65 terms

Financial Modeling

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Passive Debugging

If you happen to run a VB Function or Subroutine that contains either an incorrect VB statement or a logical error (such as dividing by zero), execution will be?
interrupted
Passive Debugging

If your
code includes a VB statement error the interruption of function execution will trigger?
the display of a message box announcing a Compile error
although error messages sometimes tells you exactly what the problem with your code is, all too often the "runtime error" signals that an error has indeed occurred but
the error described in the message is unrelated to the actual error that caused execution of your code to terminate.
The message box announcing that execution of your Function/Subroutine has terminated
offers you four options:
Continue, End, Debug and Help.
Clicking on the "Debug Option" puts you into "Break Mode", transferring you to the code window, where the line of code that caused the execution of your code to be interrupted will be highlighted in
yellow.
Active Debugging: The most difficult problem in creating VB Functions and Subroutines is that even though
your code may be executing and delivering a result, the Function/Subroutine may not be performing as you intended. Modifying VB code to perform as you intend is facilitated by using the VBA debugger to "step through" your program, executing the code in your function line by
line so that you can monitor the values assigned to the variable in your Function and checking on the branching through decision points such as IF/THEN/ELSE statements.
Note
To get the statement at which your Function is stopped (at the breakpoint) to execute, go to the Debug menu and select
"Step Over" (or hit [Shift]+[F8]).
VBA Code

Rng.Rows.Count
This gives the row count for the selection
As number of stocks in a portfolio increases, estimates of portfolio beta get more precise due to diversification of
- measurement errors
- changes in regression parameters for component stocks
The estimated betas for portfolios are better predictors of future betas than
the estimated betas for individual stocks.
CAPM predicts differences in Beta's predicts?
differences in return
Fama-French results imply that cross-sectional differences
in stock returns are explained by firm size and book-to market ratios, and possibly betas.
...
Active Portfolio Management refers to?
aggressive pursuit of superior returns through a combination of superior stock selection and market timing
Passive Management
constant exposure to systematic risk and expected return with a well diversified portfolio
Normal/Core Portfolio
Well-diversified portfolio held by a manager in the absence of "private information"
Active portfolio weights reflect?
The difference between a manager's actual portfolio weights and the weights for the Normal benchmark portfolio
Time Diversification refers to the proposition that?
the risk of an asset depends on the holding period of the investor
The key ideas of time diversification are that?
- the returns for an asset class are:

- independent and identically distributed
- constant expected yearly return and standard deviation
According to time diversification, the average yearly return _______ as the length of the investment horizon increases
decreases
What type of random numbers are those generated in excel?
pseudo-random numbers
Returns over longer periods of time are ____________ distributed
normally distributed
Bootstrapping
sampling randomly from historic/ actual distribution of prior returns
Bootstrapping

Continuously Compounded Returns are found by?
Add risk free return to market risk premium = Rm

Continuously compounded return = ln(1+.01*Rm)
Cholesky's matrix can be used to?
simulate multiple correlated standard normal variables
American options
can be exercised at any time until expiration
European options
can only be exercised at expiration
vertical/bull call option spread
long call option and short call option with same expiration. strike price of long call option must be less than strike price of short call option

(same for a put option)
Long Straddle
long call and put with same price and expiration

(short straddle is the same but you short rather than long)
Long Strangle Position
similar to a Long Straddle except the Call strike price is greater than the Put strike price
Binimoial Option Pricing Model provides the intuition of the Black-Scholes model and?
the flexibility to value american options and custom derivatives
Arbitrage by greedy traders causes option prices to satisfy certain "rational" properties so long as
1. underlying security can be sold short
2. commissions are relatively low
3. borrowing/ lending opportunities are adequate
Call options must be priced to prevent traders from earning
risk-free (arbitrage) profits by hedging risk of a call option
by trading in the stock and borrowing @ risk-free rate
Note
Implied volatility of a call option is the standard deviation for the yearly return on the stock underlying the call option that makes the model price (e.g., the Black-Scholes model price) for the option equal to the market price for the call option. This idea is the options-equivalent to a yield to maturity, which is the discount rate that makes the model price for a bond (the present value of the futures cash flows) equal to the market price of the bond.
...
What excel formula gives the number of unique number of moves in the stock prices that can occur over N moves in the stock price
Combin (N,R)
Combin (N,R) can also be denoted as?
N!/(R!*(N-R)!)
With an option VBA function

