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98 Cards in this Set
- Front
- Back
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Three phases to most arbitrage CDOs |
1) Ramp Up 2) Revolved 3) Ammortization |
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IPS Statement |
Included in the client's constraints are factors such as restrictions based on preferences, time horizons, expected cash flows, tax considerations, and liquidity needs. 1)Time 2) Liquidity 3) Legal Not returns |
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Priority of Transactions |
Procedures for compliance with this Standard are: 1) limiting the purchase of IPOs 2) restrictions on private placement, 3) establishing blackout periods, 4) reporting requirements, and 5 disclosing the firm's personal investing policies. |
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Ordinary least squares results in unbiased estimates of the regression coefficients when
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Data (or the regression residuals/errors) do not have outliers, are not autocorrelated, or are not heteroskedastic. |
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Roll Return |
Roll return is the difference between opening and closing prices of the futures position (less the return on the spot position). It is generated over time as a futures position is held. For dividend-paying assets, roll return is positive (negative) when the dividend yield exceeds (is less than) the risk-free rate. Roll return is positive in backwardated markets if the costs of carry and the term structure of forward prices do not change. Roll return is not realized when a futures contract is rolled over (i.e., by closing a nearby position and opening a deferred position) |
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Which of the following most accurately reflects the stand-alone historical performance of commodity investments over the recent decade or so? |
Commodities underperformed world equities and bonds, were highly volatile (much more than even equities), and had negatively skewed and leptokurtic (fat-tailed) returns. |
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MLPs Gains Tax |
Recaptured gains associated with MLP distributions are taxed at ordinary income tax rates. |
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A mortgage borrower's prepayment option is best characterized as which of the following? |
The ability of borrowers to prepay their mortgages (i.e., make unscheduled principal payments) gives them a put option on the mortgage rate (since they can essentially sell the mortgage rate) and a call option on the value of the mortgage (since they can essentially buy the mortgage loan). |
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PSA model |
The 100% PSA model starts in month 0 with a 0% conditional prepayment rate (CPR). The CPR is then assumed to increase by 0.2% each month until it peaks at 6% at 30 months. After the 30th month, the model assumes the CPR is 6%. For a pool with a 50% PSA, the CPRs are half (50%) of the 100 PSA rates. Therefore, the CPR will begin at 0% in month 0 and increase by (0.5 x 0.2%) = 0.1% each month. Therefore, in month 12, the CPR will be (12 x 0.1% ) = 1.2%. |
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NCREIF property index
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The NCREIF property index is an unleveraged index based on quarterly returns that are estimated using appraised values of the underlying properties.
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Effective duration
Modified duration Duration |
Effective duration accounts for the fact that expected cash flows change as interest rates change.
Modified- Changes for discrete returns |
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The SUE Hedge Fund exploits the post-earnings-announcement drift. Which of the following strategies is the hedge fund most likely employing?
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Buying stocks of firms that announced high unexpected earnings and short selling stocks of firms that announced low unexpected earnings.
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Advantages of investing in a FoF over direct hedge fund investing -
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Diversification and professional management
Access (e.g., to closed funds) Liquidity facility |
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Advantages of investing in a FoF over a MSF -
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Manager selection
Operational risks - Each MSF has a single operational infrastructure, so it is more vulnerable to its failure. In contrast, the operational risk of a FoF is spread across managers with different risk structures. |
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FoFs, on average, produce lower returns than even broad hedge fund indices. Which of the following would be the most correct explanation
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FoFs have lower survivorship bias because they include returns of failed funds in their records, while indices typically remove or exclude returns from failed funds.
FoFs also have lower instant history bias, since they calculate returns from the investment date. Fung and Hsieh estimate that annual survivorship and instant history biases for FoFs are 1.4% and 0.7%, respectively, versus 3% and 1.4% for individual hedge funds. |
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UCITS funds rules
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Leverage typically cannot exceed 200% of a UCITS fund's NAV.
