Hi Adam and Sachin,
I respectfully disagree with bopth of you. I do not want you to miss any point on Saturday.
You have typed as below and I am dsaying it is incorrect.
12. Wealth tax FVIF = ((1 + R) ( 1 + Tax))^n
Below if the basis of my disagreement with you:
Please refer to Volume 2, Reding 10, section 3.1.4 (Wealth-Based Taxes) in 2015 CFA Curriculum and look at equation 4. It is as below:
Equation (4)
FVIFw = [(1 + r)(1 – tw)]n
Hope this helps.
Good luck.
Harsh
Harsh is taking issue with the + sign in the tax portion of the equation. It should be 1 - T, not 1 + T
Following is a typo (I guess)
#77, point 2 is for full segmentation, not for full integration. point 1 is for full integration already.
I do not mean to pinpoint the typos but they are really critical at the last momement.
I really appreciate you taking the efforts to posting the full list on this forum.
Good Luck.
Yes I am, and that + or - makes a huge difference between gaining points and losing points.
Good note! But disagree with 146 c
Ahhh wow I was so tired I do didnt see that typo on my part I will fix thanks for the catch
I couldn’t agree more please keep searching for errors or things you disagree with I fixed this typo
146c I’m pretty sure is from a previous AM tests guided answer I will look for it in the text and get back to you with the quote
146c was one of the pros of MCS. I remember the lady’s name was Finnegan. She had no job and low tax rate, but expected her tax rate to increase when she got a new job. Using Monte Carlo would be able to account for the changes in tax rates. Not accounting for tax changes is a drawback of MVO, not Monte Carlo.
yes, that’s what i remember. It’s pros of MCS.
I agree with your comment I believe this point had to do with 3 drawbacks how MCS is typically used by practitioners and what you should do to fix it. I will find it in the cirriculum if it is still there otherwise I will remove
That is correct. On page 90 of Volume 6 of CFAI cirriculum under 3.2.1 Calendar Rebalancing the last 3 sentences: “On any given rebalancing date, the portfolio could be very close to or far away from optimal proportions. In the former case, the portfolio would be nearly optimal and the costs of rebalancing may swamp the benefits. In the latter case (being far away from optimal proportions), an investor might incur unnecessarily high costs in terms of market impact by rebalancing.”
I will change the con of 43 to be “high costs relative to the benefits”
Cheers.
I think the primary benefit is maintaining the investor’s desired exposure to systematic risk factors. Your statement is subject to illiquid portfolio.
351. 5 Steps in monetization
A. Identify objectives and constraints
B. Identify tools and strategies
C. Tax pros and cons
D. Non Tax pros and cons
E. Formulate strategy
352. If tax rate at contribution = tax rate at withdrawal then TDA will have same benefits as TEA
UNLESS you are maxing out, then TEA is superior
353. Tax efficient management does not require a passive approach. You can be tax efficient and be active if you tax loss harvest.
If tax rates are lower in the future harvest now
if tax rates are higher in the future its better to harvest later
354. Disintermediation Risk - when rates rise consumers can access the cash value of their policies by surrendering or borrowing against with motivation of investing in higher rates.
This reduces the liability duration, and thus the asset duration and thus changes the time horizon. It also changes the liquidity risk as there may be a need to liquidate assets to payout surrender cash.
This is a feature of Whole Life (however a past exam also included fixed annuities as having disintermediation risk). I would advise interpreting this as: if its a fixed rate policy of any kind that is locked in for a period of 3 or more years it is most likely subject to disintermediation risk unless otherwise stated that it can’t be surrendered
Term Life, Variable/Universal Life is the industry response to reduce disintermediation risk
355. Quasi Endowment / Funds Functioning as Endowment (FFE)
Endowment funds are typically meant to be preserved in perpetuity and are typically restricted in their indenture on what they can be spent on. If the Market Value of the endowment is less than the book value you cannot spend it. An endowment will typically be single stage and perpetual. Endowments are subject to UFIMA and any conflicts of interest should be mentioned in the legal section. They are nontaxable unless they are benefiting one individual person (conflict of interest). Smoothing rules will increase their risk tolerance as they can bear more volatility. A small reliance on the endowment increases risk ability. If the endowment. The perpetual nature increases risk ability. The low liquidity needs increase risk ability
Quasi endowments/Funds functioning as endowment however are not true endowments , typically have no restrictions and can be spend if market value is less than the book value. They are generally related to construction projects and should be mentioned in the liquidity section. They can make the time horizon multi-stage if there is a construction project related to them
356. Geometric Smoothing Rule
Spend = Smooth Rate * Last Years Inflation Adjusted Spend + (1 - Smooth Rate) * (Spend Rate * Last year begin market value)
Last years begin market value used for ease of budgeting
357. Rules for Defined Contribution Plans (ERISA)
A. Provide Menu of at least 3 diversified choices and allow free flow between choices
B. Written IPS which documents compliance with fiduciary standards, adequate invest option selection process. IPS is a governing set of principals not an individual IPS.
C. Provide educational resources to assist participants in selecting their own investment objectives and constraints
*There are no limits on employer stock in DC plan only a defined benefit plan (which is 10%)
*Particpants bear investment risk, employer contributions more stable
*Portability of plan and no risk if employer goes bankrupt and participants can choose their investments based upon what works best for them
358. Cash Balance Plan = Defined Benefit Plan
only difference is that this used to introduce the concept of investment risk but the accounts value is purely hypothetical
359. High board turnover causing short term focus should be put in unique section of foundation Also if a foundation/endowment has a small amount of trained staff this will probably exempt them from using complicated investments such as alternatives. Also remember that minimums on private are typically 5M and you need 5 to be diversified. Thus you need a minimum 25M investment in private equity. If the endowment is only 50M this will be innappropriate due to huge illiquidity from alt. Good rule of thumb is endowment/foundation needs to be at least 250M in size if not 500M.
