CFA III Asset Allocation 关键词清单 Vol 3

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CFA III Asset Allocation Vol 3
Study Session 8 Asset Allocation & Related Decisions in Portfolio Management (1)

Reading 16 Introduction to Asset Allocation（少量习题 8 道）

3.The Investment Governance Background to Asset Allocation 3N180
Investment governance：structure to ensure that assets are invested to achieve the
asset owner’s investment objectives within his risk tolerance and constraints and in
compliance with all applicable laws and regulations. 3N180
3.1 Governance Structures 3N180
管理方涉及：1）governing investment committee 2）investment staff 3）third-party
resources 3N181
Most effective models share six common elements: 3N181 (LOS a)
1) Articulate investment program’s long- and short-term objectives.
2) Allocate decision rights and responsibilities among the functional units in the
governance hierarchy effectively.
3) Specify processes for developing and approving IPS
4) Specify processes for developing and approving the program’s strategic asset
allocation.
5) Establish a reporting framework to monitor the program’s progress toward the
agreed-on goals and objectives.
6) Periodically undertake a governance audit by independent third party.
3.2 Articulate Investment Objectives 3N181
1）The ultimate goal is to find the best risk/return trade-off consistent with the asset
owner’s resource constraints and risk tolerance.3N181
2）consideration of fund liquidity needs and the liquidity characteristics of fund’s
investments.3N182
3）A high risk/high expected return asset allocation is likely to lead to wider swings in
interim valuations. 3N182
3.3 Allocation of Rights & Responsibilities 3N182 Knowledge, capacity & time
Exhibit 2 Allocation of Rights & Responsibilities 3N183（表格列出具体事务分工）
3.4 Investment Policy Statement 3N184
1. An introduction of 1) document’s purpose and scope and 2) asset owner
description.
2. A statement of investment objectives
3. investment constraints.
4. Allocation of decision rights and responsibilities among functional units.
5. Investment guidelines to be followed in implementation (e.g., permissible use of
leverage and derivatives) 和禁止投资资产类别.
6. frequency and nature of reporting to the investment committee and BOD
7. Risk management framework 3N184
3.5 Asset Allocation & Rebalancing Policy 3N185:
Specification of rebalancing responsibilities is good governance.
3.6 Reporting Framework 3N185: Key elements should address 1) performance
evaluation, 2) compliance with investment guidelines, and 3) progress toward

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achieving the stated goals and objectives.
3.7 The Governance Audit 3N185
1) Avoid decision-reversal-risk: 错误时间颠覆既定选择 3N186
2) consider the effect of investment committee member and staff turnover on
investment program durability. 3N186
3) Assure accountability.(blame avoidance:) 3N186
4.the Economic Balance Sheet & Asset Allocation 3N188
定义：1）conventional assets and liabilities (called “financial assets” and “financial
liabilities” in this reading)
2）additional: extended portfolio assets and liabilities
 For individual investors, 1. human capital (PV of future earnings), 2. PV of
pension income, and 3. PV of expected inheritances; 4 PV of future
consumption(liability).
 For an institutional investorinclude 1. underground mineral resources or 2. PV
of future intellectual property royalties. 3. Extended portfolio liabilities: PV of
prospective payouts for foundations 3N188
Life-cycle balanced funds ( target date funds ) 3N188

5 Approaches to Asset Allocation 3N191

5.1 Relative Objectives 3N194(LOS c) 背

5.2 Relevant Risk Concepts 3N194(LOS d)

1. Asset-only approaches :范例 mean–variance optimization,辅之以 monte carlo sim
1) volatility (standard deviation) of portfolio return as a primary measure of risk.
2) tracking risk (tracking error): measure risk relative to benchmarks
3) Downside risk: semi-variance, peak-to-trough maximum drawdown& VaR. 3N195
2. Liability-relative approaches: 3N195
1) shortfall risk: risk of having insufficient assets to pay obligations when due;
2) volatility of contributions needed to fund liabilities.
主要考虑 differences between asset and liability characteristics (e.g., their relative
size, their interest rate sensitivity, their sensitivity to inflation).
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3. Goals-based approaches: 3N195
1) Risk of failing to achieve goals.
2) The plural in “liabilities” and “goals” underscores that these risks are related to
multiple future points in time. Overall portfolio risk is thus the weighted sum of the
risks of each goal.
5.3 Modeling Asset Class Risk 3N195 (LOS e)
Asset classes 三大类 super classes: 3N195
1. Capital assets: An ongoing source of something of value (such as interest or
dividends), valued by net present value.
2. Consumable/transformable assets. Assets, such as commodities, that can be
consumed or transformed into something else of economic value but without an
ongoing stream of value.
3. Store of value assets: Neither income generating nor valuable as a consumable
or an economic input; examples include currencies and art.
The following are five criteria that will help in effectively specifying asset classes for
the purpose of asset allocation:3N196 （要背）
1.Assets within an asset class are relatively homogeneous.
2.Asset classes are mutually exclusive.
3.Asset classes are diversifying.==>low correlations between asset classes.
4.Asset classes cover all possible investable assets, which also pushes up the efficient
frontier(increases expected return at all risk levels ) 3N197
5. If liquidity and expected transaction costs for an investment of a size meaningful
for an investor are unfavorable, an asset class is not practically suitable for
investment.3N197
List of asset classes 3N197: 1)Global public equity 2) Global private equity 3N197
3) Global fixed income: 3N198
4) Real Assets: includes assets that provide sensitivity to inflation, such as private real
estate equity, private infrastructure, and commodities. 3N198

Using broadly defined asset classes with fewer risk source overlaps is consistent
with achieving a diversified portfolio. 3N199

（Risk）Factor-based approaches: assign investments to investors’ exposures to

specified risk factors. 与 asset class-based appraoches 相比，没有更优越。3N200

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asset classes 之间有 overlaps in source of risk 如下图 3N200

<1> Multifactor risk models：use factors as the units of analysis, specifying risk factors
and the desired exposure to each factor. Asset classes can be described with respect
to their sensitivities to each of the factors. labeled “factor-based asset allocation”
in contrast to “asset class-based asset allocation,” which uses asset classes directly as
the unit of analysis. 3N200
<2> Risk factors not directly investable but as relates to expected risk premium.200
The following are a few examples of how risk factor exposures can be achieved. 201
1) Inflation: Going long nominal Treasuries and short inflation-linked bonds isolates
the inflation component.
2) Real interest rates: Inflation-linked bonds(provide a proxy for real interest rates).
3) US volatility: VIX (Chicago Board Options Exchange Volatility Index) futures
provide a proxy for implied volatility.
4) Credit spread: Going long high-quality credit and short Treasuries/government
bonds isolates credit exposure.
5) Duration: Going long 10+ year Treasuries and short 1–3 year Treasuries isolates
the duration exposure being targeted.

6 Strategic Asset Allocation 3N201也叫 policy portfolio

Quantitative approaches utility function as a mathematical representation of
preferences that incorporates the investor’s risk aversion optimal asset allocation=
provide the highest utility to the investor at the investor’s investment time horizon
3N201

Selection of a strategic asset allocation: 3N202-203

1. Determine and quantify investor’s objectives.
2. Determine investor’s risk tolerance and how risk should be expressed and
measured.
3. Determine investment horizon(s). 3N202
4. Determine other constraints and requirements on asset allocation choices.203
5. Determine the approach to asset allocation that is most suitable for the investor.
6. Specify asset classes, and develop a set of capital market expectations for the
specified asset classes.
7. Develop a range of potential asset allocation choices for consideration through

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optimization exercises.
8. Test the robustness of the potential choices. Simulations to evaluate potential
results to investment objectives and risk tolerance over investment horizon(s) for
the different asset allocations developed in Step 7.
9. Iterate back to Step 7 until an appropriate and agreed-on asset allocation is
constructed.
6.1 Asset Only 203 Mean-variance optimization特征：组合大百分比配置 equity
1) An efficient frontier: portfolios offer the greatest return at each level of portfolio
return volatility.
2) Sharpe ratio is a key descriptor of an asset allocation: If a portfolio is efficient, it
has the highest Sharpe ratio among portfolios with the same return volatility 203