Holdings must be reported at least every two weeks. Investments in instruments issued by the same entity are limited to 10% of a UCITS fund's assets (if derivatives are included, the cap is 20% of assets). Most jurisdictions do not permit investments in commodities (in part because they are not sufficiently liquid to satisfy UCITS requirements). |
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Mezz Debt |
Mezzanine debt does not require a credit rating. It almost always has an equity kicker, usually in the form of equity warrants. Its term is about 5-7 years, compared to that of leveraged loans, which is about 5 years. It can make payments-in-kind as well as in cash. Most expensive form of debt |
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Blanket Subordination vs Springing |
Blanket subordination is a provision of the inter-creditor agreement between the mezzanine investor and the senior creditors. It prevents payment of principal or interest to the mezzanine investor until the senior debt has been fully repaid. where as Springing subordination permits payments to be made to mezzanine investor while senior debt is outstanding. However, if the issuer defaults on the senior debt, payments to mezzanine investors stop until the default has been resolved. |
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Fulcrum Securities |
Fulcrum securities are junior debt securities that are often converted into the equity of a reorganized firm. T hey are purchased by investors investing in distressed debt and seeking to gain control of the distressed company. |
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Diversity Score of a Portfolio |
The diversity score of a portfolio with all uncorrelated securities equals the number of securities in the portfolio. A portfolio with perfectly correlated securities has a diversity score of one. |
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Balance Sheet CDO |
Where the goal is to manage the bank's risk (in particular, to free up some of the bank's regulatory capital). Balance sheet CDOs can be cash-funded or synthetically constructed using some credit derivative (and synthetic CDOs can be either funded or unfunded). |
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Cash Funded CDOs vs Synthetic CDOs |
Cash-funded CDOs need the borrower's consent to transfer loans to the CDO trust, whereas synthetic CDOs do not. Cash-funded CDOs use the collateral's cash flows to pay the returns on the CDO securities, whereas synthetic CDOs use the income from the CDSs (or total return credit swaps) to pay the CDO investors. Cash-funded CDOs transfer the loans themselves to a CDO trust, whereas synthetic CDOs only transfer the risk profile of the loans. Proceeds from selling cash-funded CDO securities are used to buy collateral for the CDO trust. In contrast, proceeds from selling synthetic CDO securities are invested in low-risk Treasuries. |
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Key benefits of cash-funded balance sheet collateralized debt obligations to banks? |
The three key benefits are reducing 1) regulatory capital 2) increasing loan capacity 3) reducing liabilities and reducing credit exposure and preserving customer relations. |
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Ancillary offices for HF's in what part of the due diligence process? |
admin proccess |
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A fund manager is assessing the risk that options that she sold will be exercised against the fund that she manages. Which of the following is the most accurate term for this type of risk? |
Short volatility risk is the risk that an option written by the find manager is exercised, subjecting the fund to significant losses. |
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Gate vs Hard Lock Up |
A hard lockup period does not allow investors to make any withdrawals during the lockup period. vs While a gate restricts withdrawals by investors, it is typically only instituted during a crisis (not from the outset of the fund). |
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The following are necessary in order for alpha to be a zero-sum game: |
Investors have the same investment horizon, The same risk tolerance level, and the risk and return expectations; Market segmentation does not exist and investments can be divided and traded at no cost. With regard to taxes, investors must pay the same tax rate or there is no tax. Therefore, there can be taxes, but it must be the same rate for all investors in order for alpha to be a zero-sum game. |
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Restricted List |
List of companies that are based purely off factual information and not analysts opinion |
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Whisper numbers |
Unofficial earnings numbers |
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UCITS Funds |
Can be sold to any investor Must be authorized from regulator in their home country Can use external managers but must be approved by regulator Leverage limit to 200% Holding must be reported every two weeks Investments in instruments 10% max to 20% Prohibited from investing in physical commodities |
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Durbin Watson |
Positive auto correlation when less than 1 Negative auto correlation greater than 3 |
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Information Ratio |
Excess bench return/ tracking error |
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When the economy is at a high: |
Commodities are at a high, financial asset prices are at a low Commodities are at a high, financial asset prices are at a low |
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CLN |
CLN over Futures bc no need to roll over CLN holders get LOWER coupon due to inherent option in Not all CLNs are principally protected |
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Commodities Futures Source of Return |
1) Excess Return 2)Spot Return 3) Collateral Yield 4) Roll Yield |
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CPO and CTA Requirements |
Both CPOs and CTAs are required to register with the Commodities Future Trading Commission and National Futures Association CFTC & belong to NFA |
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Signals for moving averages |
Buy when shorter term avg is higher Sell when shorter term avg is lower Shorter is important vs long term High buy low sell |
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Corporate Engagement |
Friendly manner where HF works with firms management team Shareholder votes are obsolete |
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Covenants |
Negative promise to not to such as additional debt, dividends etc Positive- Promises to engage in things like certain ratios |
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VC Investing |
Empirical evidence significant persistence of performance of VC FundsAccess to managers is importantDiversification of vintage year is importantBusiness risk, liquidity and specialization are risks |
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Tranche as Option |
Senior Tranche= 1) Covered Call 2) Riskless Bond +short put Mezz Tranche: 1) Collar 2) Bull Call Spread 3) Bear Put spread Equity: 1) Long Call 2) Financed long asset + long put |
