Chapter 16

A contrarian investment strategy is based on the belief that a. Stock returns are mean reverting. b. The best time to buy is when other investors are bullish. c. Rising stocks will continue to rise. d. Passive management is preferred to active management. e. A long/short portfolio will outperform a long only portfolio.

A

A fundamental tenet of the contrarian investment strategy is the notion that a. All stock returns are mean reverting. b. Certain stocks outperform others during different stages of the business cycle. c. Value stock investing is superior to growth stock investing. d. Growth stock investing is superior to value stock investing. e. None of the above.

A

The asset allocation strategy that separately examines capital market conditions and the investor's objectives and constraints is called a. Integrated asset allocation. b. Tactical asset allocation. c. Sector rotation. d. Strategic asset allocation. e. Insured asset allocation.

A

An active portfolio manager sold $90 million of stocks in a year. If the portfolio had an average value of $110 million in assets under management what is the portfolio turnover ratio? a. 22.2% b. 81.8% c. 90.0% d. 110.0% e. 122.2%

ANS: B Portfolio Turnover = (Dollar value of securities sold)/(Average dollar value of assets managed) = $90 million/$110 million = 81.8%

Fund XYZ had a pretax return of 10.2% and a tax-adjusted return of 9.5%. Calculate Fund XYZ's tax cost ratio. a. 0.006 b. 0.106 c. 0.116 d. 0.342 e. 0.635

ANS: E Tax Cost Ratio = [1 {(1 + 0.095)/(1 + 0.102)}](100) = [1 0.99365](100) = 0.635

The goal of the passive portfolio manager is to minimize a. Alpha b. Beta c. Standard error d. Tracking error e. Portfolio risk

D

Which of the following statements regarding 130/30 strategies is false? a. Analyst can make full use of their knowledge of undervalued and overvalued stocks. b. Long positions up to 130% of the value of the portfolio cab be made. c. Short positions up to 30% of the value of the portfolio can be made. d. 130/30 strategies are not very popular due to the increased risk of hedging. e. The use of short positions creates leverage.

D

The following are ways to implement index portfolio investing a. Buying shares in index mutual funds b. Buying hedge funds. c. Buying exchange traded funds d. a and b. e. a and c.

E

The goal of a passive portfolio is to track the index as closely as possible.

True

Tracking error is defined as the degree to which the portfolio's returns deviate from those of the actual index.

True

A portfolio manager who is trying to generate alpha could use a. Hedge funds b. Mutual funds c. Insured asset allocation d. ETFs e. None of the above

A

Which of the following statements about investment style is false? a. Growth stocks generally have smaller capitalizations than value stocks. b. Value stocks have P/E and P/B ratios significantly lower than those of growth stocks. c. Value stocks dividend yields are much higher than those of growth stocks. d. Growth and levels of earnings is higher in growth stocks. e. Value stocks have a higher risk premium.

A

The table below provides returns on a portfolio along with returns for the corresponding benchmark index for the past eight quarters. The table also provides the difference between portfolio returns and the benchmark index, the average of these differences over the past eight quarters and the standard deviation of these differences. Period Portfolio Index Difference 1 0.05 0.027 0.023 2 0.036 0.046 0.010 3 0.022 0.019 0.003 4 0.012 0.022 0.010 5 0.003 0.001 0.002 6 0.023 0.03 0.007 7 0.089 0.081 0.008 8 0.008 0.006 0.014 Average 0.003 SD 0.011789 The annualized tracking error for this period is a. 2.36% b. 4.08% c. 2.89% d. 3.33% e. 1.18%

ANS: A Annualized Tracking Error = 0.011789 = 0.0236

Value stocks would have the following characteristics: a. Low price/book, high price/earnings. b. Low price/book, low price/earnings. c. High EPS growth, high profitability. d. Low EPS growth, high profitability. e. None of the above.

B

Which of the following statements is false? a. A manager's choice to align with an investment style communicates information to clients about the investor's focus, area of expertise, and stock evaluation methods. b. An investment manager's style cannot be used as a basis for measuring the manager's performance relative to a benchmark. c. Style identification allows an investor to select investment managers that allow his overall portfolio to be properly diversified. d. Style investing allows control of the total portfolio to be shared between the investment managers and a knowledgeable sponsor. e. None of the above (all are true statements)

B

Which of the following is not a technique for constructing a passive index portfolio? a. Full replication b. Sampling c. Quadratic programming d. Linear programming e. None of the above (that is, all are techniques for constructing a passive index portfolio)

D

All of the following are advantages of ETFs over mutual funds except a. Ability for continuous trading while markets are open b. Ability to time capital gain tax realizations c. Smaller management fee d. Can be bought and sold like common stock e. Smaller brokerage commission

E

Active equity portfolio management is a long-term buy-and-hold strategy.

