Evaluate Advanced Portfolio Strategies - Series 65

1. State the common scaling rule to target volatility using recent realized volatility.

   New weight $=\text{old weight}\times\frac{\sigma_{\text{target}}}{\sigma_{\text{realized}}}$. The rule scales positions inversely to realized volatility to align with the desired target.

2. What is financial leverage in portfolio management?

   Using borrowed funds or derivatives to amplify exposure and returns. Leverage magnifies gains and losses by increasing investment exposure beyond owned capital through borrowing or instruments like futures.

3. What is net exposure for a long-short portfolio?

   Net exposure $=\text{long}-\text{short}$. Net exposure reflects directional bias by subtracting short positions from long positions.

4. What is the expected daily return of a $-2\times$ inverse ETF if the index is up $1\%$?

   $-2\%$ (before fees and tracking error). Inverse leveraged ETFs aim for multiples of the negative index return on a daily basis.

5. What is the expected daily return of a $3\times$ leveraged ETF if the index is down $2\%$?

   $-6\%$ (before fees and tracking error). Leveraged ETFs target multiples of the index's daily performance, amplifying both gains and losses.

6. What is the formula for the Sharpe ratio?

   Sharpe $=\frac{R_p-R_f}{\sigma_p}$. Sharpe ratio evaluates risk-adjusted performance by excess return over risk-free rate divided by standard deviation.

7. What is volatility targeting in portfolio management?

   Adjusting exposure to maintain a specified portfolio volatility level. Volatility targeting dynamically reallocates to achieve a consistent risk level amid changing market conditions.

8. Identify the volatility measure typically used for options-based hedging costs.

   Implied volatility. Implied volatility from options prices reflects market expectations of future fluctuations, influencing hedge pricing.

9. What is the basic return relationship for a $2\times$ leveraged ETF before fees?

   Daily return target $\approx 2\times$ the index daily return. Leveraged ETFs aim to deliver multiples of the underlying index's performance on a daily basis.

10. What is volatility decay (compounding effect) in daily reset leveraged or inverse ETFs?

    Path-dependent return drag when volatility is high over multiple days. Compounding in daily resets causes returns to deviate from multiples over time, especially in volatile periods.

11. What is the key difference between inverse exposure via shorting and via an inverse ETF?

    Shorting has borrow/margin risk; inverse ETF is packaged daily reset exposure. Direct shorting involves ongoing costs and risks, while inverse ETFs offer convenient, reset-based bearish bets.

12. What is the maximum loss on a long position in a leveraged ETF?

    Limited to $100\%$ of the invested amount. Leveraged ETFs cannot lose more than the initial investment, as they do not involve borrowing beyond the fund's structure.

13. If $\sigma_{\text{target}}=10\%$ and $\sigma_{\text{realized}}=20\%$, what is the scaling factor?

    Scaling factor $=\frac{10\%}{20\%}=0.5$. The factor reduces exposure when realized volatility exceeds the target to maintain risk consistency.

14. What is the primary purpose of portfolio hedging with inverse or short exposure?

    Reduce systematic (market) risk and limit drawdowns. Hedging offsets broad market risks, protecting against large losses during downturns.

15. What is gross exposure for a long-short portfolio?

    Gross exposure $=|\text{long}|+|\text{short}|$. Gross exposure sums the absolute values of long and short positions to measure total market involvement.

16. What is the basic return relationship for a $-1\times$ inverse ETF before fees?

    Daily return target $\approx -1\times$ the index daily return. Inverse ETFs seek to provide the opposite daily performance of the benchmark index.

17. Calculate net exposure if long is $120\%$ and short is $40\%$ of NAV.

    Net exposure $=80\%$. Net exposure calculates directional market tilt by differing long and short percentages relative to NAV.

18. State the formula for beta of a portfolio relative to a benchmark.

    Portfolio $\beta=\frac{\text{Cov}(R_p,R_m)}{\text{Var}(R_m)}$. Beta measures systematic risk by the covariance of portfolio returns with the market divided by market variance.

19. What is margin call risk in leveraged accounts?

    Forced liquidation when equity falls below maintenance requirement. Margin calls occur to prevent excessive losses, requiring asset sales if account equity drops too low.

20. What is the formula for portfolio leverage ratio based on gross exposure?

    Leverage ratio $=\frac{\text{gross exposure}}{\text{net asset value}}$. This ratio quantifies leverage by comparing total position exposure to the portfolio's underlying asset value.

21. Identify the primary risk that leverage adds even if expected return is unchanged.

    Amplified volatility and higher probability of large drawdowns. Leverage scales up both upside and downside, intensifying fluctuations and the risk of significant value drops.

22. What is the maximum loss on a short sale of a stock or ETF?

    Potentially unlimited loss as price can rise without bound. Short positions face unlimited risk since asset prices can theoretically increase indefinitely.

23. What is the formula for maximum drawdown?

    Max drawdown $=\frac{\text{peak}-\text{trough}}{\text{peak}}$. Maximum drawdown quantifies the largest peak-to-trough decline to assess downside risk.

24. Calculate gross exposure if long is $120\%$ and short is $40\%$ of NAV.

    Gross exposure $=160\%$. Gross exposure aggregates absolute long and short positions to indicate total leverage used.

25. Which market condition most increases tracking error for daily reset leveraged ETFs?

    High volatility with frequent reversals (choppy markets). Choppy conditions amplify compounding effects, leading to greater divergence from expected long-term returns.

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