LOS h: describe the use of global market-value weighted portfolio as a baseline

asset allocation 3N207
This portfolio sums all investable assets (global stocks, bonds, real estate etc) held by
investors.使用原因：
1) most efficient use of risk budget.
2) the discipline it provides in relation to mitigating any investment biases, such as
home-country bias (discussed below).
GMVP is expressed in two ways: 第一步：allocates assets in proportion to the global
portfolio of stocks, bonds, and real assets. 第二步（进一步细分）：disaggregates
each of these broad asset classes into regional, country, and security weights using
capitalization weights.3N207-208
Home-Country Bias: 3N208
6.2 Liability Relative 3N208: 大比例配置 fixed income securities(liability-hedging assets) to
avoid underfunded status. 有多余资产再配置 equity(return-seeking assets) as a buffer. 3N210
6.3 Goals Based 3N211 例子 Investor Case Facts: The Lee Family 3N211
基于 behavioral finance. 3N212mental accounting
Add higher risk assets to longer-term, aspirational sub-portfolios while adopt a more
conservative allocation for sub portfolios addressing lifestyle preservation. 3N213

Lifestyle-minimum: provide protection for lifestyle in a disaster scenario 3N213

Lifestyle-baseline: needs outside of worst cases.
Lifestyle-aspirational: a desire for a chance at a higher lifestyle. 3N213

7 Implementation Choices 3N216 LOS i

Two kinds of passive/active choices faced by investors related to asset allocation: 7.1 & 7.2

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7.1 Passive / Active Management of Asset Class Weights 3N216
Tactical asset allocation : short-term deviation from strategic asset allocation 3N216active
managementdynamic asset allocation
Key barrier to TAA: monitoring & trading costs (capital gain taxes). 3N216
7.2. Passive/Active Management of Individual Allocations within Asset Classes 3N217
<1> Passive management approach:常见：indexing (lowest cost 方法) or buy&hold a fixed
portfolio of bonds to maturity. 3N217
<2> active management objective: to achieve, after expenses, positive excess risk-adjusted
returns relative to a passive benchmark. 3N217
<3> 其余 implementation choices:blended-> both passive & active elements. 3N217
Unconstrained active investment: not managed with consideration of any traditional asset class
benchmarkquantified by tracking risk or active share. 3N217

Asset class allocations with different approaches on the spectrum，沿着上述图表横向调节 218

Asset owners 投资决定取决于：3N218 （理解记忆，非 LOS i 内容）
1） available investments.
2） Scalability 投资额度大小调节性 of active strategies being considered.
3） Feasibility of investing passively while incorporate client-specific constraints.
4） Beliefs on market informational efficiency. A strong belief would orient the investor away
from active management.
5） Trade-off of expected incremental benefits relative to incremental costs and risks of active
choices.
6） Tax status. Taxable investors have higher hurdles to profitable active management (high
turn-over)than tax-exempt investors.3N218
3N219

Example 8 Implementation Choices (1) 3N219 (solution 2 描述可再看)

Example 9 Implementation Choices (2) 3N220
7.3 Risk Budgeting Perspectives in Asset Allocation and Implementation 3N221
Risk budgeting: questions of which types of risks to take and how much of each to take. 3N221
比如：Volatility standard deviation of returns；Tail risk: VaR. 3N221
Risk budgeting can be stated in absolute or relative terms, in money or percent terms. 3N221

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与 Active/passive implementation choice 相关Active risk budgeting: determines how much
additional risk the investor is willing to take relative to benchmark. 3N221
1) At the level of overall asset allocation, active risk can be defined relative to the strategic
asset allocation benchmark.
2) At the level of individual asset classes, active risk can be defined relative to the asset class
benchmark. 3N221
8.Rebalancing: Strategic Considerations 3N222
Rebalancing: adjust portfolio weights to more closely align with strategic asset allocation.
1. Rebalancing is a key part of the monitoring and feedback step. 3N222
2. Systematic rebalancing maintains the original strategic risk exposures. N222
8.1 A Framework for Rebalancing 3N223
1）calendar rebalancing: Simplest approach：rebalance a portfolio to target weights on a period
basis. 3N224
2）Percent-range rebalancing: tighter control of asset mix set rebalancing thresholds or trigger
points, stated as a percentage of portfolio value around target values. 3N224
For example, if the target allocation to an asset class is 50% of portfolio value, trigger points at 45%
and 55% of portfolio value define a 10 percentage point rebalancing range (or corridor) for that
asset class value.如何具体操作见 3N224
8.2 Strategic Considerations in Rebalancing 3N225(LOS j)
Strategic considerations generally include the following, all else being equal:
3N225cost-benefit approach:
1. Higher transaction costs for an asset class imply wider rebalancing ranges.
2. More risk-averse investors, tighter rebalancing ranges.
3. Less correlated assets, tighter rebalancing ranges.
4. Beliefs in momentum favor wider rebalancing ranges, whereas mean reversion encourages
tighter ranges.
5. Illiquidity, Wider range.
6. Derivatives create synthetic rebalancing 3N225Derivatives overlay is cost efficient 但需要
higher level of risk oversight 3N226
7. Taxes, which are a cost, discourage rebalancing and encourage asymmetric(taxable account)
and wider ranges.225 (For example, a 25% target asset class might have an allowable
range of 24%–28%, which is –1% to +3%.)3N226
8. The greater the volatility, the tighter the range . 3N225

Reading 17 Principles of Asset Allocation 3N235（无习题）

2.Developing Asset-Only Asset Allocations 3N237
2.1 Mean-Variance Optimization: Overview 3N237
Risk Budgeting tool: Mean–variance optimization=>determine how much to allocate to each
asset in order to maximize the expected return of the portfolio for an expected risk level. 3N237
Equation 1: Um = the investor’s utility for asset mix (allocation) m
Rm = the return for asset mix m
λ = the investor’s risk aversion coefficient

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其中：Um 和 Rm 以百分比表达;如果是 decimals 表达法，则 0.005 换成 0.5 。3N238
Um 也叫 certainty-equivalent return—所得值 stated in terms of risk-free return investor would
value equally. 3N238
1) Budget constraint ( unity constraint): 最常见，The constraint that weights sum to 100%
3N238
2) Non-negativity constraint: next most common constraint allows only positive weights or
allocations (i.e., no negative or short positions). 3N238
3) To find all possible efficient mixes that collectively form the efficient frontier, the optimizer
iterates through all the possible values of the risk aversion coefficient (λ) and for each value
finds the combination of assets that maximizes expected utility.3N239
4) The efficient mix at the far left of the frontier with the lowest risk is referred to as the global
minimum variance portfolio, while the portfolio at the far right of the frontier is the
maximum expected return portfolio. 3N239
如何设定 risk aversion: risk preference (willingness)+ risk capacity(ability) 3N239

Exhibit 2 Efficient Frontier – Base Case 3N242

as one moves from left to right along the efficient
frontier, the investor takes on larger and larger
amounts of risk for smaller and smaller increases
in expected return.

Example 1: Mean-Variance-Efficient Portfolio

Choice 1 3N244
Example 2: A Strategic Asset Allocation Based on
Distinguishing a Nominal Risk-Free Asset.246
(portfolio with one risk free asset & one risky
asset) 3N246-247

LOS c interpret & critique an asset allocation in relation to an investor’s economic balance sheet.
1) Human Capital & residential real estate property are two large components of an investor’s
total investment portfolio.
2) Allocation to them must be constrained to their current value as a percentage of investor’s
total portfolio 3N247
3) Increase investor’s capacity to bear risk.

