If our Human Capital is Bond-like, we should invest more aggressively (equity) and our demand for life insurance

increases.

A short position in an option is either out-of-the-money and no payment is due, or it is in-the-money and the short owes payment to the
long. Therefore the short position bears NO CREDIT RISK.

Honor willingness as long as it is below or equal to ability -- except for the wealthy independent!

Additional compensation arrangement requires both clients and employer give the written approval except when compensation is
immaterial, then verbal is OK.

Box Spread: combo of a Bull Call and Bear Put Spread; a non-directional strategy . . . seeks to exploit arbitrage opportunities between options
prices of the same underlying.

Taylor Rule: gives an estimate for central bank interest rate decisions:

R target = R Neutral + 0.5*(GDP Forecast - GDP trend) + 0.5*(Inflation Forecast - Inflation target)

When distinguishing between Type I and Type II errors, remember "Type I HORN."
Type I HO (Null Hypothesis) RN (Reject Null)
Null = Manager adds no value; Reject and conclude that manager adds value when he actually does not.

I - If only defense
C- Ceteris-paribus defense
A - Almost right defense
S - Single predictor defense
H - hasn’t happened yet defense

SAMURAI (For properties of a valid benchmark):

Specified in advance, Appropriate, Measurable, Unambiguous, Reflective of manager's current opinions, Accountable (Manager), Investable.

Types of benchmarks - MBS FRAC!

Manager Universe - Broad Mrkt indices - Style indices
Factor model - Returns based - Absolute - Custom

Legal / Regulatory Constraints for Endowments and Foundations: UMIFA and Prudent Investor

ERISA prohibits investment of more than 10% of DB plan assets in the company stock, but NO such law applies to DC plans

Durations: Dfixed-Dfloating>0. To shorten duration take floating Asset (i.e. receive floating and pay fixed)

Claw back provision: If PE sponsor received early distribution but failed to deliver the expected profit; he has to give back money.

Private equity has low liquidity and allocation to this class should be 5% or less with a plan to keep the money invested for 7-10 yrs

Adding REITs to stock / bond --> higher return --> marginally lower sd --> higher sharpe ratio
Adding direct real estate investment to stock / bond --> lower return --> significantly lower sd --> higher sharpe ratio

Going long a pay-fixed swap will lower your portfolio duration, while going long a pay-floating swap will increase your portfolio duration.

For a domestic investor, currency risk is about half the risk of foreign stocks and about twice the risk of foreign bonds.
There are four main reasons not to trade bonds - "please stop bothering susan"
please = Portfolio constraints (biggest cause of inefficiency in bond markets)
stop = story disagreements
bothering = buy and hold
susan = seasonality

There are eight main reasons to trade bonds - "really can cook, no salt you say?"
really = relative value pick up (biggest reason)
can = credit upside
cook = credit defense
no = new issue trades
salt = sector-rotation trades
you = yield curve pickups
say? = structure trades

Distressed Debt Arbitrage = long debt and short equity of the same company.

Total Active Return = True active return + Misfit active return

true = Manager return - Normal port return
misfit = Normal port return - Benchmark

Increase in Age -> Lower demand for life insurance

Higher risk aversion -> Higher demand for life insurance
Greater initial wealth -> Lower demand for life insurance
Stronger Bequest Motive -> Higher demand for life insurance

Stock-based compensation and bonuses: Complements

Explicit Incentives and Implicit Incentives: Substitutes

In a non-trending market, Constant Mix outperforms Buy-and-Hold outperforms CPPI

In a trending market, CPPI outperforms Buy-and-Hold outperforms Constant Mix

Investor's Utility Adjusted Return = Expected Return Portfolio - 0.005 * Risk Aversion Score * Portfolio Variance (when using returns and
variance as whole numbers, not decimals)

"(Insert name of firm) has prepared and presented this report in compliance with the Global Investment Performance Standards (GIPS®)."

Total commodity return = collateral return + roll return + spot return

*For roll return it is the futures differential minus the spot return

Without rebalancing, classical immunization only works for a 1-time instaneneous change in i-rates. We cease to be immunized when (1) i-
rates change and (2) Time passes

Currency Management Strategies:

Balanced Mandate - Asset Manager also manages currency
Currency Overlay - Currency managed within IPS by another currency manager
Separate Asset Class - Currency managed under its own separate guidelines
(Note - CFAI says it's a suboptimal strategy if managed in two-steps. Simultaneous management would be better.)

