Investment Process, Operations, and Risk

Question 1

1. Distinguish between a fund’s stated, actual and permitted investment strategies.

Answer 1

• The stated investment strategy of a fund is the investment strategy that a diligent investor would expect the fund to pursue, based on a reasonable analysis of information made available by the fund.
• The actual investment strategy of a fund at a particular point in time is the investment strategy being implemented by the fund.
• The permitted investment strategies of a fund delineate the range of investment strategies that the fund’s managers have communicated and are mandated as allowable for the fund to implement.

Question 2

2. What is style drift and what is another name for style drift?

Answer 2

• Style drift (or strategy drift) is the change through time of a fund’s investment strategy, based on purposeful decisions by the fund manager in an attempt to improve risk-adjusted performance in light of changing market conditions.

Question 3

3.What is the term that describes the explicit or implicit set of procedures through which investment decisions are made?

Answer 3

• The investment management governance process

Question 4

4. Contrast the broad and narrow interpretations of market risk in the context of the risk of the investment
   process.

Answer 4

• The broad interpretation of market risk in the context of the risk of the investment process describes any systematic or idiosyncratic dispersion in economic outcomes attributable to changes in market prices and rates. In contrast, the narrow interpretation of market risk is used synonymously with systematic risk to refer to the portion of an asset’s total risk that is attributable to changes in the value of the market portfolio or to a return factor that drives general market returns.

Question 5

5. Contrast the broad and narrow interpretations of operational risk.

Answer 5

• The broad interpretation includes any economic dispersion caused by investment, operational or business or activities. The narrow interpretation focuses only on the potential losses from the fund’s operational activities, such as the middle-office and back-office operations.

Question 6

6. Explain why or why not a rogue trader can be viewed as gaming the system.

Answer 6

• A rogue trader can viewed as gaming the system because a rogue trader intentionally establishes substantial positions well outside of the fund’s investment mandate to maintain or improve his or her career. That is, the rogue trader, by establishing positions well outside the fund’s investment mandate, strategically circumvents the intention of the rules of a particular system to gain benefits.

Question 7

7. List the three major components to controlling operational risk.

Answer 7

• Prevention
• Detection
• Mitigation.