2.2 Monte Carlo Simulation (LOS g)

1) formulate a multi-period problem 3N250
2) For a given asset allocation with no cash flows 无不断存取款动作, returns’ sequence is
irrelevant; ending wealth will be path independent；反之有影响，用 Monte Carlo 来测影响程
度 3N250
2.3 Criticism of Mean-Variance Optimization 3N252
1. Sensitivity to input small changes: Outputs (asset allocations) are highly sensitive to small
changes in inputs.
2. Subset asset classes concentration: Asset allocations are highly concentrated in a subset of

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available asset classes.
3. skewness and kurtosis: Investors are concerned about more than the mean and variance of
returns, the focus of MVO. Significant skewness and kurtosis in actual returns.
4. Risk diversification: Although asset allocations may appear diversified across assets, risk
sources may not be diversified.
5. Ignores liabilities: most portfolios exist to pay for a liability or consumption series, and MVO
allocations are not directly connected to what influences the value of the liability or the
consumption series.
6. single-period framework: MVO is a single-period framework that does not take account of
trading/rebalancing costs and taxes.3N252
2.4 Addressing the Criticisms of Mean-Variance Optimization 3N254 问题 1&2
2.4.1 Reverse Optimization 3N254 反转 MVO 计算过程
Reverse optimization takes as its inputs a set of assumingly optimal asset allocation weights, with
additional inputs of covariances and risk aversion coefficient, solves for expected returns.=>
implied or imputed returns. 3N254-255
Most common set of starting weights is the observed market-capitalization value of assets or
asset classes that form the opportunity set. 3N255global market portfolio
2.4.2 Black-Litterman Model 3N256 (complementary addition to reverse optimization)
Start with excess returns (in excess of risk-free rate) produced from reverse optimization and
then provides a technique for altering reverse-optimized expected returns so that they reflect an
investor’s own distinctive views yet still behave well in an optimizer. 257（具体数理内容书忽略）
进而影响 efficient frontier asset allocation 3N257-258
2.4.3 Add Constraints beyond the Budget Constraints 3N259 为何加限制
Typical constraints: 3N259
1. specify a fixed allocation to a specific asset
2. specify an asset allocation range for an asset 3N259
3. specify an upper limit, due to liquidity considerations, on an alternative asset class. 3N259
4. specify the relative allocation of two or more assets 3N259
5. In a liability-relative setting, include a constraint to require an allocation to assets that hedge
the liability (systematic risks). 3N259
2.4.4 Resampled Mean-Variance Optimization 3N260
combine mean–variance optimization framework with Monte Carlo simulation and, all else equal,
leads to more-diversified asset allocations==>these intermediate frontiers 称 为 simulated
frontiers,由此重组的 resampled efficient frontier 是这些的平均值线. 3N260
2.4.5 Other Non-Normal Optimization Approaches 3N261
问题 3:投资者 preferences go beyond mean & variance and into skewness & kurtosis. 3N261
=>incorporate skewness, kurtosis or both into utility function and use an asymmetric definition
of risk, such as conditional VaR3N261
2.5 Allocating to Less Liquid Asset Classes 3N265 (LOS d) 3N265
Illiquidity assets offer an illiquidity premium. 3N265
(1) Due to the lack of accurate indexes, it is more challenging to make capital market assumptions
for less liquid asset classes,
(2) even if there were accurate indexes, there are no low-cost passive investment vehicles to
track them.

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In addressing asset allocation involving less liquid asset classes, practical options include the
following: 3N266
1. Exclude less liquid asset classes (direct real estate, infrastructure, and private equity) from
the asset allocation decision and then consider real estate funds, infrastructure funds, and
private equity funds as potential implementation vehicles when fulfilling target strategic
asset allocation.
2. Include less liquid asset classes in asset allocation decision and attempt to model the inputs
to represent the specific risk characteristics of the likely implementation vehicles.
3. Include less liquid asset classes in the asset allocation decision and attempt to model the
inputs to represent the highly diversified characteristics of true asset classes. 3N266
2.6 Risk Budgeting 3N267
The goal of risk budgeting is to maximize return per unit of risk—whether overall market risk in
an asset allocation setting or active risk in an asset allocation implementation setting.
The ability to determine a position’s marginal contribution to portfolio risk is a powerful tool. 267
(1) approximate portfolio risk change (total risk, active risk, or residual risk) due to an individual
holding change,
(2) determine which positions are optimal, and
(3) create a risk budget.
marginal contribution to total risk (MCTR) identifies the rate at which risk would change with a
small (or marginal) change in current weights.==>
MCTRi = (Beta of asset class i with respect to portfolio)(Portfolio return volatility). 3N267
Absolute contribution to total risk (ACTR) how much an asset class contributes to portfolio
return volatility ACTRi = (Weighti)(MCTRi).

An asset allocation is optimal from a risk-budgeting perspective when the ratio of excess return
to MCTR【=(Expected return – Risk-free rate) / MCTR】 is the same for all assets and matches the
Sharpe ratio of the tangency portfolio. 3N267

2.7 Factor-Based Asset Allocation 3N269 (LOS h)

1) typical factors used in asset allocation include size, valuation, momentum, liquidity, duration
(term), credit, and volatility. 3N269
2) Exception of the market factor, the factor represents a zero (dollar) investment, or
self-financing investment, in which the underperforming attribute is sold short to finance
an offsetting long position in the better-performing attribute. For example, the size factor
is the combined return from shorting large-cap stocks and going long small-cap stocks (Size
factor return = Small-cap stock return – Large-cap stock return).==>this removes most
market exposure from the factors; 所以 the factors generally have low correlations with the
market and with one another. 3N269

3 Develop Liability-relative Asset Allocations 3N273

3.1 Characterizing the liabilities 3N273 (LOS j)
A liability：be fixed or contingent. Fixed: 比如 A corporate bond with a fixed coupon rate;
Contingent: 比如 defined Benefit Pension Plan 3N273
Quasi-liabilites: endowment of a university 3N273=> not legal cash paying liabilities; speding

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needs of an individual
Exhibit 23. Characteristics of Liabilities That Can Affect Asset Allocation 3N274
1.Fixed versus contingent cash flows
2.Legal versus quasi-liabilities
3.Duration and convexity of liability cash flows
4.Value of liabilities as compared with the size of the sponsoring organization
5.Factors driving future liability cash flows (inflation, economic conditions, interest rates, risk
premium)
6.Timing considerations, such as longevity risk
7.Regulations affecting liability cash flow calculations
they affect the choice of appropriate discount rate(s) to establish PV of the liabilities;
Basis risk: quantifies the degree of mismatch between hedging portfolio and the liabilities.274

3.2 Approaches to Liability-Relative Asset Allocation 3N276 (LOS k) 3 大法

3.2.1 Surplus Optimization 3N277
Equation 2:

where ULRm = surplus objective function’s expected value for asset mix m;
E(Rs,m) = expected surplus return for asset mix msurplus return = (Change in asset value –
Change in liability value)/(Initial asset value);
λ (lambda) = investor’s risk aversion.
注 the change in liability value (liability return) = the time value of money for the liabilities + any
expected changes in the discount rate & future cash flows over the planning horizon.

This surplus efficient frontier approach is a

straightforward extension of the asset-only
portfolio model MVO. 3N277
建模过程如 MVO 但求取 Surplus efficient
frontier, except include expected returns
and variances of the liabilities, which can
be obtained by factor approach.3N277

如何 lowering volatility of surplus(Surplus

risk)higher percentage commitment on
hedging asset(longing bonds) 3N281(倒数
第二段)
3.2.2 Hedging / Return-Seeking Portfolio Approach 3N282
1) Basic case: create an asset portfolio that hedges the liabilities and remainder is managed
independently using MVO. composition of the hedging portfolio: the designated cash flows
can be hedged via cash flow matching, duration matching, or immunization.3N282-283
2) Variants of two-portfolio approach:
 partial hedge: capital allocated to hedging portfolio is reduced to generate higher expected
returns 3N283
 Dynamic versions: investor increases allotment to hedging portfolio as funding ratio

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increases. This allotment specification is referred to as the liability glide path. 3N283
注：Hedging portfolio must include assets whose returns are driven by the same factor(s) that
drive the returns of the liabilities. (positive correlations) 3N283

Limitations: 3N284 basic approach can’t be directly applied when

1. Funding ratio < 1, investors can’t create a fully hedging portfolio 3N284
2. A true hedging portfolio is unavailable to hedge certain kinds of risk(hurricanes) 284
3.2.3 Integrated Asset-Liability Approach 3N285 不像前两个方法发生在 liabilities portfolio 决
策之后。Most comprehensive of the three approachesThe institution must render significant
decisions regarding the composition of its liabilities in conjunction with 同时 the asset allocation.
3N285Asset-Liability Management for Banks & Dynamic Financial Analysis for insurance
companies.==>multi-period models 3N285
This approach can be implemented in a factor-based model, linking the assets and liabilities to
the underlying driving factors. It is capable of modeling transaction costs, turnover constraints,
and other real-world constraints.3N286
3.2.4 Comparing the Approaches 3N286 Exhibit 31 在书 287 页

Example 9 Robustness and risk assessment in liability-relative asset allocation 3N289

