66 - Module 10: Portfolio Management Quiz

All of the following are associated with passive portfolio management, except: A. Efficient market theory B. Random walk theory C. Index investing D. Market timing

: D. Market timing Market timing. Market timing is used in active portfolio management, as the approach involves frequent purchases and sales (with a high portfolio turnover) compared to the buy and hold strategy of passive management. [Module 10, Portfolio Management Module, Section 2.1 & 2.2]

As an investment adviser, you have a client who is seeking to invest funds based on the value of certain securities. Of the following, which two investment measurements would you seek to determine the security with the most value? I. Low price/earnings ratio II. High price/earnings ratio III. Low price/book ratio IV. High price/book ratio A. I and III B. I and IV C. II and III D. II and IV

A. I and III Low price/earnings and low price/book ratios. Value investors are looking for under priced stock. The lower a company's price/earnings and price/book ratios are, the more unrecognized value the company will have. [Module 10, Portfolio Management Module, Section 2.4]

Which of the following describes an investment strategy that spreads the risk among varying classes of securities or among different issues of the same class? A. Aggressive strategy B. Diversification strategy C. Concentration strategy D. Passive strategy

B. Diversification strategy Diversification strategy. While spreading the risk of a downturn in one class of investments or a particular issue of the same class, this strategy also limits the potential return of a single class or issue. The opposite of diversification is concentration, wherein assets are funneled into a single class or issue, hoping that one position will pay off big. So, while diversification is relatively "passive" compared to a concentrated approach, it is also somewhat safer from a risk/reward point of view. [Module 10, Portfolio Management Module, Section 1.0]

If you take the market price of a security and multiply it by the number of outstanding shares, what is the resulting number called? A. Market share B. Market capitalization C. Market value D. Market breadth

B. Market capitalization Market capitalization. This is the definition of market capitalization - the market price times the number of outstanding shares of stock. Market value is the value that the shares will sell for to other investors. Market breadth is the percentage of stocks that have increased compared to the percentage of stocks that have decreased in a certain period (such as a day, a week, or a month). The statistical basis for market breadth is the advance-decline ratio. Market share is the percentage of sales in a particular industry by a given company. For example, Dell Computer has a 40% market share, meaning that 40% of the computers being sold are Dell computers. [Module 10, Portfolio Management Module, Section 3.0]

A new company, ABC, Inc., had its initial public offering (IPO) and sold 20 million shares at a price of $32.50 per share. As far as market capitalization is concerned, what size company is ABC, Inc.? A. Micro cap B. Small cap C. Mid cap D. Large cap

B. Small cap Small cap. The formula for market capitalization is the number of shares multiplied by the market price. So, 20,000,000 times $32.50 per share equals $650,000,000. According to the Standard & Poor's criteria for market capitalization, ABC, Inc., is a small cap company because its market capitalization of $650,000,000 places it in the $250,000,000 to $1 billion range. Micro cap would be up to a max of $250,000,000; mid cap is $1 billion to $5 billion, and large cap is over $5 billion. Market capitalization is often used as one of the criteria for index fund investing. [Module 10, Portfolio Management Module, Section 3.0]

Which of the following best describes tactical allocation? A. The allocation of funds in a portfolio into asset classes according to a fixed percentage and rebalance the portfolio as one or another of the asset classes exceeds or is less than the set percentage B. The allocation of funds in a portfolio into asset classes according to a set percentage and then change the percentage as market conditions change C. The allocation of funds in a portfolio into one asset class according to the market and then changing the asset class as the market changes D. The allocation of a minimum amount of funds in a portfolio into safe investments and then adding more risk as the value of the portfolio increases above the minimum value

B. The allocation of funds in a portfolio into asset classes according to a set percentage and then change the percentage as market conditions change The allocation of funds in a portfolio into asset classes according to a set percentage and then change the percentage as market conditions change. If there were a rebalancing of the assets to maintain the percentage, then this would be strategic allocation. Having the minimum in safe funds and only investing when this minimum is above a certain amount is insured allocation. [Module 10, Portfolio Management Module, Sections 1.2, 1.3, & 1.4]

Which of the following theories is part of the passive management of a portfolio? A. The diversification theory B. The random walk theory C. The rebalance theory D. The market timing theory