For Grinold/Kroener: always look for real or nominal g! - real should be used, as inflation is a separate component; thus, do not sum nominal
g and i

Beta of A = standard deviation of A / standard deviation of market * correlation

Covariance of A and B = Beta of A * beta of B * square of standard deviation of market
Jensen's Alpha: Portfolio Return - Expected Portfolio Return based on SML
IR: Active Return / Standard Deviation of Active Returns
* Note: IR doesn't capture all portfolio variability, just the variability of excess returns *
Sharpe: (Return Portfolio - Rf) / (Standard Deviation Portfolio)
Treynor: (Return Portfolio - Rf) / Beta Portfolio
M2: Rf + Sharpe * Standard Deviation Market

Implication of cyclical and secular changes in the corporate bond market include:
1. securities with embedded options will command a premium due to their scarcity
2. the percentage of long-term issues will decline - effective duration and aggregate interest rate risk sensitivity will also decline.

Moral Hazard Problems (Corporate Governance):

a) Insufficient effort results when company execs are too occupied with various non work related interests (i.e. golf game, buying expensive
art, etc.) instead of focusing and putting enough effort to get the job done
b) Extravagant projects is when management continue to invest in high profile or pet projects even though the return on the investments is
not in the best interest of the company and its shareholders
c) Entrechement -- when managers invest in bad projects but in projects where they have a strong understanding so that they become more
valuable to the company
d) Self-Dealing – funnel business to companies they own or family and friends.

Factor Value Effect on

corridor
width
Transaction Costs + +
Risk Tolerance + +
Correlation + +
Volatility + -
Volatility of rest of the portfolio + -
+ = higher; - = lower

A contango commodity market occurs when the lease rate is less than the risk free rate.

Cross Default Provision: issue considered in default if defaulted on another credit agreements
Jump to Default: AKA current credit risk

Grinold and Kroner:

R(i) = Div1/P0 + i + g - (DELTA) S + (DELTA) P/E
Ri = expected return on stock i
Div1 = dividend next period
P0 = current stock price
i = expected inflation rate
g = real growth rate in total earnings
(DELTA) S = change in shares outstanding
(DELTA) P/E = change in P/E ratio

Market Neutral Strategy has a Beta of Zero. Manager can add Beta exposure using futures, swaps, etc.
Short Extension Strategy: Net Portfolio beta=Beta Long+Beta Short, hence can outperform long only strategy as it exploits benefits of short-
selling. Generally designed with Beta of 1.

Payer's Swaption--gives the buyer of the option the right to enter into a swap where the option buyer pays the fixed rate . Converts a future
FRN into fixed rate obligation.
Receiver's Swaption--gives the buyer of the option the right to enter into a swap where the option buyer receives the fixed rate. Converts a
future fixed rate obligation into floating rate obligation.

Macro-attribution Analysis - ARABIA

A - A cash contribution
R - Risk free asset
A - Asset Allocation
B - Benchmark
I - Investment Manager
A - Active Allocation

Asset Manager Code of Conduct

C ompliance
L oylaty
T rading
I investment analysis & advice
P erf & val
D isclosures

Cadbury Report
N on-executive directors
O utside help available
R egular stuff to discuss
M eet regularly, full control
S eparation of C-suite & board
F ollow rules of the BOD

Real Estate GIPS

Ce=Co+sum(Wi*CFi)
Rc=(MV1-MVo-Ec+S)/Ce
RI=(INC-EXP-INT-TAX)/Ce
Forecast Defense Mechanism - ICASH

Trade date accounting is preferred to settlement date and the inclusion of accrued interest and dividends would be ideal. Matrix pricing is the
use of estimated prices taken from quoted prices on securities with similar characteristics; this could clearly introduce inaccuracies in the
measurement of returns.

long term economic growth comprised of change in employment and change in productivity.
-employment changes driven by population growth and labor force participation
-changes in productivity driven by capital good inputs and changes in labor factor productivity

P = M+S+A
p = portfolio return
m = market return
s = style return (manager benchmark - market)
a = active return (portfolio return - manager benchmark)

relative value of a gift vs bequest = FV gift/FV bequest. if ratio > 1, gifting is better
FV gift = [1 + rig(1-Tig)]^n
FV bequest = (1-Te)[1+rie(1-Tie)]^n

FV taxable gift = PV(1-Tg)[1 + rig(1-Tig)]^n

FV taxable gift where gifter pays the tax: PV(1-Tg+TeTg)[1 + rig(1-Tig)]^n

Traps – SCRAPO – Status Quo, Confirmation bias, Recallability, Anchoring, Overoptimism

Biases – ROAA – Reference, Overconfidence, Anchoring, Aversion to ambiguity
An investor whose decisions are impacted by mental accounting will look at investments as separate, focusing on the risk of investments in
isolation.