4. Developing Goals-Based Asset Allocations 3N289: A goals-based asset allocation disaggregates
investor’s portfolio into a number of sub-portfolios, each of which is designed to fund an
individual goal (or “mental account”) with its own time horizon and required probability of
success. 3N289
Exhibit 33 Institutional and
Individual Ways of Defining
Goals 3N290
Mathematical expectation =
weighted expected return of
portfolio components（不用
背）
Minimum expectations: the minimum return expected to be earned over the given time horizon
with a given minimum required probability of success. 3N291also act as discount rate
4.1 The Goals-Based Asset Allocation Process 3N291
第一步：create portfolio modules(pre-optimized subportfolios),
第二步：identify client goals and match each of these goals to the appropriate sub-portfolio of a
suitable asset size. 3N293
4.2 Describing Client Goals 3N293: labeled goals: less precise details with clear need.
或者把 goals 分为：investor seeks to achieve: needs, wants, wishes & dreams 和 seeks to avoid:
nightmares, fears, worries, & concerns. 3N294==》 措辞从 needdream 体现渐进 more room
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for risk taking(riskier structured portfolio) 3N295
4.3 Constructing sub-portfolios 3N295 Exhibit 36 “Highest Probability- and Horizon-Adjusted
Return” Sub-Portfolio Module under Different Horizon and Probability Scenarios根据 time
horizon 和 required probability of success 选择 sub-portfolio module set 中 highest annualized
minimum expectation returnsoffer the lowest funding cost for the given goal.
4.4 The Overall Portfolio 3N298
Overall allocation to certain asset class =∑ Module X’s required capital 占 ttl capital 的百分比 *
certain asset class 占 module x 的百分比 3N300
4.5 Revisit the Module Process in Detail: Modules need to be revisited on a periodic basis. 304
4.6 Periodically Revisit Overall Asset Allocation 3N304 regularly review & portfolio
rebalancingtaxable clients are concerned with costly rebalancing. 3N304

5 Heuristics & Other Approaches to Asset Allocation 3N306 (LOS n)

Heuristics: rules that provide a reasonable but not necessarily optimal solution 3N306
1) The”120 minus your age” rule: 120 – Age = Percentage allocated to stocks ( vs fixed income
split) 随年龄增长，公式体现 target date funds 特征 3N306
2) The 60/40 stock/bond heuristic: 3N308
3) The Endowment (Yale) Model: asset allocation approach that emphasizes large allocations to
non-traditional investments, including equity-oriented investments driven by investment
manager skill (e.g., private equities) earn illiquid equity premiums 3N308
4) Risk Parity: asset allocation that each asset (asset class or risk factor) should contribute
equally to total risk of the portfolio for a portfolio to be well diversified. 3N309
Equation 3 3N309

wi = the weight of asset i

Cov(ri,rP) = the covariance of asset i with the portfolio
n = the number of assets ; σ2P = the variance of the portfolio
注：primary criticism: focus on risk and ignore expected returns. 3N309
5) the 1/N rule: equally weighting allocations to assets at each rebalancing date. 3N311

6 Portfolio Rebalancing in Practice 3N311

Rebalancing 取决于：weighing of benefits & costs.

1. 上表 corridor width 指：percent range rebalancing 中的 range 范围。

（LOS o）
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Study Session 9 Asset Allocation & Related Decisions in Portfolio Management(2)

Reading 18 Asset Allocation with Real-World Constraints 无习题

2 Constraints in Asset Allocation 3N322
2.1 Asset Size: it may limit the opportunity set asset classes accessible to asset owners.
<1> Asset owners have increasing returns to scale. 来自 a combination of cost savings related to
internal management, a greater ability to negotiate fees with external managers, and the ability
to support larger allocations to private equity and real estate investments.
<2> Smaller asset owners constraints: too small to adequately diversify across the range of asset
classes and investment managers or may have staffing constraints (insufficient asset size to justify
a dedicated internal staff). 3N324
<3>Regulatory restrictions: impose a size constraint to be qualified investors(exclude small
owners). 3N325
Example 1 Asset size constraints in Asset Allocation 3N326 （可再看一遍） ：其中注意点：
1） small asset owners make commingled investments(fund of funds) in private equity, hedge
funds etc(因为人手不足)
2） for commingled investment in private equity etc, limited staff resources give rise to the need
of expertise level necessary to select and monitor these more complex asset classes in BOD.
3N327
2.2 Liquidity 3N327 考虑两个维度：liquidity needs of asset owners & liquidity characteristics of
asset classes in the opportunity set. 3N327
1) Long-term investors exploit illiquidity premiums available in such asset classes as private
equity etc 3N328
2) Liquidity needs must also consider the particular circumstances and financial strength of the
asset owner and what resources they may have beyond those held in the investment portfolio.
3) evaluate potential liquidity needs under an extreme market stress event. 3N328
4) asset owners’ governance capacity: maintain course through crisis for illiquid investments to
produce expected rewards. 3N329
2.3 Time Horizon 3N330
Changing Human Capital: optimal allocation of financial capital changes through time towards
bonds. 3N331
Changing Character of Liabilities: affect asset allocation. 3N331
2.4 Regulatory & Other External Constraints 3N334
2.4.1 Insurance Companies 3N335
1) Insurers match assets to projected, probabilistic cash flows of the risks they are underwriting.
Fixed-income assets 为最主要投资品 3N335
2) Risk considerations: the need for capital to pay policyholder & company’s financial strength
ratings. 3N335
3) Allocations to certain asset classes are often constrained by a regulator. 3N335
4) Insurance regulators set a minimum capital level for each insurer based on that insurer’s mix of
assets, liabilities, and risk. 3N335
2.4.2 Pension Funds 3N335: Some countries regulate maximum or minimum percentages in
certain asset classes influenced by tax rules. Pension funds are also subject to a wide array of
funding, accounting, reporting, and tax constraints that may influence the asset allocation

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decision.
2.4.3 Endowments & Foundations 3N337
1) Tax incentives: many countries provide tax benefits tied to certain minimum spending
requirements（鼓励 minimum distribution）.3N337
2) Credit Considerations: external factors restrict level of risk-taking in the portfolio. 比如
subject to balance sheet metrics specified by its lender(s) 3N338
2.4.4 Sovereign Wealth Funds 3N338
1) The governing entities adopt regulations that constrain the opportunity set for asset allocation.
2) As publicly owned entities, SWFs are subject to broad public scrutiny and tend to adopt a
lower-risk asset allocation than might otherwise be considered appropriate given their long-term
investment horizon. 3N338
除了 2.4.1-2.4.4 之外，还有 cultural & religious factors + Environmental, social & governance
considerations / constraints (ESG 变成 an asset class 有 mini investment). 3N338
Example 4 External Constraints & Asset Allocation 3N339

3 Asset Allocation for the Taxable Investor 3N340

3.1 After-tax portfolio optimization 3N341 (LOS b)
Equation (1) rat = rpt(1 – t)    Where: rat = the expected after-tax return ; rpt = the expected
pre-tax (gross) return ; t = the expected tax rate 3N341 适用 bonds（interest income）3N341

Equation (2) rat = pdrpt(1 – td) + parpt(1 – tcg)  

Where: pd = the proportion of rpt attributed to dividend income ;
pa = the proportion of rpt attributed to price appreciation
td = the dividend tax rate
tcg = the capital gains tax rate 3N341
适用 equity:两部分收入：dividend + capital appreciation 3N341

Equation (3) σat = σpt(1 – t)   where σat = the expected after-tax standard deviation

σpt = the expected pre-tax standard deviation 3N342（部分波动风险转嫁给政府 via tax）

3.2.Taxes & Portfolio Rebalancing 3N344 (LOS b)
Rebalancing results in taxation on realized gains/losses，所以 taxable asset owners 必须做好权
衡 3N345因为 after tax volatility 减，而 asset class 间 correlation 不变，rebalancing ranges for
taxable portfolios > [tax-exempt ones under a similar risk profile(desired risk level)]. 3N345
Equation 4: Rat =Rpt / (1 – t)   ; where Rat = the after-tax rebalancing range ; Rpt = the pre-tax
rebalancing range 3N345
3.3 Strategies to Reduce Tax Impact 3N345 1. tax loss harvesting: 3N345
2. strategic asset allocation: placing (or locating) less tax-efficient assets in accounts with more
favorable tax treatment, such as retirement savings accounts. 3N345
1) After-tax value of assets in a tax-deferred account  Equation (5) vat = vpt(1 – ti)  
where: vat = the after-tax value of assets ; vpt = the pre-tax market value of assets
ti = the expected income tax rate upon distribution 3N345
2) The portion of a taxable asset owner’s assets that are eligible for lower tax rates and deferred
capital gains tax treatment(即 equity) should first be allocated to the investor’s taxable accounts,
while taxable bonds & high-turnover trading strategies in tax-exempt or tax-deferred accts; 例外