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International Swaps and Derivative Association 7 triggers: |
1) Bankruptcy 2) Failure to Pay 3) Restructuring 4) obligation acceleration/default 5) Repudiation/moratorium 6) Gov intervention |
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Normative |
Represent what prices should be, not technical |
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Conversions: Conversion Ratio Conversion Value Conversion Premium |
Conversion Ratio- Number of shares you can convert at, fixed Conversion Value- Conversion ratio times current stock price Conversion Premium- Difference of Convertible bond price and conversion value (higher when stock price is lower) |
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Dispersion trade |
Long position in options of individual equities and short the options on index |
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Null vs Alternate |
Null usually = to a value Alternate could be not equal too or >, < |
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T Value |
Standard errors and t values are inversely related |
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Cash and Call strategy |
Invest in a riskless asset and a call option Investment amount in each is PV of riskless asset and then remainder in Call option |
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Incurrence |
Covenant with immediate action |
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Haircut |
How much you discount loan after valuing collateral |
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Leverage Loans |
1)Rating of borrower below BBB or Baa 2) Coupon of 125-200 bps above LIBOR |
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Confidence Interval |
Indication of a Parameters True Value |
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Key Players for Active Investing |
1) Active Initiators 2) Active Followers (Free Riders) 3) Passive Investors |
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Why do Convertible Bonds offer high returns? |
1) Limited Demand 2) Benefits to corporation are high |
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Parametric Var vs Non-Parametric Var vs Modified Var |
Parametric assumes normal distribution Non- no assumptions, Monte Carlo or historical Modified Var- Incorporates non-normality |
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Farmland and Timberland on a Graph |
Both have pos skew and low correlation |
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Raw Moment Central Moment and Kurtosis vs Excess Kurtosis |
Raw Moment- Mean Central- 0 Kurtosis= 3 Excess is Kurtosis -3 |
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Normative |
How prices should behave |
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Third Market and Fourth Market |
3rd Market- Nasdaq intermrket, OTC market 4th Market- Electronic exchange |
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Managed Futures Historical Performance |
Outperformed traditional assets Low correlation to global equities Less vol Normally distributed |
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LBOs 4 benefits |
The corporate governance principles established by the LBOs should remain when the firms later go public. LBOs serve as warnings to firms with inferior corporate governance practices. The schemes implemented by LBO firms can serve as examples to other firms seeking to improve their efficiency. The existence of LBOs may help to prevent inefficient diversification in conglomerates. |
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Side Pockets |
Side pockets are used to separate illiquid assets from the rest of the fund. Only a hedge fund's existing investors share in a side pocket's profits/losses. Future investors in the fund do not participate in its returns. |
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Best Way to Price Illiquid Securities |
An external pricing service is the best way to price illiquid securities. This approach reduces inherent conflicts of interest, resulting in fair prices.Marking-to-model pricing is another approach, but it can result in inaccurate prices. |
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CFO |
The CFO is the investor's principal link to the hedge fund manager since it is the CFO who handles reporting the manager's performance. |
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flash report |
summary report of an investment that is often released before a full recommendation report is released (particularly if the full report will take time to be completed). This is done to reduce the time between the decision to make an investment recommendation and the dissemination of the recommendation, and helps to comply with Standard III(B). |
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Commodity Performance |
Commodity investments had little correlation with equities except in extreme cases (for very high and very low returns), which means they can likely provide some diversification benefits to an equity portfolio. Commodity investments underperformed world equities and generated negatively skewed, leptokurtic returns. |
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Reasons commodity market shocks result in relatively high returns for long commodity positions - |
Increase in commodity prices Positively skewed (not symmetric) returns Lack of correlation between commodity shocks Lack of correlation between commodity shocks and financial market shocks |
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waterfall structure |
The distribution of CDO cash flows is determined by the waterfall structure. The CDO cash flows are first distributed to the super senior tranche, then to the senior tranche, and so on to lower priority tranches. The most subordinated tranche is the equity tranche. |
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Reduced Form Model |
Using pricing of similar risky credits to price and illiquid possibly distressed credit |
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NCREIF core real estate style box includes properties with which of the following characteristics? |
Most liquid, most developed, least leveraged, and most recognizable of the properties. Assets are held for a long time to benefit from rental cash flows. Most of the return comes from income generation. |
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Debt service coverage ratio |
The debt service coverage ratio is the ratio of a property's net operating income divided by the annual interest and principal payments on the property's mortgage, that is, the loan's total debt payments. It is a measure of how well the net income can cover these debt charges. |
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Loan to Value |
Debt/Assets, includes the debt |
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Fixed Income arbitrage |
Fixed-income arbitrage strategies are relative value strategies that profit by taking advantage of small discrepancies between the prices of related fixed-income instruments. To accomplish this goal, fund managers buy one security and simultaneously selling another with very similar properties such that market events affect them in the same way. In effect, this strategy profits by betting on differences in changes in interest rates. |
