection of mispricing opportunities Nelson-Siegel
• what does the Nelson-Siegel model do? use an exponential functional form that vary according to flexibility and degree of smoothness to fit yields (price bonds) across maturities depending on the number of "exponential terms" used
• how are commodity prices often determined? what are typical commodities? by supply and demand. gold, platinum, fuel, cereals.
• what does the Solow model explain? a long run growth model, looks at capital accumulation, population (labour) growth, and increases in productivity largely driven by technological progress
• what do endogenous long-run growth models link technology to? R&D, productivity, innovation, scientific research and opportunities for talented individuals
• what are the general objectives for monetary policy? to achieve price stability (typically around a long-run inflation level) and to achieve stability ot output (economic activity or unemployment around their natural levels)
• how does changes in the inflation target affect bond prices? Bond prices are a direct function of the Yield to Maturity. If central bank lowers the inflation target, the yield is lowered, and the bond price is going up (changing forward rate in the long-run), the long-run yields are affected primarily. If inflation target goes up, the bond prices go down.
• what is R-star? what influences it? the real neutral interest rate that equilibrates the economy in the long run, is influenced by determinants of long-run macroeconomic growth
• what is return? the amount of currency made or lost on an investment over some period of time
• N? times per year
• T? years
• p0? initial investment
• what is risk? refers to the likelihood that the actual return on an investment will differ from the expected one
• what is VaR? cutoff point, where maximum loss is
• expected shortfall? average point in the VaR (average from cutoff and maximum loss)
• what happens to skewness and kurtosis if the return distribution is normal? they don't matter
• what is meant by quantile? determines how many values in a distribution that are above or below a certain limit
• what does tail risk measure mean? a measure of the worst-case outcomes for the portfolio
• examples of tail risk measures? VaR and expected shortfall
• how does risk affect utility score? more risk = lower utility score
• A? measure of risk aversion
• how does risk aversion impact? leads ut to having different portfolios. the extent to which variance of risky portfolios lowers utility depends on degree of A
• A > 0 risk averse investor
• A=0 risk neutral investor
• A<0? risk lover
• asset allocation? allocate funds among risky assets
• capital allocation? allocate funds between the risky portfolio and the risk-free asset
• why is risk free assets risk free? their short term nature makes their values insensitive to interest rate fluctuations
• how does CAL (capital allocation line) get its slope and intercept? intercept=rf, slope=sharpe ratio
• what does it mean when kinked CAL? on the right of the point where it gets kinked, you have started to borrow money to invest
• what is the slope of the indifference curves? risk aversion
• which investors have steeper indifference curves? more risk-averse ones
• examples of systematic risk? from macro environment, US economy etc
• examples of unique (firm-specific) risk? personnel quality, local condition etc
• what are portfolio weights? fraction of each individual investment in the portfolio
• what is portfolio return? weighted average of the returns of the investments within it
• what does perfect correlation mean? the stocks move in the same direction, with the same amount (negatively or positively)
• what is the Sharpe ratio? how does a higher sharpe ratio impact a portfolio? ratio of reward to volatility. portfolio with the highest ratio is the portfolio where the line with the risk free investment is tangent to the efficient frontier of risky investments
• what does CAPM try to explain? how marketwide risk affects return of an asset
• according to CAPM, which portfolio is the tangent portfolio that maximises the sharpe of the portfolio? the market portfolio (m)
• where does overvalued assets lie with regards to the SML? below
• where does undervalued assets lie with regards to the SML? above
• what is Jensen's alpha? intercept a of the regression that provides a measure of investment performance
• what does a positive Jensen's alpha value mean? earning excess returns, means a fund manager has "beat the market" with their stock-picking skills.
• jensen's alpha >0? stock outperformed the market portfolio
• jensen's alpha <0? stock underperformed the market portfolio
• what is λk ? risk premium of factor k
• Important factors in Fama-French 3 factor model? R(mt)=market return, SMB=small-big excess return, HML=high minus low excess return of book value
• which additional factor does Carhart add? WML - excess return of winners minus losers
• ke? cost of equity
• why is the PE ratio is much more sensitive to changes in expected growth rates when interest rates are low than when they are high? growth produces cashflows in the future, and the present value of these cashflows is smaller at high interest rates
• higher beta = lower PE
• what does active portfolio management entail? provides investors with the potential to earn higher returns than the benchmark. Active investors can have expertise that enables them to select investments that do better than the market
• what are 2 models of active portfolio management? Treynor-Black model and Black-Litterman model
• what is the error term - snirkly e? diversifiable risk, firm specific
• what is the goal of the Treynor-Black model? optimize portfolio construction based on its Sharpe ratio (max Sharpe), using stocks with good alphas rather than bad alphas (less in stocks with bad alphas)
• What is the goal of the Black-Litterman model? create stable, efficient portfolios with a low mean-variance based on an investor's unique insights that solve the problem of input sensitivity
• what does the OLS regression do? ensures that the mean-squared errors are minimized
• What does the Black-Litterman model do? model that allows portfolio managers to use forecasts (views) and apply these views to portfolio construction. On top of that, the model uses past data and a set of equilibrium considerations derived from an asset pricing model (CAPM)
• how are risk measures calculated? by dividing a risk premium (ri-rf) with a risk measure
• which absolute risk-adjusted measures do we have? Sharpe ratio, Sortino ratio, Conditional Sharpe ratio, Theynor ratio
• which relative risk-adjusted measures do we have? Information ratio and Jensen's alpha, Modigliani-Modigliani (M2) and Tracking error
• what are stalwarts? established companies that are still growing fast due to a specific advantage
• which risk-adjusted measure should we use for stalwarts? sharpe ratio due to that the diversification minimizes risk
• what are turn-arounds? companies that are on the verge of bankruptcy and are acquired and restructured.
• which risk-adjusted measure suit turnarounds the best? conditional sharpe ratio as it measures extreme negative returns
• what are cyclical companies? companies that follow the business cycle which explain short term fluctuations in the economy
• which risk-adjusted measure is the best for cyclical companies? sortino ratio as it measure extreme outcomes which is good to know during economic expansions
• R2 in CAPM? measure of goodness of fit of the regression, attributed risk to market risk
• 1-R2 in CAPM? risk attributed to firm-specific risk
• what is omega in black litterman? has to do with certainty, a certain investor has low omega
• what is Q in black litterman? a skilled investor affects variable Q. but th skilled investor must be certain, otherwise no effect

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