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Because tax-exempt and tax-deferred accounts may not be immediately accessible without tax
penalty, a portion of the bond allocation may be held in taxable accounts if its role is to fund
near-term consumption requirements. 3N346
4 Revise the Strategic Asset Allocation 3N350
源于 a change in goals, a change in constraints, or a change in beliefs：3N350
1. Goals 3N350
•Changes in business conditions affecting the organization supporting the fund and, therefore,
expected changes in the cash flows
•A change in the investor’s personal circumstances that may alter her risk appetite or risk
capacity
2. Constraints 3N350
•Changes in the expected payments from the fund (
•A significant cash inflow or unanticipated expenditure (liquidity needs)
•Changes in regulations governing donations or contributions to the fund.( regulatory constraint)
•Changes in time horizon resulting from adoption of a lump sum distribution option at
retirement
•Changes in asset size as a result of merging pension plans
3. Beliefs 3N351Investment beliefs are a set of guiding principles that govern the asset owner’s
investment activities. Changes in the economic environment and capital market expectations or
a change in trustees or committee members are two factors that may lead to an altering of the
principles that guide investment activities.3N351

P.S. a change to an asset allocation strategy may reasonably be implemented without a formal
asset allocation study.==> Glide path (rebalancing policy) as time progresses target date
mutual funds in retirement investing 3N353
Example 6 Revising the Strategic Asset Allocation 3N353
5. Short-Term Shifts in Asset Allocation 3N356
1. Tactical Asset Allocation: certain asset classes have more favorable momentum. 基于
investment returns in short run are predictable 3N356
2. Generating alpha through TAA decisions is dependent on successful market or factor timing
rather than individual security selection（更侧重 reweight broad asset classes, sectors etc）.356
3. TAA is an asset-only approach. 3N356

Ways to evaluate TAA decisions 3N356

•a comparison of Sharpe ratio realized under TAA relative to that under SAA;
•evaluate information ratio or the t-statistic of the average excess return of TAA portfolio over
SAA portfolio;
•plot realized return and risk of the TAA portfolio versus that of SAA’s efficient frontier. TAA
portfolio 虽然收益好，但 could be less optimal than other portfolios along the efficient frontier.

缺点：3N356: 1) higher trading costs & taxes 2) 增 risk concentration relative to SAA.
5.1 Discretionary TAA ( qualitative ) 3N357
Discretionary TAA is used to mitigate or hedge risk in distressed markets while enhancing return
in positive return markets (i.e., an asymmetric return distribution).

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Short-term forecasts consider information about current and expected political, economic, and
financial market conditions that may affect short-term asset class returns.3N357 包 括
economic sentiment indicators( consumer spending) 3N357
Market sentiment indicators: 1) margin borrowing: current & future level of bullishness, 2) short
interest: current & future bearish sentiment 3) Volatility index ( fear index) : market expectation s
of near-term volatility. 3N357
5.2 Systematic TAA 3N358 ( Quantitative)
Capture asset class level return anomalies that have been shown to have some predictability and
persistence. Value and momentum both among securities within asset classes (for security
selection) and at the asset class level (for asset class timing). 3N358
Value factor: return of value stocks over those of growth stocks.
Momentum factor: return of stocks with higher prior returns over those with lower ones.
Valuation ratios: predictive power: dividend yield, cash flow yield, and Shiller’s earnings yield.358
Carry in currencies uses short-term interest rate differentials to determine which currencies (or
currency-denominated assets) to overweight (or own) and which to underweight (or sell short).
Carry in commodities compares positive (backwardation) and negative (contango) roll yields to
determine which commodities to own or short.
Yields-to-maturity and term premiums (yields in excess of the local risk-free rate) signal the
relative attractiveness of different fixed-income markets.3N358
Trend following: 3N358
1) most recent 12-month return: 近 12 个月回报能在下 12 个月持续
2) moving-average crossover: 金叉死叉 3N358
Example 7 Short-term Shifts in Asset Allocation 3N359
6. Dealing with Behavioral Biases in Asset Allocation 3N361 (LOS e)
6.1 Loss Aversion 3N362 In goals-based investing, loss-aversion bias can be mitigated by:
1) frame risk in terms of shortfall probabilityl.
2) fund high-priority goals(sub portfolios) with low-risk assets, Riskier assets can then be used
to fund lower-priority and aspirational goals. 3N362
Institutional investing: herding behavior among plan sponsor. 3N362
6.2 Illusion of Control: the following investor behaviors might be attributed to this bias: 3N363
 Alpha-seeking behaviors, such as attempted market timing in the form of extreme tactical
asset allocation shifts or all in/all out market calls
 Alpha-seeking behaviors—institutional investor who believes her superior internal resources
give her an edge over other investors in active security selection and/or the selection of
active investment managers.
 Excessive trading, use of leverage, or short selling
 Reduce, eliminate, or even short asset classes that are a significant part of global market
portfolio based on non-consensus return and risk forecasts
 Retaining a large, concentrated legacy asset that contributes diversifiable risk—员工持有公
司大量股票。3N363
如何缓解该 bias: market portfolio derived from MVO should be used as the starting point for
the allocation and shifts in allocation away from this position should be subject to a formal
review process. 3N363

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6.3 Mental Accounting 3N363 Goals-based investing 包含 mental accounting directly into asset
allocation solution 3N364 案例还包括 concentrated stock positions(创业者拥有公司大部
分股权)
应对措施：assign concentrated stock position to an aspirational goal—即 investors are willing to
assign a lower probability of success.. 3N364
6.4 Representative Bias 3N364 也称 recency bias 此类问题表现：
1) Tactical shifts in response to recent returns or news.
2) return chasing 3N364 overweighting asset classes with good recent performance.
如何防范：3N364 An objective asset allocation process and a strong governance framework.
6.5 Framing Bias 3N365
案例：1) committee-oriented decision making process 所有人听老大的 3N365 2) asset
allocation: investor’s choice of an asset allocation is influenced by manner in which risk-to-return
trade-off is presented. 3N365
Risk 表述方式不同：standard deviation, VaR & conditional VaR 3N365-366
应 对 措 施 ： present possible asset allocation choices with multiple perspectives on the
risk/reward trade-off. 3N366
6.6 Availability Bias 3N366 (easily recalled outcomes) ,
案例：引申出 familiarity biashome bias 3N366
应对措施：use global market portfolio as the starting point for asset allocation, where deviations
from this baseline portfolio must be rigorously vetted. 3N366
Example 8 Mitigate Behavioral Biases in Asset Allocation 3N367

Reading 19 Currency Management: An Introduction 重点章节大量题 24 点

2 Review of Foreign Exchange Concepts 3N374
2.1 Spot markets 3N375 报价基础 Price currency / Base currency. 3N376
1) 报价小数保留 4 位 3N376one pip = 0.0001
2) Spot exchange rate use T+2 settlement. 3N377
3) Buyer: bid prices; Seller: offer price. 3N377
2.2 Forward Markets 3N377
Quoted in forward premium or discount (forward points) = difference between forward X rate
quote & spot one 3N377
Exhibit 3 Sample Spot & Forward Quotes (Bid-offer)
3N378
To convert any of these quoted forward points into a
forward rate, one would divide the number of points by
10,000 (to scale down to the fourth decimal place, the
last decimal place in the USD/EUR spot quote) and then
add the result to the spot exchange rate quote. 3N378
1） To close out a forward position, it must be offset with an equal and opposite forward
position using spot exchange rate and forward points available in the market when the
offsetting position is created. 3N378cash flow settlement in price currency at forward
settlement date 3N379
2） Up-the-bid-and-multiply; down-the-ask-and-divide 3N379

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Forward contract price before expiration：3N379

