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CFA Level III Updated
How does the Brinson-Fachler holdings-based attribution model decompose active return into allocation and selection effects?
The Brinson-Fachler model decomposes active return into allocation effect (sector over/underweighting), selection effect (stock picking within sectors), and interaction effect. This reveals whether a manager adds value primarily through top-down sector bets or bottom-up security selection.
What is returns-based style analysis, and how does Sharpe's RBSA method identify a fund's effective style exposures?
Returns-based style analysis uses constrained regression of fund returns on style benchmarks to estimate effective asset class exposures without needing holdings data. The weights must be non-negative and sum to one, revealing a fund's true style mix and potential style drift.
How does the Brinson performance attribution model decompose portfolio returns into allocation, selection, and interaction effects?
The Brinson-Hood-Beebower model decomposes active return into allocation effect (sector weighting decisions), selection effect (security picking within sectors), and interaction effect (the combined impact of overweighting sectors where stock picks also outperformed).
What are the main credit strategies in fixed income portfolio management?
Credit strategies in fixed income include credit spread duration positioning, sector rotation, security selection, credit curve strategies, and relative value trades. Each aims to generate alpha from different aspects of credit risk and spread dynamics.
What are crisis alpha funds and how do they differ from other hedge funds?
Crisis alpha = returns during market stress. Funds: CTAs, tail risk, short-bias, macro. Costs carry in bull markets, pays in crashes.
What is the proper compliance framework for an investment firm under the CFA Institute Code and Standards?
An effective compliance program covers three pillars: prevention (policies, training, pre-clearance, information barriers), detection (surveillance, reporting channels, audits), and enforcement (investigation, sanctions, regulatory reporting). The CFA exam tests both the framework design and its application to specific violations.
What are the recommended (but not required) practices under GIPS?
GIPS recommendations include independent verification, composite examination, daily valuation, additional risk measures, and supplemental analytics — optional but highly credibility-enhancing.
What calculation methods does GIPS require?
GIPS requires time-weighted returns when client controls flows, money-weighted returns when manager does, asset-weighted composites, and monthly valuation with trade-date accounting.
Can someone explain the Grinold–Kroner model step by step with numbers?
The Grinold–Kroner model breaks the expected return on equity into three intuitive building blocks: income return, earnings growth return, and repricing return. Here's a step-by-step numerical walkthrough.
What is Direct Alpha and how does it differ from PME?
Direct Alpha is annualized excess return of a PE fund vs benchmark, computed as IRR of benchmark-adjusted cash flows. More interpretable than KS-PME's multiple format...
How do I measure security selection alpha within a fixed income sector?
Selection alpha = weight x (portfolio sector return - bench sector return). Meridian's 70bps within BBB contributes 12.6bps to total active return (at 18% weight). Single-period not conclusive; requires IR > 0.5 over 3+ years for skill evidence.
How does prospect theory change optimal portfolio allocation compared to expected utility theory?
Prospect theory portfolio optimization uses loss aversion and probability weighting instead of expected utility, producing portfolios with lower equity allocations than mean-variance optimization due to disproportionate pain from losses, but with small speculative positions driven by overweighting of extreme gain probabilities.
How do you construct a custom fixed-income benchmark by blending standard indices?
Custom fixed-income benchmarks are built by blending standard sub-indices in proportions that match the mandate's target duration, credit quality, and sector exposures. The process requires solving for blend weights, defining rebalancing rules, and documenting the methodology in the IPS.
How do fixed income portfolio managers implement duration timing bets, and what are the risks of getting the rate call wrong?
Duration timing generates alpha by deviating from benchmark duration based on rate forecasts. Expected alpha equals the duration deviation times the yield change, but rate forecasting is notoriously unreliable and the strategy typically produces modest risk-adjusted returns.
How does an Intentionally Defective Grantor Trust (IDGT) freeze estate value while allowing tax-free asset growth for beneficiaries?
An IDGT is 'defective' for income tax purposes (grantor pays trust's taxes) but separate for estate tax purposes (assets excluded from estate). The grantor sells appreciating assets to the IDGT for an installment note, and because it's a grantor trust, the sale triggers no capital gains tax.
How does the framing effect alter an investor's risk tolerance based purely on how information is presented?
The framing effect shows that identical investment information presented differently — as gains vs. losses, annual vs. cumulative returns — can shift an investor's equity allocation by 20-40 percentage points. Ethical advisors present multiple frames to elicit stable risk preferences.
What are the main endowment spending rules, and how do they balance stability of spending with capital preservation?
Endowment spending rules trade off spending stability against capital preservation. The simple rate has high spending volatility but preserves capital well. Rolling averages and geometric smoothing progressively reduce volatility. The Yale hybrid rule (inflation-adjusted prior blended with market-based current) provides the smoothest spending while maintaining inflation protection.
How does multi-factor regression analysis identify a fund's factor exposures, and how does this affect alpha interpretation?
Multi-factor regression decomposes fund returns into systematic factor loadings (market, size, value, momentum) plus residual alpha. Much of what appears as CAPM alpha often shrinks dramatically when factor exposures are accounted for, revealing that perceived skill was actually cheaply replicable factor tilts.
What are the unique risks and opportunities in emerging market debt?
Emerging market debt offers higher yields but carries unique risks including sovereign default, currency depreciation, political instability, liquidity constraints, and contagion. Portfolio managers must choose between hard and local currency exposure based on risk budget and return objectives.
How do trend-following managed futures generate 'crisis alpha'?
Trend-following takes long/short futures across asset classes based on momentum. Generates crisis alpha during sustained bear markets. 5-15% typical allocation.
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