360. Independent foundation - 5% in excess of expenses - Family/Individual
Company Sponsor - 5% in excess of expenses - Corp Sponsor - tied to company
Operating - 3.33% or 85% of income in excess of expenses - Family/Individual - Has board of Dir and is used to fund research/organization
Community - no spend requirement - General Public funds - fund social/education/religions and has board of dir.
I believe you need an adjustment here
Representative
Illusion of control
Cognitive
Hindsight
Confirmation
Cognitive should be changed to Conservatism
Great job with these notes! Thank you1
Fixed the RICHC Mneomnic. Thanks for the catch!
Hi harsh I did not realize that. You are right. I should have looked carefully. Thanks.
361. Underwriting cycle - most pronounced for nonlife (aka causality) where competition causes desire for higher returns. Portfolios take on more risk and acheive higher returns which leads to cutting of premiums to better compete. These cuts to premium usually make the premiums income insufficent to pay for claims which causes reliance on port liquidations to satisfy claims. Non-Life are taxable investors and they switch between nontaxable and taxable bonds depending upon where they are in the profitability (underwriting) cycle. Growth of surplus is important to maintain competitve stance. It’s also extremely important for liquidity due to shift of tax to nontax bonds and due to liquidiations of port to satisfy claims.
Generally they maintain a T-Bill reserve, are more subject to inflation risk than life insurance as they insure replacement value. They have uncertain timing and uncertain cash flow size wheras life insurance just has uncertain timing. They can have geographic concentrations which should be noted in unique and rely heavily on income generated by port. “Long Tail” describes the payoff to claimants which typically takes years. Portion of income relating to actuarial assumed rate to meet claims is generally not taxed. Generally short term liabilities They are heavily regulated but not as much as life insurance.
362. Prepaid variable forward is a collar + a loan in one security. It is not considered a sale for tax purposes and is exempt from US margin rules
363. Joint Ownership, Rights of survivorship, trusts, retirement plans and life insurance all avoid probate.
364. Secular Changes in Bonds - there are less put/call features and less long term bonds (so these both command premiums in market). Aggregate duration has decreased (due to less long term bonds). Increased use of credit based derivatives and more non-government international bonds. Interm term bullets most popular.
365. Long term bullets have most convexity. Sinking funds are a series of partial calls which are more convex than a puttable/callable bond when rates rise and have more upside if rates fall IF PURCHASED AT A DISCOUNT
366. As maturity increases credit risk exponentially increases
367. Structure Trade Motivations - From viewpoint of a bond buyer:
Puts do well for high volatility and rising/flat rates
Calls do well for low volatility and rising/flat rates
Bullets are best for falling rates
3 68. Motivation for trading on the run is liquidity. Curve adjustment is curve position/duration
369. More issuance actually tightens spreads as it provides price confirmation and decreases price uncertainty.
370. OAS is used to assess relative value across MBS/Callable/bullet. Its main weakness is that it excludes default risk when valuing the option and thus can’t be used for high yield or emerging market debt
Less option adjusted issuance has diminished use. Another con is that it does not account for the volatility of credit spreads. For example a 1 year corp bond with an OAS of 100 does not have the same credit risk as a 10 year bond with an OAS of 100 due to higher volatility of spreads the longer the maturity is.
371. Credit Default Swap spreads are used for high yield and emerging debt
372. Interest rate swap spreads are not used for high yield/emerging debt.
They require homogenity (aka vanilla bullet)
Used mainly in europe
allow comparison of fixed with float debt
another benefit is not based on treasury rates
373. Liquidity premium constantly varies but is decreasing over the long term
374. Repo is legally a sale and repurchase wheras prepaid variable forward is not a sale. Bank custody is a cheap alternative to physically deliverying a repo collateral.
375. Pure indexing is rarely implemented for bonds due to the difficulty and cost of replicating the index due to large number of bonds, illiquidity of some bonds, limited issuance of some bonds, heterogenous nature of bonds, and constantly changing composition of the index
376. Bums Problem - Is related to fixed income indexes that are weighted based upon issuance size. The bums who borrow the most have the highest weight which increases the credit risk of the index. Equal weighting can reduce this problem but then you have the issue of more illiquidity in the index. There are liquid versions of indexes that should be used as benchmarks as most bond indexes are not investable.
377. Income/Reinvestment Risk = Decreases if rates rise
Market Risk = Duration Risk = Interest Rate Risk = can eliminate by matching duration and convexity (easier to match convexity by matching bond sectors such as MBS and % in callable debt)
Issuer Exposure = Event Risk —as a result of default/downgrade
Contingent Claim/prepay risk = from callable/MBS debt
Yield curve risk —Match key rate duration
Spread Risk ----match port spread duration
378. Shifts in the LEVEL of interest rates represent 90% of the changes in the yield curve
379. Compare what credit spreads are baked into the price using arbitrage agreements and forward rates of corporates with forecast
380. 3 inputs for total return analysis
A. Investment horizon
B. Expected reinvestment rate
C. Change in price given interest rate forecast