SMM510 Portfolio Management

Explain which information is typically included in an investment policy statement.

(10 marks)

Compare and contrast naïve risk parity and mean variance optimisation strategic asset allocation approaches, clearly outlining the pros and cons of each approach.

(50 marks)

You have constructed a Constant Proportion Portfolio Insurance (CPPI) portfolio. The current value of your portfolio is $110M, out of which $80M is invested in SPDR (S&P500) ETF and the remaining amount in the 10-year Treasury bond. The minimum value of the portfolio that you can afford to have is £90M. The S&P500 index rises by 4% in the next month and then falls by 5% in the month after that. What will be your equity and bond position at the end of the second month, if you rebalance monthly? Assume no change in the value of the bond and no change in the multiplier. Explain the CPPI strategy, all your workings and interpret the value of the multiplier.

(40 marks)

You are given the following information on two UK equity funds:

Portfolio	Expected Return	StandardDeviation	Semi-Deviation	Trackingerror
Portfolio 1	11%	12%	8%	3%
Portfolio 2	8%	11%	8%	4%

The risk-free rate is 2%. The expected return, standard deviation and semi- deviation of the FTSE All Share index (which is used as a benchmark for both of the funds) are 9%, 12% and 6% respectively. Calculate the Information ratio, Sortino ratio and M-squared. Comment on funds’ performance relative to the benchmark explaining in detail each of the measures of performance used, and comment on fund’s unsystematic risk.

(50 marks)

How would you construct a ‘small minus big’ (SMB), ‘high minus low’ and ‘momentum’ (WML) factor for the Carhart (1997) four factor model using stocks from FTSE All Share index in the UK? Explain the model in question and interpret Carhart alpha of a fund that has value of 0.007 per month (p-value = 0.04).

(25 marks)

The following Henriksson and Merton (1981) equation is obtained for ABC mutual fund:

��_ÆB_C_,_t — ��_f_,_t = 0.002 + 0.76(��_m_,_t — ��_f_,_t)+ 0.36��(��_m_,_t — ��_f_,_t) + ��_ÆB_C_,_t

(0.31) (0.04) (0.01)

The values in the brackets are p-values associated with coefficients above them.

Interpret the market timing ability of ABC mutual fund explaining the model used to estimate it.

(25 marks)

Explain the difference between smart beta funds and standard index tracking funds. Give examples of smart beta strategy and explain why an investor may favour it over standard index tracking.

(20 marks)

How can stratified sampling be used in line with core-satellite approach to index tracking? Explain, outlining the characteristics of each of these methods.

(30 marks)

Rank the following index-replicating methods according to the expected size of their tracking error: full replication of the Small Cap Index, full replication of the Large Cap Index, synthetic indexation with the Large Cap Index futures contracts. Explain your ranking, and give reasons for the presence of the tracking error in index tracking portfolios even in full replication approach.

(40 marks)

What are inverse ETFs and are they popular?

(10 marks)

Explain the theoretical payoff from a portable alpha strategy highlighting i) under which circumstances the strategy leads to losses, and ii) why its payoff appears to ignore the interest earned on the proceeds from short-sale.

(30 marks)

Company MNO announces that it will merge with company XYZ. It is a cash merger, in which MNO proposes a purchase of XYZ shares. Your evaluation shows the deal has a high probability of closing. Explain which long/short strategy you could apply to profit from this announcement and how would you apply it? How would your answer change if this was a share merger?

(25 marks)

Discuss fund manager-specific risks associated with long-short investment strategies.

(25 marks)

How can one diversify manager- or strategy-specific risks in long-short investing?

(10 marks)

What differentiates global macro equity hedge fund strategy from global equity mutual fund strategy?

(10 marks)

The following four bonds are available to you:

Bond	A	B	C	D
Price	99	100.5	104	105
Coupon	5.5%	4%	6.5%	4%
Maturity	1 years	5.5 years	6 years	14 years
Yield	6%	5%	5%	2.5%
Price Value of a Basis Point	0.9	8	9	12

Scenario 1: You are allowed to short-sell. Short-term interest rates are expected to decrease, and long-term interest rates are expected to increase. Discuss the bond trading strategy you would apply to profit from the shift in the yield curve described. Illustrate how you would apply that strategy using bonds from the table above if you had £4M to invest in the long position.

(20 marks)

Scenario 2: You are allowed to short-sell. How would you hedge an £8M position in a 14-years bond (D) with a position in the 1-year bond (A) and 6-year bond (C)? The standard deviation of yield of bond A is 3bps, of bond C is 5bps and of D is 4bps. The correlation coefficient between the yields of bonds A and C is 0.921, A and D is 0.804 and C and D is 0.896. Explain what kind of yield curve shift scenarios this hedge will protect you from, given the positions in the three bonds.

(40 marks)

Use any bonds of your choice from the table above to construct a cash and risk neutral butterfly trade. Explain this strategy and discuss why it would be preferred by pension funds compared to other types of butterfly trades.