Exam Question Notes

• Memory Pool

• Waiting area for valid but not confirmed transactions

• Device linked to a network and maintaining a ledger copy

  
  

• Smart contract that lists digital asset ownership

• Outside real-world data onto blockchain

  
  

• Wallet storing keys and transaction capabilities

• Private trial phase where manager tests different strategy with own money before launch

• Focus on contribution for profit (economic), people (social), and planet (environmental)

• Excessive number of statistical tests until wished result appears

• Correlation of a single variable with its own past values

• Hours studied: 2 hours every day or an increase of 15 minutes every day

• Measures the strength and direction of the relationship between two variables, always ranging from −1 to +1:

• Number quantifies relationship (+1 = positive relationship (high follows high); 0 = no relationship, -1 = -1 negative relation (low follows high)

• Tells you how much one variable moves per unit of another — unbounded, can be any number.

• Tax-neutral jurisdiction -> only investor-level taxation in respective jurisdiction

• Whether result is real or just due to random chance

• Whether effect of result is large enough to matter in practice

• Bond Yield - Risk-free Rate

1 - Recovery Rate

Credit Spread / Loss Given Default

• Fund’s Back Office

• Safekeep and monitor securities

• Trading Services Provider

• Hold and Safeguard assets

• Private, Customized Agreement between parties to buy / sell on a future date

• Standardized Agreement between parties to buy/sell on a future date on an exchange

• Model calculating expected return of asset based on risk relative to market

• Return only possible by market risk

Risk-free Rate + Market Risk Premium

Risk-Free Rate + Beta * (Exp. Market Return - Risk-Free Rate)

• Default statement of no effect which is tried to be rejected

• Suspected claim there is an effect -> accepted when null hypothesis is rejected

• False positive -> rejecting null when true

• False Negative -> failing to reject null when false

• Constant variance (spread/vol) across observations

• Changing variance (spread/vol) across observations

• Measure of an asset’s sensitivity to market movements

• 1 -> moves with market

• >1 -> amplifies the market

• <1 -> moves less than market

• 0 -> uncorrelated to market

• >0 -> moves opposite to market

• Fund’s market exposure slowly rising over time as fund gets bigger

• Fund’s beta increasing due to economic changes

• Fact that beta is not constant

• Beta rising / falling aligned to economic cycles

• Measure of how much an asset’s price or return move

• Distribution leans to one side with longer tail

• Distribution with thin tails and flatter peak

• Distribution with fat tails and sharper peak

• Measure of average spread of values around their mean

• Small SD -> values cluster tightly around mean

• HIgh SD -> values are widely spread (unpredictable)

• Loan to purchase RE, secured by that property as collateral

• Repaid over time with principal + interest

• Default -> lender foreclosures collateral

Interest Rate + Origination Fees (upfront charges paid to lender prior loan)

(Probability of realizing CF * Potential 1. Year CF) / Discount rate + rate of decline in CF

• Assets that support economic activity and revenue dependent on economy

• Assets that provide public / social services and revenue backed by government

• Reduced spending in infrastructure due to funding gap

• Private players enter infra investments

• Company that owns, operates, finances income-producing RE

• Public & Private REITs

• Distribute 90%+ of their income

• Office

• Retail

• Industrial

• Residential

• Property types outside of traditional sectors

• Purpose-built properties requiring specialized management

• Model stating that shape of forward curve is based on costs and benefits of storing the commodity

• Prices reflect spot price + cost of carry

Storage Costs + Financing Costs - Convenience Yield

• Benefit of physically holding a commodity

• Negative cost as it rewards holding in times of shortage

• Lender’s right to pursue a borrower’s assets that can be executed after default

• Acquisition and Holding of land at various stages of readiness with expectation that value rises once infrastructure expands

• Capital intensive set up but low operating costs with natural monopolies and high barriers to entry

  
  

• Agent makes decision in own interets rather than principals

• Timing risk in harvesting periods

• Risk of Recession

• Risk that Counterparty fails to meet obligations

• All investors hold the same risky market portfolio -> same % allocation

• Risk tolerance only changes the split between risky portfolio and risk-free assets

