QUESTIONS
1. ABCD Asset Management is going to pick a new benchmark for their investment-grade fixed income fund. The investment banking arm of ABCD’s parent company, ABCD Capital, publishes an investment-grade bond index which includes Treasuries, agency debt, and mortgages. Name at least two of the principles of a good index that ABCD Asset Management would violate if they chose ABCD Capital’s investment-grade bond index as their benchmark and give the reasons why those principles might be violated.
2.
a. Discuss the principles as they relate to creating a custom index using the Markowitz model of mean/variance optimization.
b. What do you see as the main issues as they relate to the principles?
3. Specify three different optimization criteria that can be used in scenario-based portfolio construction. Briefly describe the relationship between them, and their respective pros and cons.
4. ABCD asset management has a fund benchmarked against a USD fixed income index, which includes Treasuries, agency debt, TIPS, mortgages and investment-grade corporate bonds. Specify at least four constraints that can be used by ABCD when formulating a scenario-based optimal portfolio versus an index. Also describe briefly how the scenarios should be selected to avoid an implicit bias in positioning.
5. Discuss the interplay between the weighting (or probabilities) in a set of bearish/bullish scenarios, maxmin, and the constraints used in the optimization.
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