HEC, 2022-2023

Asset Management : Final exam

Total : 200 points

Questions : 70 points
Problems : 130 points

Instructions :

You can answer with pdf/word documents. You can also send me your excel file. With
regards to formulas, I would like to see the general formula (screenshot from the slides or
word equations) and its application using numbers ( screenshots from xls with “show
formulas” or excel files). You can upload your exam file to Blackboard or send it to
bertrand@hec.fr or jean-charles.bertrand@hsbc.fr The deadline is October 26th 12pm.

Questions (70 points) : Please give clear and concise answers

1. Which factors are going to have an impact on the participation rate of an OBPI
strategy ?
- Interest rates (high interest rates makes the option less expensive and thus
increases the gearing / volatility (low volatility implies lower price of the call
option and thus high participation rate / Time period (the longer the period the
higher the gearing because the amount devoted to buying the call increases with T
more rapidly than its cost) / dividend receipts (high dividends makes it possible to
buy more options)

2. What are the classic valuation indicators for bond markets? (Chap 4.4)
- Yield curve steepness= Long term rate – Short term rate
- Cleaner measure: Long-term rate – Consensus Forecast of average future short-
term rates
- According to Liquidity (Term or Risk) Premium theory, Long-Term rate =
Average expected short-term rates + Risk premia
- Real yield= Long term rate – Expected inflation (to anchor valuation to macro
economic fundamentals because there is a natural link between interest rates and
inflation)

3. Are Mean-Variance optimal portfolios so optimal ? (Chap 5.2)

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 - No because Estimation errors for the covariance matrix implies a large number of
parameters to estimate and the optimization process could lead to unreasonable
portfolios or instable optimal portfolios

4. Please explain how to replicate in a systematic way Buffet’s investment strategy

- Long term focus (seek the quality of assets and hold them for the long haul)
- Value investing: It’s far better to buy a wonderful company at a fair price than a
fair company at a wonderful price
- Quality over quantity: Buffett prefers a concentrated portfolio of high-quality
stocks
- Competitive advantage: Seek companies with a competitive edge that is difficult
for competitors to replicate
- Patience and emotional decisions: don’t panic during market downturns

5. What does Doing Good and Doing Well mean for investors ? Is it realistic ? (Chap 7)
- It means that investors aim to achieve both a positive impact on society or the
environment (doing good) and financial returns (doing well)
- Whether "Doing Good and Doing Well" is realistic for investors depends on
several factors:

6. Why is it difficult for smart investors to fully exploit the behavioural mistakes of other
investors? (Chap 3.1)
- Principal Agent problem / Horizon issue
- “The market can stay irrational longer than you can remain solvent”, Keynes

7. Why are fund rankings useless most of the time?

-

8. What are risk-based smart beta strategies?

- Risk-based smart beta strategies are designed to provide investors with a more
efficient and diversified way to achieve their investment goals
- Different strategies:
o Volatility and Minimum Variance: One of the most well-known risk-based
smart beta strategies is minimum volatility or low volatility. These
strategies aim to construct portfolios that exhibit lower volatility compared
to the broader market. The idea is to reduce downside risk while
maintaining competitive returns.
o Diversification: Risk-based smart beta strategies often incorporate
diversification across sectors and industries. Diversifying across different
types of risk factors can help mitigate concentration risk.
o Equal weights
o Risk parity: allocating assets based on their risk contributions rather than
market capitalization

9. Does Financial theory justify Passive Investing?

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Problem 1 (30 points) : Factor Models and Tracking-Error

On the basis of a two-factor model, consider a portfolio and its benchmark with the following
characteristics :

Factor 1 Sensitivity Factor 2 sensitivity Specific Risk

Portfolio 1.05 0.4 2%
Benchmark 1.02 0.1 1%

The standard deviation of the first factor is 15%. The standard deviation of the second factor
is 5%. The correlation between the two factors is equal to 20%. The specific risks are
uncorrelated with each other.