• Line that shows best risk-return combinations achievable by mixing risk-free assets with the market portfolio

• Fully-funded (upfront payment) bond whose payoff rides on a commodity's price - commodity exposure in a debt wrapper with no leverage

• Normalized NOI the property is expected to generate once stable conditions are reached

• Expected unlevered stabilized return on the cost of development

• Return rate at which comparable properties are valued

• Lower market cap relative to development yield -> more profitable

• NOI / Property Value

• Gap between development yield and the market cap rate

• Stabilized Annual NOI / Total Development Costs

• Market Cap > Development Yield = dont build

• Hard Costs -> physical goods

• Soft Costs -> non-physical costs

• Projected Stabilized NOI / Market Cap Rate

• Ratio showing how much of a development total cost is funded by loan

• Loan Amount / Total Development Cost

• Lenders cap LTC to limit risk

• Publicly traded company sells privately stocks to private investors at discount

• Include a lock up period before tradeable

• Private investor buys shares at fixed price -> number of shares and dilution is known upfront

• Structured: Investor buys shares at floating conversion price -> number of shares and dilution is unknown upfront

• Toxic: Stock price drops -> conversion price drops -> investors converts into more shares -> dilutes other shareholders who are selling -> stock price drops further = death spiral

• PIPE shares are sold below market value to entice investors to commit capital privately

• Privately placed common stock

• Registered common stock

• Convertible shares

• Equity Line of Credit

• Agreement between company and investor

• Formula-based quantity stock sell at intervals to investors

• Time

• Performance

• Violations of Covenants

• Predefined goals a startup must reach for the next round of funding

• Rules written into a loan / bond that that borrower must follow

• Positive (Affirmative) -> borrower must do

• Negative (Restrictive) -> borrower must not do

• Decline in IPOs

• Increasing number of public firms going private

• Buy / Sell of Non-core division and spinning it off as standalone business

• Buying distressed company and restructuring back to health

• Buying a company and boosting its operational efficiency

• Buying a platform company and making multiple add-on acquisitions

• Private Placement to transfer risk from issuer to lender

• No disaster -> Principal back + interest payment

• Disaster -> Partial or full principal lose

• High Yield and Uncorrelated Returns -> Great Diversifier

• Unsecured tradable security where investors lends money to issuer

• Lender receives fixed coupons and princiapl at maturity

• Many investors and traded on exchange

• Issued by Corporations and Governments

• Direct Lending Agreement -> lender gives borrower money

• Borrower pays floating rate + principal portion

• Not traded, secured, one issuer / investor

• Issued by companies

• Insurance against a borrower’s default

• Protection buyer pays fixed premiums and recevies lump sum in default

• Protection seller collects premiums and pays out in default

• Insurance transfers risk exposure from balance sheet

• Unfunded

• Lump sum payout

  
  

• Single, one-time payment

• Legal separation that insulates one vehicle from anther one -> both ways

• The credit risk of the CDO's tranches depends only on the underlying assets in the SPV — Not on the health of the sponsoring bank that created it

• CDO sits bankruptcy remote -> bank can go bankrupt and CDO remains unaffected

• Structured product of bonds, loans, other debt that pools together many debt assets and repackages them into tranches with different levels of risks and returns

• Senior

• Mezzanine

• Equity

• 1: Balance Sheet vs. Arbitrage

• 2: Cash-funded vs. Synthetic

• 3: Cash Flow vs. Market Value

• CDO with no real bonds / loans inside -> uses CDS to copy credit risk -> collects premium to pay its tranche investors and pays out if default occurs

• Similar to cash flow CDO but with derivatives

• Sponsor Bank -> offloading risk and pays premiums

• SPV -> sells protection and issues tranches

• Investors -> tranche holders and protection sellers with risk bearing

• Professional (good for industry + society)

• Misaligned (good for industry + bad for society)

• Unnecessary (bad for industry + good for society)

• Absent (bad for industry + society)

• Individual investment account owned by single investor but managed by professional manager

• Investor directly owns the underlying assets

• Offered through brokerage and managed by independent manager

• Direct ownership

• Tailored objectives

• Transparency

• No limited liability -> losses can exceed contribution

• Higher minimums

• More complex

  
  