B. The random walk theory The random walk theory. The random walk theory assumes that market prices follow a random path up and down, and that it is impossible to predict the market's future movements by looking at past performance. The diversification theory is a defensive strategy. The rebalance theory is a strategic asset form of asset allocation. The market timing theory is a tactical asset form of asset allocation investing. [Module 10, Portfolio Management Module, Section 2.1]

Dollar cost averaging is an investment funding technique used to minimize which of the following? A. Market risk B. Timing risk C. Opportunity risk D. Exchange-rate risk

B. Timing risk Timing risk. Dollar cost averaging involves investing a fixed dollar amount into a specific investment on a regular basis over a long period of time. During periods of price decline, the amount invested allows more shares to be purchased, lowering the average cost per share. This creates a lower price at which the investor will break even and be profitable as the price rebounds. Investing this way on a periodic basis, such as monthly, minimizes timing risk. [Module 10, Portfolio Management, Section 4.0]

A company has been trading in the secondary market for over 10 years. They currently have 20,000,000 shares outstanding and the stock price is $20. A $5.00 stock dividend has been announced and will be paid out in six months. What is the company's market capitalization? A. $300 million B. $350 million C. $400 million D. $500 million

C. $400 million $400 million. To calculate market capitalization, you need to multiply the number of outstanding shares by the stock price (in this case, 20 million x $20 = $400 million). Do not get fooled by the upcoming dividend. The current market cap is based on the current stock price. [Module 10, Portfolio Management Module, Section 3.0]

Which of the following strategies best describes active management? A. Look for undervalued or overlooked securities, with the expectation of longer hold periods B. Look at companies whose sales, earnings, or market share is rising faster than other companies in the same industry C. Assume that the market is not always efficient, that market prices are not random, and that it is possible to forecast market direction and take advantage of this forecast D. Buy at reasonable prices and hold securities for the long term

C. Assume that the market is not always efficient, that market prices are not random, and that it is possible to forecast market direction and take advantage of this forecast Assume that the market is not always efficient, that market prices are not random, and that it is possible to forecast market direction and take advantage of this forecast. Advocates of this strategy believe that by using fundamentals and market timing, it is possible to purchase undervalued securities and forecast when to sell them. [Module 10, Portfolio Management Module, Section 2.2]

A shareholder decides to automatically put his cash dividends into more shares of the same company's stock. What is this type of program called? A. Constant dollar investing B. Lump-sum investing C. Dividend reinvestment D. Dollar cost averaging

C. Dividend reinvestment Dividend reinvestment. You may also see this abbreviated as DRIP. Most companies that pay cash dividends have instituted such programs. Generally, it is a good deal for the shareholder because as dividends are paid, they are automatically reinvested in additional shares of the company's stock with no commission or sales charges. So, for each quarter in which a dividend is paid, the shareholder's stake in the company grows by the amount of the dividend. Constant dollar investing is when a client picks a certain dollar amount for a minimum asset level and maintains that level through liquidation or more deposits. Lump-sum investing is the immediate investment of a client's funds into assets without really paying attention to market timing. Dollar cost averaging is a strategy that involves investing a fixed sum on a regular basis, without regard for price. Thus, more of a given investment will be purchased when the price is low, and less when the price is higher, thus reducing the impact of market risk. [Module 10, Portfolio Management Module, Section 4.0]

Which of the following is not a characteristic of index investing? A. Diversification B. Lower taxes C. Higher transaction fees D. Lower costs

C. Higher transaction fees Correct answer (false statement): Higher transaction fees. Just the opposite is true; transaction fees are lower with index investing. The investor makes one transaction to purchase shares of an index fund instead of buying shares in several individual companies that make up the fund. The other choices are all advantages of index investing. [Module 10, Portfolio Management Module, Section 2

There are numerous methods of investing. One of these methods is called the "buy and hold" method. Which two of the following are advantages of the "buy and hold" method of investing? I. There are lower transaction and commission costs II. This method allows for better buys due to finding securities that are undervalued and then investing in them III. This strategy takes advantages of the market movement IV. There is a lower tax result each year A. I and II B. III and IV C. I and IV D. II and III

C. I and IV I and IV. Costs for transactions and commissions are lower because there is less buying and selling. In addition, since the securities are held for long periods, there will be no tax consequence until the securities are sold. Active management can benefit from market movements in that they can take advantage of undervalued securities. With active management, the account has ready money available to take advantage of good buys, whereas the buy and hold positions will try to find good values over the long-term life of the account. This theory holds that over the long haul, the stocks will rise. [Module 10, Portfolio Management Module, Sections 2.1 & 2.2]