According to behavioral finance, expert forecasters are overconfident in their forecasting ability due to cognitive dissonance.

Cognitive dissonance states that individuals will avoid information (reflecting what has been actually experienced) that is in disagreement
(dissonance) with the individual’s perceived ability of himself or herself. As a result, experts will have limited recollection of their failures.

Frame dependence refers to investors' tendency to frame their tolerance on the current direction of the market or in the context of the
information received rather than on its own merits.

Anchoring refers to the inability to fully incorporate (adjust) the impact of new information on projections.

Representativeness can cause investors’ perceptions to be based upon current or historical information rather than unbiased expectations
resulting in overpriced “winners” underperforming and underpriced “losers” outperforming as prices return to their intrinsic values.

If someone developed her investment style through trial and error, learning from her own mistakes. This is a sign of heuristic-driven bias.

Behavioral finance assumes that:

1.investors are loss averse, which means they prefer uncertain losses to certain losses.
2.investors exhibit biased expectations, due to overconfidence in their ability to forecast the future.
3.investors construct portfolios via asset segregation, meaning that they tend to focus on an asset’s individual investment features versus its
impact on the overall portfolio position

By admitting his mistake but reiterating other projections, one used the "single predictor" defense.

Feeling that they should spread out their risk, but not knowing how leads to the 1/n diversification heuristic. Often times, participants will
only have a rough understanding of the effects of correlation and diversification and will simply divide their assets equally over the
investment options in the plan in an attempt diversify their portfolio.

DC participants tend to hold excess stock of the company they work for due to familiarity and a perceived endorsement by management.

The endorsement effect refers to the misconception that by offering an investment as an alternative, the sponsor is implicitly endorsing it as
a good investment.

Note that the status quo bias refers to a lack of action on the part of the participant. Also note that putting too much in company stock would
be an example of an investor being “boundedly selfish” in that there does not seem to be a determination if the investment would be in the
investor’s best interests.

When overconfident investors revise their forecasts based on new information, they tend to overestimate the impact. As an overconfident
investor, one will be disappointed by the subsequent movements in Bison stock because of her initial overoptimism after the earnings
announcement.

Investors who use anchoring tend to underestimate the impact of new information because they are anchored in their old beliefs. One will be
pleased by the subsequent movements in stock because he will have initially underestimated the impact of the positive earnings
announcement.

For an immunization strategy using futures:

(1) Approx. # of contracts = [(Target Duration - Initial Duration) * Initial Value] / (Duration, ctd * Price, ctd)] * CTD Conversion factor

(you multiply the CTD Conversion Factor by the entire bracketed term.. not just DD of CTD)

(2) Hedge ratio, where yield beta > 1

= [(Duration, bond to-be-hedged) * (Price, bond to-be-hedged)/ (Duration, ctd * Price, ctd)] * CTD Conversion Factor * Yield Beta
Differences between AMC and Professional Standards
Code is for individual – AMC is for the Firm
AMC is a minimum standard, should adopt additional policy and procedures to adopt the AMC.
Seek best Execution
Have qualified personnel
3rd party portfolio information (e.g. custodian confirmation)
Client brokerage policies
Compliance officer who is not an investment or operations person and reports to either BoD or CEO
Business Continuity Plan
• Hard copy or electronic records of client information
• Allows for communications with clients, vendors, suppliers and employees
• Allows for investment analysis to be conducted
Use Fair Market values – you can use 3rd party or internal valuation methods – need to disclose your policy
Disclose proxy policies and how client can get more information
If firm is audited like a mutual fund – how the audit can be obtained
Disclose significant personnel changes
Disclose trade allocation policies
Have a client confidentiality policy
Should consider having an anti-money laundering policy
Establish a minimum value for gifts, create limits by vendor
Sidecar, tag-along arrangements are okay
Have something in IPS on tactical asset allocation must be agreed to by PM and Client
Annual IPS review
Performance sent out within 30 days after end of quarter
Okay to have pooled fund where client and manager participate as long as client is not disadvantaged
Written compliance procedures that are acknowledged by Employees (in writing)
6 yrs of record retention