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Volatility Swaps |
1) Counter party risk can influence influence realized pay offs 2) Bet on Vol so want realized vol to be higher than strike vol 3) Less costly then options bc there is less rebalancing Final Payoff = Variance Notional Value x (Realized Volatility - Strike Volatility) |
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accruals anomaly |
Investors care more about a firm's net income than its cash flow. So if accounts receivable go up and more than revenue signal to short the stock, HFs care more about CF than net income or receivables. History shows that customers often default which results in earning surprises later. |
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fundamental equity long/short strategies |
Equity long/short funds are generally concentrated in a few positions and so they are typically not well diversified. Long/short strategies take directional positions with net long exposure to equity markets. Fundamental long/short strategies construct portfolios based on analyzing company fundamentals, which means they use a bottom-up approach. |
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multiple-factor scoring model |
Multiple-factor scoring models are used to optimally combine different anomalies into one single model. Assigning scores to each stock for different anomalies achieves this goal. |
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Pairs Trading |
Two stocks that are highly correlated and usually move together provide profitable trading opportunities when their prices diverge, since they are expected to converge again later. Thus, a pairs trade can earn profits by shorting the relatively overvalued stock and going long the relatively undervalued stock. |
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Which of the following represents the premium that venture capitalists expect to earn over the public stock market? |
400-800 basis points |
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Secondary Buyout |
One PE firm to another |
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LBO Firm Fees |
LBO firms generally charge management fees in the range of 1.25% to 3%. Their incentive fees run high at 20% to 30%. |
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Takeout provisions |
Allow mezz investors right to purchase more senior debt after a certain portion has been repaid to become firms senior debt holder and eventually possibly equity holder. |
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The four essential questions for the risk review address levels of risk |
the specific risks, the measures of risk, and how the risks are managed. |
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Admin review |
The administrative due diligence review takes care of examining the "disaster plan". It also encompasses reviewing any regulatory actions pending against a fund, examining employee turnover, and identifying the account representative. |
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first step in most statistical hypothesis tests |
Specify the null and alternative hypotheses. |
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Which of the following solutions is best suited to deal with the problem of beta expansion of hedge funds? |
Beta expansion typically occurs in down markets, as systematic risk increases when markets decline. Therefore, data from declining markets should be included in the analysis. |
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chumming |
The process of chumming involves making many different predictions in the hope that at least one will turn out correctly. A mutual fund family may open multiple funds in the hope that a few will outperform. It would then close the funds with the poorest performance and market the funds with the highest performance. |
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Multicollinearity |
increases the standard errors of the regression coefficients and reduces the t-statistics [since t-statistic = Estimated value / Standard error, so a large denominator (SE) results in a smaller fraction (t-statistic)]. |
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Market-timing skill indicated by: |
Positive bi,diff (i.e., the difference between up-market beta and down-market beta |
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Beta of a regression |
1) Slope of line 2) Systematic risk |
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reprisals |
an act of retaliation of a firm to an analyst |
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Global Investment Performance Standards |
showing the performance history of managed assets, members should comply with the GIPS |
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Record Retention |
In accordance with Standard V(C), Record Retention, members and candidates must develop and maintain appropriate records to support all investment-related communications with clients, such as investment analyses and recommendations. Generally, the responsibility to maintain records that support investment action falls with the firm, rather than the individual professional. However, in order to comply with Standard V(C), members and candidates are required to keep research documents that support the current investment-related communication. |
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novation |
The process of novation (also known as assignment) refers to replacing one party in the CDS with another party. |
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Unwinding CDS |
If the hedge fund unwinds by offsetting the CDS, it may need to post collateral on the offsetting swap and will likely be exposed to credit risk. If the hedge fund unwinds by terminating the swap, it would need to pay the counterparty the present value of the remaining credit risk exposure.Unwinding through novation (i.e., assigning the swap contract to another dealer) avoids these issues. |
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Call option on credit risk is |
Protection for bondholder |
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Reasons for not using traditional pricing models (e.g., CAPM) to price credit risk - |
There are few default events available for estimation of statistics - thus, there are more market-related events. Default may occur for a number of reasons (not just market-related). Investors may not be able to hold diversified portfolios of credit products in order to effectively eliminate idiosyncratic risks. Credit risk may arise due to a counterparty's unwillingness (not its inability) to fulfill its obligation. |
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A key to CDOs is that they transform credit-risky assets into highly rated securities. This is accomplished by |
Prioritizing the CDO securities (so many tranches are subordinated to the senior tranche), providing diversification via the collateral portfolio, and instituting credit enhancements that provide additional safety features. This enables the CDO securities to have a higher rating than the securities |