1) 先 long a base currency，要 close before expiration, 则 short the same base currency for
remaining contract days
2) FPt 计算一律用 up-the-bid-and-multiply 原则（用 bid price） ，因为要 close 之前合约需要
买回 price currency.
3) R = interest rate for price currency.
2.3 FX Swap markets 3N380: base currency is bough spot and sold forward or vice versa.
two-legs3N380
1) Matched swap: two legs of the swap is of equal size 3N380 vs mismatched swap 3N380
2) FX swaps are used to “roll” forward contracts forward as they mature. For example, consider
the case of a trader who bought GBP1,000,000 one month forward against the CHF in order to
set up a currency hedge. One month later, the forward contract will expire. To maintain this long
position in the GBP against the CHF, two days prior to contract maturity, given T + 2 settlement,
the trader must (1) sell GBP1,000,000 against the CHF spot, to settle the maturing forward
contract; and (2) buy GBP1,000,000 against the CHF forward. That is, the trader is engaging in an
FX swap (a matched swap in this case because the GBP currency amounts are equal). 3N380
2.4 Currency Options 3N381 类似其他 option markets like bonds & equities. 3N381
Put & call option(vanilla options) & exotic options (more flexibility) 3N381
3. Currency Risk and Portfolio Return & Risk 3N381 LOS a
3.1 Return Decomposition 3N381 LOS a
Foreign-currency return: Return of the foreign asset measured in foreign-currency terms382
Domestic-currency return on a foreign asset
Equation (1): RDC = (1 + RFC)(1 + RFX) – 1  3N382RFX is the percentage change of foreign
currency against domestic currency.【domestic currency is always the price currency】(外币升
值是好事) 3N382USD appreciate by 5% against the Euro 指 Euro/USD 中 1 美元所对价的 Euro
增加了 5%。
公式 2 是公式 1 的拓展式：3N383domestic-currency return on a portfolio of multiple foreign
assets will be equal to Equation 2 3N383

RFC,i = foreign-currency return on the i-th foreign asset, RFX,i = appreciation of the i-th foreign
currency against the domestic currency, and ωi = portfolio weights of foreign-currency assets 383
3.2 Volatility Decomposition 3N384 LOS a
Equation 3: RDC ≈ RFC + RFX
Equation 4: ============
Equation 5:由公式 4 推到：
公 式 5 是 variance of
domestic-currency return. 我们取该式的平方根作为 risk volatility 测量=>单个 foreign 投资
Equation 6: variance of the domestic-currency returns for the overall foreign asset portfolio

domestic-currency
return (RDC) of two different foreign-currency investments（两个 foreign 投资）, and the ωi as

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portfolio weights that sum to one. 3N384【If short-selling is allowed in the portfolio, some of
these ωi can be negative as long as the total portfolio weights sum to one.3N385】
4 Currency Management: Strategic Decisions 3N387 (LOS b)
4.1 Investment Policy Statement 3N387 (LOS c)
4.2 Portfolio optimization problem 3N388 (LOS b)
Handle asset allocation with currency risk as a two-step process: (1) portfolio optimization over
fully hedged returns; and (2) selection of active currency exposure, if any. 3N389
fully currency hedgeRFX=0，equation 2, RDC = RFC &σ(RFX)=0, Equation 5, σ2(RDC) = σ2(RFC)
接下来 portfolio construction 只需要按正常 mean-variance optimization 走 （no currency risk）
4.3 Choice of Currency Exposure. 3N389(LOS b)
risk spectrum between being fully hedged and actively trading currencies
4.3.1 Diversification Consideration 3N389
1)Time horizon (of IPS 重要): long rununhedged foreign currency exposure does not affect
long-run portfolio return. 3N389==》currency long run mean-reverting 3N390
2) asset composition of foreign-currency asset portfolio: negative correlation between RFCassets &
RFX increases portfolio diversification降低 currency hedge 需求 3N390
4.3.2 Cost Consideration 3N391 1)Trading costs 2) Opportunity Costs. 3N391
1.Trading Expenses: 1) bid-offer spread by dealers 2) long currency option with upfront premium
3) Forward contract roll-over with an FX swap to maintain the hedge. 4) maintain an
administrative infrastructure for trading 3N391
2. Opportunity costs: 100% hedged放弃潜在汇率收益 3N392
4.4 Locate Portfolio Along Currency Risk Spectrum 3N392 (LOS b)
4.4.1 Passive Hedging 3N393: to keep the portfolio’s currency exposures close, if not equal to,
those of a benchmark portfolioperiodic rebalancing to realign then with investment objectives
4.4.2 Discretionary Hedging: similar to passive hedging due to a neutral benchmark portfolio but
portfolio manager has some limited discretion for deviation from neutral position.3N393
4.4.3 Active Currency Management 3N393: an extension of discretionary hedging: the portfolio
manager is allowed to express directional opinions on exchange rates, but is nonetheless kept
within mandated risk limits. 3N393
4.4.4 Currency Overlay 3N394-395:
A broad term covering outsourcing of currency management. At the extreme, overlay manager
will treat currency as an asset class and may take positions independent of other portfolio assets
(seek currency alpha).
4.5 Formulate a client-appropriate currency management program 3N396 (LOS c)
IPS 中 currency positioning, should be biased toward a more-fully hedged currency management
program the more: 3N396
1） short term the portfolio investment objectives;
2） risk averse the portfolio beneficial owners are;
3） immediate income and/or liquidity needs;
4） fixed-income assets are held in a foreign-currency portfolio;(high correlation between
fixed-income & foreign currenciesall interest rate sensitive )
5） cheaply a hedging program can be implemented;
6） volatile (i.e., risky) financial markets are;13 and
7） skeptical the beneficial owners and/or management oversight committee are of the

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expected benefits of active currency management.(not fully hedged)
5. Currency Management: Tactical Decisions 3N399Active Currency Management(LOS d)
5.1 Active Currency Management Based on Economic Fundamentals 3N399
1) Simple economic model: in the long run, the real exchange rate will converge to its “fair value,”
(determined by purchasing power parity) but short- to medium-term factors will shape the
convergence path to this equilibrium. 3N399
2) in the short term, 一国 currency value increase：
<1> more undervalued relative to their fundamental
value
<2>have greatest increase rate in their fundamental
value
<3>with higher real or nominal interest rates
<4> with lower inflation relative to other countries
<5> countries with decreasing risk premiums.
5.2. Active Currency Management Based on
Technical Analysis 3N401 based on 3 broad themes
1) historical price data can be helpful in projecting future price movements 3N401
2) historical patterns in the price data have a tendency to repeat, which provides profitable trade
opportunities.  a study of market psychology 3N401
3) technical analysis does not attempt to determine where market prices should trade (fair value,
as in fundamental analysis) but where they will trade(emotional & irrational act).3N401
使用工具：1. Visual cues 2. Quantitative technical indicators: 200-day moving average of daily X
rates. 3N402
5.3. Active Currency Management Based on the Carry Trade 3N402: borrow in low-yield
currencies and invest in high-yield currencies基于 uncovered interest rate parity. 3N402
%ΔSH/L ≈ iH – iL where %ΔSH/L = percentage change in the SH/L spot exchange rate (the
low-yield currency is the base currency), iH = interest rate on the high-yield currency and iL =
interest rate on the low-yield currency. 3N402(利率高的国家远期货币贬值)==》a positive value
for %ΔSH/L means a depreciation of the high-yield currency. 3N402
An implication of uncovered interest rate parity: forward rate should be an unbiased predictor of
future spot rates. 3N403
Forward rate bias: 但往利率高的国家远期货币不但不贬，还升值（short-medium terms）403
与 covered interest rate parity 公式推导出来的结论相反。
Covered interest rate parity: Given A/B quote structure: 3I 243
F = forward rate ( quoted as A/B)
S0=spot rate (quoted as A/B)
days = number of days in the underlying forward contract
RA=interest rate for Currency A
RB=interest rate for Currency B
Trading the forward rate bias: buy currencies selling at a forward discount, and sell currencies
trading at a forward premium. (forward rate bias overstate forward premium & understate
forward discount) 3N403
小结：carry trade = trade the forward rate bias 3N403（选择买卖币种的原则）
3N403