The number of jumps and time to expiration determines the?
fraction of a year between jumps
What is an Asian Option?
Asian options the payoff is determined by the average underlying price over some pre-set period of time.
What are BS Merton?
...
What are Monte Carlo?
...
What is a Barrier option?
It cannot be exercised if the option exceeds a certain price
Measurements for Interest Rate Sensitivity must be consistent with what properties?
- Bond prices vary inversely with yields
- If two bonds have the same coupon rate, the bond with the longer tome to maturity will have a greater percentage change in price for a given change in yields
- If two bonds have the same time to maturity, the bond with the lower coupon rate must have a greater percentage price change for a given change in yields
Common assumptions when measuring interest rate are
- bonds are not subject to default risk
- the term structure is flat
- changes in yields take the form of parallel shifts in the term structure of interest rates
Types of shifts in yield curves
- parallel shifts
- Twists
Duration
the elasticity of the bond price with respect to a change in one plus the periodic yield used to compute the present value of the cash flows
Duration is the weighted average of?
Duration is the weighted average of the time to maturity of a bond's cash flows
Excel's Yield and Duration Functions require what date form?
a date serial number as Date (yyyy,mm,dd)
A bond's duration is a _________ function of the coupon rate
decreasing
As a bond's coupon rate increases, the duration weights for the near term dates increase which has what impact on duration?
this reduces the duration of the bond
A bond's duration is a ______ function of yield to maturity
decreasing
The duration for a zero coupon bond equals?
time to maturity
The duration measure we have discussed is an exact measure of interest rate sensitivity so long as
1. Flat Term Structure - the yield for long-term bonds is equal to the yield for short-term bonds

2. Parallel Shifts in the Yield Curve - any change in interest rates takes the form of identical changes in yields for short and long maturity bonds
Objective of Immunization
Lock in holding period return by balancing price risk and reinvestment risk to create a position having zero net exposure to short-run changes in interest rates
A position is immunized if for any changes in interest rates
the new portfolio value compounded to the end of the investment horizon using the new set of yields is equal to a pre specified target terminal value
The most common technique use to immunize fixed income portfolios is?
duration matching
Common Approaches to Managing Interest Rate Risk
- Maturity matching

- cash flow matching

- duration matching
Maturity matching
Portfolio invested in bonds that mature at the end of the investment horizon. Fully eliminates price risk at the expense of reinvestment risk
Cash flow matching
portfolio closely matches cash inflows to amount and timing of liability stream funded by portfolio. This method requires purchase of bonds that may be unattractive apart from coupon rate/maturity
Duration matching
exploits offsetting nature of price risk and reinvestment risk so that funding of projected future liabilities unaffected by changes in interest rates
The end-of-horizon value for a fixed income portfolio
dedicated to funding either (1) a single payment liability or
(2) a stream of future liabilities at multiple dates can be
locked-in by setting the portfolio duration equal to either
- the length of the investment horizon
- the duration of the projected liability stream
higher coupon bonds have more convexity than
the PV for a single payment liability
Portfolio rebalancing is required due to changes in portfolio duration caused by?
- changes in interest rates

- Passage of time
as yields fall duration increases so that portfolio duration exceeds
length of the investment horizon
Duration drifts occurs because
duration declines less rapidly than the length of the investment horizon (passage of 1 year reduces bond duration by less than 1 year)
Bond portfolios with convex cash flows have greater exposure to
twists in the yield curve

(gives up yield if short rates fall by more than long rates)
If term structure is flat, the duration of a bond portfolio is
a simple weighted average of the durations for the
component bonds.