Which two of the following are the major advantages of a passive management approach? I. Diversification II. Lower capital gains taxes III. Lower transaction costs IV. Dollar cost averaging A. I and IV B. I and II C. II and III D. III and IV

C. II and III II and III. Lower capital gains taxes and transaction costs. While diversification and dollar cost averaging are possible with a passive management approach to investing, they are not specifically major advantages. Lower capital gains taxes and lower transaction/commission costs are. With the buy-and-hold strategy of the passive approach, an investor makes purchases and hopes that by holding the positions for a long period of time, the natural growth in the overall market will provide sufficient returns on his investment. [Module 10, Portfolio Management Module, Section 2.1]

An investment adviser suggests to a client that her funds be invested based on fixed percentages for each asset class. As an asset class increases or decreases in market value due to market movement, the adviser suggests that the assets be rebalanced to reflect the previously determined percentage. What is this portfolio management strategy called? A. Tactical asset allocation B. Insured asset allocation C. Strategic asset allocation D. Market timing asset allocation

C. Strategic asset allocation Strategic asset allocation. In strategic asset allocation, funds are divided among a liquid class, (money market funds and/or T-bills), long-term growth class, (stocks), and long-term income class (bonds). As one class outperforms the others, more funds are placed in the other two classes, or positions are reduced in the over-performing class and placed in the under-performing classes to rebalance the portfolio back to its original allocation. Tactical asset allocation involves changing the proportions of allocations among the classes as market conditions change - a kind of market timing. Insured asset allocation involves determining a base value for the whole portfolio and shifting the assets between investment classes to maintain the base value. Market timing asset allocation is another term for tactical asset allocation. [Module 10, Portfolio Management Module, Section 1.2]

Major swing trading is a form of which of the following? A. Constant dollar investing B. Strategic asset allocation C. Tactical asset allocation D. Insured asset allocation

C. Tactical asset allocation Tactical asset allocation. Major swing trading is a form of tactical asset allocation. It involves buying stocks during bear market declines and selling during bull market rises. The risk is buying too late and selling too soon when compared to a buy and hold strategy. [Module 10, Portfolio Management Module, Section 1.3]

An investor regularly deposits fixed sums of money into specific investments, regardless of the market price at the time the deposits are made. What is this strategy called? A. Lump-sum Investing B. Dividend reinvestment C. Value investing D. Dollar cost averaging

D. Dollar cost averaging Dollar cost averaging. Dollar cost averaging requires investors to make deposits on a regular basis without regard for market trends or timing. More shares are purchased when prices are low; fewer when prices are high. This tends to lower the per-share cost of the investment. Lump-sum investing places all of a client's funds into the market at once. This involves market timing risk. Dividend reinvestment converts cash dividends paid on a stock into more shares of the same stock; thus, the client acquires an increased stake in the issuing company without the transaction costs. Value investing seeks securities that are undervalued when compared with other securities in the same industry. [Module 10, Portfolio Management Module, Section 4.0]

A stock trading in the S&P 500 would most likely be: A. Micro Cap B. Small Cap C. Mid Cap D. Large Cap

D. Large Cap Large Cap. The stocks that compose the S&P 500 are primarily large cap companies that have a market capitalization of over $5 billion. [Module 10, Portfolio Management Module, Section 3.0]

Which of the following would be considered strategic asset allocation investing? A. Changing assets as the market changes B. Maintaining a minimum balance for the portfolio and becoming aggressive as the value goes up C. Making major swing trading in the investments for market fluctuations D. Rebalancing the assets as the market fluctuates

D. Rebalancing the assets as the market fluctuates Rebalancing the assets as the market fluctuates. Strategic asset allocation is the setting of percentages in each of the asset classes and then rebalancing as the percentages change. Changing the assets and major swing trading are typical of tactical, or active, asset management. The minimum balance is for insured asset allocation. [Module 10, Portfolio Management Module, Section 1.2]

A value investor will look for which two of the following when researching a possible investment? I. High dividend payout ratios II. Low dividend payout ratios III. High P/E ratios IV. Low P/E ratios A. I and III B. I and IV C. II and III D. II and IV

The correct answer is: B. I and IV I and IV. Value investors will always look for high dividend payout ratios, low price/earnings ratios, and low price/book ratios. [Module 10, Portfolio Management Module, Section 2.4]