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Carry trade has a large negative skew (occasional large losses due to leverage positions of
low-yield currency) 404lower volatility of currency pair is better for a carry trade position404
Carry trade is based on higher rate currency appreciating or depreciating less than suggested by
uncovered interest rate parity.
Funding currencies of carry trade: low-yield currencies; 3N404
Investment currencies of carry trade: high-yield currencies. 3N404
5.4. Active Currency Management Based on Volatility Trading 3N404option market. 3N404
•Delta: sensitivity of option premium to a small change in underlying asset price. 3N404
•Vega: sensitivity of option premium to a small change in implied volatility. 3N404(call & put
option premium 都随 volatility 增而增) 3N404
Use of options allows trader to unbundle and isolate all of the various risk factors and trade them
separately. 3N404
Delta hedging: the act of hedging away the option position’s exposure to delta, the price risk of
the underlying (the FX spot rate, in this case). 3N405
Long stock position & Long forward position: delta of +1;
Short stock position & Short forward position: delta of -1.
Option hedge ratio: size of offsetting hedge position that will set the net delta of the combined
【各因素间 delta 直接加减】 if a trader was long a call
position (option plus delta hedge) to zero.
option on USD/EUR with a nominal value of EUR 1 million and a delta of +0.5, the delta hedge
would involve a short forward position (delta = -1) in USD/EUR of EUR 0.5 million.【1 mil x 0.5 /
- 1 = - 0.5 mil】3N405 Once the delta hedge has set the net delta of the position to zero, the
trader then has exposure only to the other Greeks(like vega). 3N405

Volatility trade (但涨跌方向不明)：3N405

1） straddle: a combination of both an at-the-money (ATM) put and an ATM call. A long straddle
buys both of these options.==> a short straddle is a bet that the spot rate will stay relatively
stable.
2） strangle:类似 straddlea long position is buying out-of-the-money (OTM) puts and calls
with the same expiry date and the same degree of being out of the money （但比 straddle 便宜，
因为 out of money option）
How currency options are quoted in professional FX markets: 3N406in interdealer market,
options are described in terms of their “delta.” Deltas for puts can range from a minimum of –1 to
a maximum of 0, with a delta of –0.5 being the point at which the put option is ATM; OTM puts
have deltas between 0 and –0.5. For call options, delta ranges from 0 to +1, with 0.5 being the
ATM point.全部用绝对值表示（均为正数）& as percentage3N406 25-delta and 10-delta
optionsa delta of 0.25 and 0.10, respectively 3N406
Depreciation in INR / USD rate = INR appreciates against USD. 3N408-409
LOS e: describe how changes in factors underlying active trading strategies affect tactical trading

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decision
6. Tools of Currency Management 3N409
6.1 Forward Contracts 3N410 投资者 prefer forward contracts > fututes 因为：(LOS f)
1）forwards 可以 customized. 3N410
2）no availability of selected currency pair in future & illiquid for emerging market currencies
3）futures require up-front margin & intra-period min margin request(cash injections). 3N410
6.1.1 Hedge Ratios with Forward Contracts 3N411
Static Hedge: (i.e., unchanging hedge) will avoid transaction costs, but will accumulate unwanted
currency exposures as the value of the foreign-currency assets change.412
Dynamic Hedge: rebalance the portfolio periodically.mismatched FX swap on forward contract
roll-over date. 3N412 具体案例：Roll hedge Forward. 3N413-414（for matched swap, the
convention is to base pricing on the mid-market spot exchange rate；而 mismatched swap 仍然用
up-the-bid-and-multiply;down-the-ask-and-divide）
6.1.2 Roll Yield 3N414也称 roll return. 3N414
The magnitude of roll yield = |(FP/B – SP/B)/SP/B| where “||” indicates absolute value. FP/B=all in
forward rate at contract initiation; SP/B= current spot rate 3N414
A positive roll yield results from buying the base currency at a forward discount(price currency 升
值时)or selling it at a forward premium （price currency 贬值时，获取更多 price currency）. 3N414
Roll yield = forward rate bias = carry trade 3N415 （Forward Premium 状态下， forward price curve
upward-slopping,随时间推移 Forward price 永远高于 spot rate）
The higher the expected hedge cost (negative
roll yield) the more the cost/benefit calculation
moves against using a fully hedged position.
3N416
Example 4 Hedging Decision3N416
Hedging benefit: targeted foreign currency
appreciation or depreciation percentage =
( forward forecast spot rate – current spot rate )
/ current spot rate；
Hedging cost = roll yield = (FP/B – current
SP/B)/ current SP/B=以上二者间权衡
6.2 Currency Options 3N417
Protective put: Match a long position in the underlying with a put option 3N418
需要 pay upfront premium 1) 取决于 Intrinsic value= difference between spot exchange rate
and strike price of the option. 2) time value: 该因素受 X rate volatility 影响;但随时间 decline
(time decay) 3N418 Example 5 Hedging Problems 3N418 1) hedge a required purchase of base
currency 用 call option（buy base currency at forward discount）; hedge a required sale of BC 用
put option（sell BC at forward premium，希望远期汇率涨价，但买 put 防止远期汇率掉价）
这段话背一下 3N420
6.3 Strategies to Reduce Hedging Costs and Modify a Portfolio’s Risk Profile 3N420 LOS h
move portfolio away from a passively 100% hedge ratio toward discretionary hedging.3N420

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6.3.1 Over-/Under-Hedging Using Forward Contracts 3N421
Adjust hedge ratio based on exchange rate movements: increase hedge ratio if the base currency
depreciated via longing base currency in forward contracts(buy base currency at forward discount),
but decrease the hedge ratio if the base currency appreciated. 3N421
6.3.2. Protective Put Using OTM Options 3N422==》less costly than ATM options,但有 minor
downside risk. 3N422
6.3.3 Risk Reversal (or Collar) 3N422
Risk reversal: In professional FX markets, a long position in a call option and a short position in
a put option(对冲成本，但 limited upside potential). 3N422(buying a put, writing a call) would
be a short position in a risk reversal.
6.3.4 Put Spread 3N422: buy an OTM put, and write a deeper-OTM put to gain income from
premiums; both options with same maturity. 3N422但 deeperOTM option 中 strike price 以下的
downrisk 并未转移。
6.3.5 Seagull Spread 3N423: combine original put spread position (1:1 proportion of notionals)
with a covered call position.主要是 long the put option at ATM（fully hedge the downside risk）
423调整各 strike price&size 使 zero cost.==>short seagull position.( short covered call &
deeper OTM put 是两翼，中间体是 long ATM put). 和 long seagull position ( long OTM put &
OTM call 是两翼，中间是 short ATM call) 3N424
6.3.6 Exotic Options 3N424more closer to active management and speculative end.
Exotic 相对于 vanilla：vanilla 指 European style put & call options. 3N424
Cheaper than vanilla options,但也提供 less upside potential & downside protection. 425
1) knock in: a vanilla option that is created only when spot exchange rate touches a pre-specified
level (也称 barrier) 3N424
2) Knock out: a vanilla option that ceases to exist when spot exchange rate touches some
pre-specified barrier level. 3N424
3) Digital options: binary options ( all-or-nothing options): they pay a fixed amount if they
“touch” their exercise level at any time before expiry (even if by a single pip).==>large
payoffs 使其 more expensive than vanilla options with same strike price. 3N425highly
leveraged 所以不适合 hedge 而适合 active management. 3N425
6.4. Hedging Multiple Foreign Currencies 3N428 多考虑一点：correlations between various
foreign-currency risk exposures.3N428
6.4.1 Cross Hedges & Marco Hedges 3N428
cross hedge:也称 proxy hedge: a position in one asset (or a derivative based on the asset) is used
to hedge the risk exposures of a different asset (or a derivative based on it).3N428
(只发生在 negatively correlated currency exposures 之间，都不用 Derivatives 来 hedge，两币种
间天然对冲)3N428
一部分 cross hedge 称为 macro hedges: the hedge is more focused on entire portfolio, particularly
when individual asset price movements are highly correlated. 3N43
1) defined in terms of financial scenarios ( recession, inflation etc) they are designed to protect
the portfolio from 3N430
2) Using a derivative product based on an index, rather than specific assets or currencies, can
also define a macro hedge.==>no separate hedge on single currency but on currency basket is
cost efficient. 3N430
6.4.2. Minimum-Variance Hedge Ratio 3N431 估算β公式要背诵

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A mathematical approach to determining the optimal cross hedging ratio 3N431
y=% change in asset value to be hedged
x=% change in hedging instrument value.