• Highest NAV recorded on an incentive fee computation date

• Ensures manager only earn fees on new profits

• Traditional: No fee at all while under mark

• Modified: Reduced fee on profits while under mark -> removes perverse incentive for extreme risk & shut down

Incentive Rate * Max (NAV - HWM - Hurdle)

• Entity that takes other side of every exchange-traded futures trade

• Acting as counterparty to reduce counterparty risk

• Novation -> contract is with clearinghouse; not other side

• Margin Collection -> demands & pools collateral

• Daily settlement -> marks to market

• Guarantees every contract -> diversifies risk

• Futures have clearinghouse security -> no counterparty risk

• Forwards have no clearinghouse security -> full counterparty risk

• Collateral required position opening set by the exchange

• <10% of contract’s value

• Reduces counterparty risk by ensuring daily losses can be paid

• Minimum collateral required on ongoing basis until closing

• c. 75% of initial margin -> if collateral falls below -> Margin Call

• Demand for additional collateral -> restore initial margin level

• Triggered when collateral below maintenance margin (due to mark-to-market losses)

• Cash transferred each day between parties to settle mark-to-market gaisn / losses -> losers pay in, winners receive

• Daily process of revaluing open positions at current prices and settling day’s gains / losses via variation margin

• Margin call is issued

• If investor can’t meet -> futures commission merchance closes position at market price -> clearinghouse guarantees contract -> new counterparty steps in

• Broker holding client’s account

• Has rifght to liquidate investor’s position if margin call is not met

• Both are two threshold lines

• Initial margin is being posted at opening -> from there balance moves up / down

• Maintenance margin is bottom floor -> if balance drops below -> margin call

  
  

• For-cause removal of GP for wrongdoing

• Simple majority required and GP receives no compensation

• Investments shut down until new GP

• Without-Cause removal -> requiring 75%+ votes

• Framework for failing partnership

• GP may receive some compensation

• Lets LP suspend activities or terminate the fund

• If one / more person(s) quit, retire or don’t dedicate sufficient time

  
  

• Conditions are difficult to define and prove

• Rarely litigated due to process risk -> favors GP

• PE -> small, reputation world

• Removed GPs likely unable to raise further funds -> avoidance by agreeing to restructuring

• Provision specifying how/when an agreement can be ended -> such as bad- / or good-leaver clauses

• Provision allowing a party to end relationship for any reason without cause -> similar to good-leaver clause

• Institutions that buy / sell securities for their own portolios

• Example: HF, Pensions, Foundations

• Institutions that facilitate transactions and act as intermediaries

• Example: Banks, Advisors

• Deal-by-deal

• Fund-as-a-whole

• GP earns carry on each winning deal -> No fund netting

• GP receives earlier payment, higher payout, attracts talent

• LPs discourage it -> rarely seen

• GP earns carry on fund’s total return after LPs recovered capital

• Better GP/LP alignment, LP protection, discourages excessive risk & uses clawbacks

• Return Level LPs must receive before GPs earn any carry

• Every cash goes to LPs before threshold reached

• After hurdle is met -> GP receives large share of profits to catch up

• Earning carry on all profits -> not just above the hurdle

• Requires GP to return previously-paid carry to LPs if later losses exceed split

• Protects LPs -> associated with Fund-as-a-whole

• LPA provision specifying how distributions are split and prioritized between LP and GP -> details what must be achieved before GP profit taking

• Database disproportionately reflects managers who choose to report -> good performers opt to return -> inflates average return

• Losers don’t report voluntarily

• Selection bias of the manager choosing whether to be included in database

• Failed funds are dropped from the index -> disproportionately reflects surviving funds

• Inflates average returns by 2-5% p.a.

• When fund joins database -> prior performance is backfilled

• manager start reporting after good track record

• Pushes historical performance by c. 1-5% p.a.