1.What are the standard deviations of the portfolio and the benchmark?

2. Can you calculate the tracking-error of the portfolio ?

Problem 2 (45 points) : Management of a CPPI guaranteed Fund

You are the portfolio manager of a CPPI fund indexed on S&P500. The Net Asset Value is
100 at inception. The fund has a 3-yr maturity and the 3-year interest rates is equal to 2%. The
objective of the fund is to deliver a minimum return of +0.5% per year.

1. Calculate the minimum value of the NAV at maturity. What is the value of the floor at
inception ? Calculate the value of the cushion

2. The stress test for S&P 500 is 20%. What is the value of the multiplier ? How much do you
invest in S&P 500 and in the risk free asset ?

3. S&P falls by 5% in one day. How should you rebalance the portfolio ? We make the
assumption that the floor value remains constant and that the risk free asset return is
negligible.

4. Is it realistic to assume that the floor value remains constant in a bearish equity market ?
What is the risk for the CPPI strategy ? How could it be hedged ?
.

Problem 3 (30 points) : Information Ratios and Sharpe Ratios

You want to invest in global bond markets. You have to define the benchmark and select a
fund manager.

1.You hesitate between a fully currency hedged or unhedged strategy. In order to take a
decision, you want to compare the historical risk/return characteristics of the hedged and
unhedged benchmarks :

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 Currency Hedged Benchmark Unhedged Benchmark
Annualised return 6.2% 7.5%
Annualised volatility 4% 8.9%
(standard deviation)
Risk-free rate : 4.2%

Calculate the Sharpe ratio of each benchmark. Do you want to hedge your portfolio or take
currency risk ?

We make the assumption that currency risk and interest rate risk are not correlated. Calculate
the volatility due to currency exposure.

2. You have to choose between Portfolio manager X and Portfolio Manager Y. Both
portfolios are managed against the benchmark defined in question 1. The historical
risk/return characteristics of X and Y have been the following :

Portfolio Manager X Portfolio Manager Y

Annualised return 6.6% 7%
Annualised Tracking-error 0.8% 2%

Calculate the Information ratio of X and Y. Which portfolio manager should be selected ?
What is the investment style of X and Y ?

Problem 4 (25 points) : Pimco 's Total Return Fund (source : Superstar investors, AQR)

The Pimco Total Return Fund (TRF) was arguably the best-known and until recently the
largest bond fund in the world. Bill Gross was at the helm of TRF since inception in 1987
until leaving PIMCO in 2014. The track record of the TRF earned Gross a reputation as the
Bond King. Though Gross wasn't the sole portfolio manager, many of his well-read
investment outlooks described what TRF did to try to outperform the broader bond market.

"On a somewhat technical basis, my firm's tendency to sell volatility and earned carry in a
number of forms-outright through options and futures, in the mortgage market and on the
curve via bullets and roll down as opposed to barbells with substandard carry- has been
rewarded over long periods of time". Bill Gross- Investment Outlook Apil 201

Average return Volatility Tracking-error

PIMCO total Return Fund 4.3% 4.1% 1.68%
Barclays US Aggregate 2.9% 3.6%
1-mth Treasury Bill +0.3%
January 1994-September 2014

1) Can you calculate the Sharpe ratio of the PIMCO TRF and the benchmark ? What is the
information ratio of the TRF ?

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To test if a systematic Gross strategy can explain the average returns of TRF, let's consider a
style analysis based on the following 4 factors :
- market : Barclays US aggregate Bond Index
- credit : US High Yield Index
-Low risk : duration neutral factor that is long 2 and 5-year Treasuries versus short 10 and 30-
year US bond futures
- Short volatility : selling call and put options delta hedged

Alpha Market Credit Low risk Short R2

(ann'l) volatility
Coefficien 0.3% 1.06 0.06 0.07 0.04 88%
t
T-stat 0.94 41.01 6.02 7.98 4.53

January 1994- September 2014

2) Please comment the results. What can explain the success of the TRF ?

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