Brain Teasers  You have eight balls and a balance scale. One of the balls is heavier than the other 7. What is the lowest number of weighings on the scale that you need to do in order to determine which ball is heaviest?

Answer  Two Weigh 3 against 3. Either you have a set of 3 that is heavier than the other, or you know the heavier ball is in the remaining 2 From the remaining 3 or 2, weigh 1 against 1. Then you will determine the heavier ball.

Announcements  Upcoming Presentations: Technicals Alumni Mingle  MIT Trading Competition

Market Update: The Macro View 4

5 Quantitative Finance Society Portfolio Strategies & Asset Correlations

Investment Objective – Why?  Absolute Return Hedge Funds  Relative Return Mutual Funds, Asset Management  Retirement, Pensions, Insurance Asset-Liability Management 6

Absolute Return Strategies  Equity-Focused Value-investing Event-driven, Merger/Risk Arbitrage Long/short 130/30 Equity pairs trading 100/100 (market-neutral)  Fixed Income Distressed debt/high yield Convertible arbitrage Pricing arbitrage Value credit 7

Absolute Return Strategies  Global Macro FX, Government Rates Sovereign Debt (Credit & Rates) Emerging Markets Funds Commodity Funds (Physical & Futures) Index & ETF Relative-Value 8

Absolute Return Strategies  Quantitative Volatility, Derivative arbitrage Algorithmic, High-Frequency trading Statistical arbitrage Technical analysis, momentum-based 9

Relative Return Strategies  Mutual Funds & Asset Management  Most active managers underperform the market Invest in S&P 500 or other index Passive management, cheaper fees and lower transaction costs  Asset allocation decisions are more important than single-stock selection Risk-adjusted returns come from diversification 10

Relative Return Strategies  Portfolio Theory Fixed Allocation (long-term historical)  Long-term mean-variance optimization  Efficient markets Adaptive Allocation (short-term historical)  Markets change over time because of investor behavior  Use trailing returns, correlations and volatility data instead Tactical Allocation (historical + forward-looking)  Forecast the market and incorporate your view into the allocation  Market timing  Black-Litterman model 11

Asset Classes & Correlations  Equity (Domestic, Int’l)  Fixed Income (Domestic, Int’l)  Cash, FX, Money-market funds  Commodities Metals, Agriculturals, Energy, Softs  Real Estate 12

Asset Classes & Correlations 13

Asset-Liability Management  Retirement & Pension Funds Need to pay out fixed pension benefits or retirement benefits (annuities/perpetuities) Must invest in securities to match the payments  Insurance companies Receive fixed insurance payments forever, in exchange for low-probability high-payout Reinsurance to spread risk 14

Asset-Liability Management  Fixed-income portfolio immunization Duration-hedging Convexity-hedging 15

Questions? 16