• Dying funds stop reporting final (bad) performance -> misses large negative performance

• Inflates reported performance and flipside of participation bias

• Successful manager closes fund to new investors and stops reporting -> no need for capital -> returns drop out of database

• Distortion when fund changes its fee structure after success

• Fees are raised after good performance

• Reported returns don’t reflect performance / fee of new investor

• Proportion of Hedge Funds that drop out of database at a given fund age

• Highest dropout at 14 months old

• Tendency to over-rely on first piece of information (anchor) for decisions

• Tendency for one’s expectations to influence how information is interpreted -> skewing results to expectation

• Negative news about hedge funds cause economic losses

• Arising not from market impact but from association -> some investors don’t allocate for that

• Pattern in the market that shouldn’t exist in perfect efficiency

• Anomaly lets you earn higher risk-adjusted returns

• Investment strategies identifiable from publicly available information

• Price Momentum

• Prive Reversal / Mean Reversion

• Earnings Momentum

• Net Stock Issuance

• Accounting Accruals

• Insider Trading

• Anomaly test tests two things at once:

  • Market efficiency (is there an anomaly?)

  • Is the risk model correct (e.g., CAPM)

• Any found anomaly can just be a model misspecification

• Anomalies with reasoned explanation are more trustworthy than purely empirical ones

• Once discovered & traded -> anomaly tends to disappear (alpha decay)

• Valid anomaly explain who you earn excess return from and why they keep trading against you

• Price trend continues

• Securities that have done well keep doing well (losers lose)

• Price trend flips

• Prices that moved far from their average revert back

• Prices keep drifting (slow continuation) after initial jump in the surprise’s direction after earnings momentum

• Firms with strong earnings growth tend to keep outperforming

• Related: Earnings Surprise, Standardized Unexpected Earnings (SUE), Post-Earnings-Announcement Drift

• Firms issuing shares tend to underperform

• Firms buying back shares tend to outperform

• Management Market-Timing Signal Mechanism:

  • Issuance -> management thinks stock is overvalued

  • Buyback -> management thinks stock is undervalued

• Firms with high accruals (accounting entries, no cash) tend to underperform -> market corrects firm when cash doesn’t hit

• Accrual-heavy earnings are lower quality, less sustainable, and easy to manipulate

• Low accruas tend to out perform -> trustworthy as cash hits

• Legal insider trading -> insiders disclosed trades signal future performance

• Illegal insider trading -> recognized anomalies

  • Predictor -> insiders profit from undisclosed information

• Gap between target’s current price and the deal’s offer value

• Arbitrageur’s potential profit if deal closes

• Risk that an announced merger fails -> target price crashes

• Main risk in merger arbitrage

• Example: regulaltor block, shareholder rejection, failed financing

• Merger arbitrageur buys target at small discount to deal price due to completion risk

• Wants to collect the merger spread by bearing the risk until deal closes

• Like selling a put / insurance option

• Arbitrageur collects small steady spread (=premium) but suffers large loss if deal fails

• Short vol, negative skew, excess kurtosis

• Cash Deal

• Stock Deal (stock-for-stock)

• Acquirer pays cash for the target (no share swap)

• Arbitrageur just buays target at current discounted price and receives fixed offer price at closing

• No need to short acquirer -> acquirer stock price irrelevant as fixed payment and no swap

• Acquirer buysd target by swpping own shares for target shares

• Arbitrageur buys the target -> will receive acquirer shares when deal closes

• Short the acquirer to hedge any acquirer stock price volatility before deal closes

• Ratio tells you how many acquirer shares to short per target share

• Exchange ratio = hedge ratio

• Example: 50 acquirer shares for 100 target shares -> short 50 acquirer shares; deal closes you receive 50 acquirer shares which cancel out with 50 shorted shares -> locked-in merger spread

• Signed contract locking in merger terms

• Point at which deal becomes official

• Penalty one party pays if it walks away from the deal

• Can partly cushiosn the arbitrageur if deal collapses

• Third party enters merger with higher bid -> sparking bidding war

• Source of upside for arbitrageur as target’s price increases and the long position benefits

• Risk that regulators block merger on antitrust grounds -> deal recuces competition too much

• Major cause of deal failure -> deal announced but regulators refuse

• Risk that acquirer can’t secure funding needed -> cash deals