如何估算β=
(regression)
所得
β就是 minimum variance hedge ratio
6.4.3 Basis Risk 3N431: price movements in the exposure being hedged and the price
movements in the cross hedge instrument are not perfectly correlated, and that the correlation will
change with timeminimum variance hedge ratios to be re-estimated with growing data base.432
7 Currency Management for Emerging Market Currencies 3N438 LOS i
7.1. Special Considerations in Managing Emerging Market Currency Exposures 3N438
1) higher trading costs than major currencies[特别是 cross rates set] 2) illiquidity under extreme
market events 438 increased volatility 导致 higher cost option hedging strategies, forward
contract hedging strategies & cross hedge ( correlations between currencies) 3N439 3）government
involvement in setting X rateoccasional extreme market eventscovered interest parity 失效
（free capital flow 受阻）3N440
7.2 Non-Deliverable Forwards 3N440应对 government capital control
Non-deliverable forwards: similar to regular forward contracts, but they are cash settled (in the
non-controlled currency of the currency pair) rather than physically settled. 3N440[net exchange
of gain/loss in developed market currencies]
1） 应交割货币如为 non-deliverable，那么以交割当天 currency pair 牌价转换成 deliverable
货币结算。
2） 但 capital control 国家政府干预导致交割当天汇率波动可能导致 reverse any 投资
gains.3N441
3） NDF 不一定按照 covered interest parity 来定价，而是基于 individual supply & demand in
offshore markets. 3N441

Reading 20 Market Indexes & Benchmarks(少习题 6 点)

2. Distinguishing between A Benchmark & A Market Index 3N465 (LOS a)
market index: performance of a specified security market, market segment, or asset class. 3N465
Most appropriate benchmark for an investment manager often is not an available market index.
1) specified in advance at start of an evaluation
2) Appropriate: consistent with manager’s investment approach and style and portfoilo’s
objectives & constraints.
3) Measurable
4) Unambiguous: identities and weights of securities constituting the benchmark are clearly
defined.
5) Reflective of manager’s current investment opinions:
6) Accountable: manager should agree to accept performance differences between portfolio and
benchmark as reflecting active management
7) Investable:
3 Benchmark Uses & Types 3N466 Plan sponsor & fund manager 3N466

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3.1 Benchmarks: Investment Uses 3N466 (LOS b)
1) Sponsor benchmarks(long run strategic asset allocationmarket indexes for each asset
classpassive 投资) need to be distinguished from fund manager benchmarks. 3N467
2) Benchmarks will convey sponsor’s expectations to the manager as to how fund assets will be
invested and their expected risk and return. 3N467
3) benchmark communicates to the board and external consultants the manager’s area of expertise
and how a manager should subsequently invest and be evaluated. 3N467
4) identify & evaluate risk exposures of the managers. 3N467active risk exposures.
5) attribute & appraise past performance and consequences of manager’s investment decisions.467
6) manager selection process in terms of past performance analysis. 3N467
7) market investment products. 3N467
8) demonstration of compliance with regulations, laws, or standards. 3N468
3.2 Types of Benchmarks 3N468 LOS c & d
1. absolute (including target) return benchmarks: minimum target return for a manager to beat;
2. manager universes (peer groups): a broad group of managers with similar investment
disciplinesallow 投资者 to compare other managers performances. 3N468
3. broad market indexes: broad asset class performance.
4. style indexes: a characteristic of an asset, such as a bond’s credit rating, will be the primary
determinant of its subsequent performance.3N469
5. factor-model-based benchmarks: equation 1 3N469
Rp = ap + b1F1 + b2F2 … bkFk + εp
Where: Rp = the portfolio’s periodic return
ap = the “zero-factor” term, which is the expected portfolio return if all factor sensitivities are zero
bk = the sensitivity of portfolio returns to the factor return
Fk = systematic factors responsible for asset returns
εp = residual return due to nonsystematic factors
6. returns-based (Sharpe style analysis) benchmarks:类似 factor model 但 the factors are the
returns for various style indexes (e.g., small-cap value, small-cap growth, large-cap value,
and large-cap growth).3N470benchmark=weighted average of these asset class
indexes.==>bk= weights = non-negative & sum upto 1 470
7. custom security-based (strategy benchmark): accurately reflect investment discipline of a
particular manager. 市场无合适 index 时使用 3N470
以上均是 asset based benchmarks.
8. Liability-based benchmark: investors’ chief objective of providing for the payment of a
stream of liabilities. It will match the duration profile and other key characteristics of the
liabilities, consisting of nominal bonds, real return bonds, common shares, and other assets.
3N470
4 Market Indexes Uses & Construction 3N471
4.1 Use of Market Indexes 3N471 LOS e 顺着 plan sponsor 的视角按顺序：
1 Asset Allocation Proxies: measure asset class ex ante return, risk & correlation so that design an
IPS for different risk aversion levels. 3N471
2. Investment Management Mandates:包含 a specified benchmark indexevaluation tool. 3N471
3. Performance benchmarks: ex post performance benchmarks. 3N472
4. Portfolio analysis: currency management strategy’s effectiveness. 3N472

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5. Gauge of market sentiment : 3N472
6. Basis for investment vehicles : bss for index mutual funds, ETFs, derivatives etc 3N472
4.2 Index Construction 3N473
security weighting: 3N473
a) capitalization weighting【price x available shares=>free float】; b) price weighting: portfolios
that hold one unit of each index security. 3N474 c) equal weighting ( portfolio invests same
amount of wealth in each index security and rebalanced periodically) d)Fundamental
weighting(invest according to valuation metrics/company characteristics for a security) 3N474
4.3 Index Construciton Tradeoffs 3N475 LOS f
1) Completeness (diversification) vs Investability 3N475: eliminate hard-to-trade securities
improves an index investability；investability≠liquidity in emerging markets since the country’s
government imposes restrictions on some securities
2) Reconstitution & rebalancing frequency vs turnover 3N476: Reconstitution =index 中增减股票;
Rebalancing= readjust weights of existing securities. 此二步骤增 costly turnovercreate banks
to make float adjustment in rebalancing. 3N476
3)Objective & Transparent rules vs judgment 3N476: O&T give investors prediction power on
changes in index constituents that might occur ( added-in or deleted)及因此带来的个股价格波动;
Judgment applies to special situations that might not be anticipated by explicit rules. 3N476
5 Index Weighting Schemes: Advantages & disadvantages LOS g
5.1 Capitalization-Weighted Indexes: 3N477 好 处 1 ） clear market assessment of
constituents’relative values. 2）accessible to all investors=>marco consistency 3）less required
rebalancing than other indexes.=>self-corrects for stock split 3N477
不足：1）overly influenced by overpriced securities. 2) over-concentrated by large issues
5.2 Price-Weighted Indexes 3N478: 好处 1）simplicity of its constitution. 2) long historical
track record 不足：1）overly influenced by highest-priced securities. 2) stock split decrease such
stock weights. 3) one unit of each security portfolio construction is not practicable.
5.3 Equal-Weighted Indexes 3N478: 好处 1）small weights to large cap securities 2) better
measure on market performance based on an average of all index security return
不足：1）small-issuer bias 2）maintain equal weighting=> sell strong-performers & buy weak
performers=>increase turnover and costs. 3) small issues with illiquidity
5.4 Fundamental-weighted indexes 3N478: 好处 1） avoid overweight overvalued issues by
using fundamentals 2) more representative of an issuer’s importance in an economy 3N478
不足：1）reflect index creator’s subjective valuation view 2) may be less diversified than
cap-weighted 3）not accessible to all investors 4) construction methodology is proprietary and
composition & weightings are not fully known. 5)不适合倾向 large-cap 和 growth 的投资者做
benchmark 3N479
5.5.Choosing an Equity Index Weighting Scheme When an Index Is Used as a Benchmark
capitalization-weighted, float-adjusted indexes are considered the best for use as benchmarks
because they are the most easily mimicked with the least amount of tracking risk and cost. 3N479
A market index will not be appropriate as a benchmark if the manager’s style differs from the
index’s style. 3N480
Example A Japanese Stock Market Index 3N480
6 Benchmark Selection: An Example 3N481 LOS h (可再熟悉一遍)

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