False

An advantage of quadratic programming is that it relies on historical correlations.

False

Growth oriented investors focus on the price component of the Price/Earnings ratio.

False

Growth stocks consistently outperform value stocks.

False

It does not make economic sense for portfolio managers to try to "time" between different investment styles.

False

Sharpe's (1991) study reveals that active managers typically outperform passive managers even after transaction costs and fees.

False

The three basic techniques for constructing a passive index are: full replication, sampling and linear programming.

False

There is a direct relationship between a passive portfolio's tracking error relative to its index and the time and expense necessary to create and maintain the portfolio.

False

A benchmark portfolio is defined as a passive portfolio whose average characteristics match the client's risk-return objectives.

True

A portfolio manager who uses tactical asset allocation is attempting to create alpha.

True

Completeness funds are portfolios designed to complement active portfolios that do not cover the entire market.

True

Exchange-Traded Funds (ETF) are depository receipts that give investors a pro rata claim on the capital gains and cash flows of securities held by financial institutions.

True

In backtesting, computers are used to examine the composition and returns of portfolios based on historical data in order to determine if the investment strategy would have worked in the past.

True

Insured asset allocation is a strategy to limit investment losses by shifting funds between an existing equity portfolio and a risk-free security.

True

Style identification allows an investor to select investment managers that allow his overall portfolio to be properly diversified.

True

Style investing allows control of the total portfolio to be shared between investment managers and pension fund managers.

True

In ____ asset allocation, the investor's risk tolerance and constraints are assumed to be constant over time. However, changes in capital market conditions result in changes in the portfolio's stock-bond mix. a. Integrated b. Strategic c. Tactical d. Insured e. None of the above.

C

If you have a portfolio with a market value of $100 million and a beta (measured against the S&P 500) of 1.5, then if the market rises by 10 percent, what value would you expect your portfolio to have? a. $100 million b. $110 million c. $150 million d. $165 million e. $1.65 billion

D

Which of the following is not considered a mainstream investment style? a. Value b. Growth c. Market-oriented d. Benchmark e. Small-cap

D

Which of the following is not considered an active management strategy? a. Sector rotation b. Use of factor models c. Quantitative screens d. Full replication e. Linear programming

D

Which of the following statements regarding momentum strategies is true? a. Price momentum is a fundamental strategy. b. Earnings momentum is a technical strategy. c. Price momentum and earnings momentum strategies will often result in identical portfolio strategies and holdings. d. The earnings momentum investor will most likely acquire stocks for companies that have positive earnings surprises. e. All of the above statements are true

D

A portfolio management strategy that overweights a particular industry, relative to the benchmark portfolio, based on the next expected phase of the business cycle is called a. Tactical asset allocation. b. Indexing. c. Sector rotation. d. Contrarian investing. e. Bottom up investing.

C

An investor focusing on a growth strategy does all of the following except a. Focuses on the earnings per share (EPS) component on the P/E ratio. b. Seek out investments with higher expected growth in earnings. c. Implicitly assume that the P/E ratio will grow over the near term. d. Focuses on the current and future economic "story" of a company. e. All of the above statements are true.

C

Growth stocks would have the following characteristics: a. Low price/book, high price/earnings. b. Low price/book, low price/earnings. c. High EPS growth, high profitability. d. Low EPS growth, high profitability. e. None of the above.

C

In returns-based style analysis a coefficient of determination of 95% would suggest that a. The portfolio manager outperformed 95% of his peers. b. The portfolio manager was outperformed by 95% of his peers. c. 95% of the portfolio return variability could be attributed to portfolio style. d. 95% of the portfolio return variability could be attributed to stock selection skills. e. 5% of the portfolio return variability could be attributed to portfolio style.

C

Exchange traded funds a. Are exactly the same as index mutual funds. b. Can be bought and sold like common stocks. c. Can be sold short. d. a and b. e. b and c.

E

An advantage of sampling is that portfolio returns will not track the index as closely as with full replication.

False

With dollar-cost averaging a manager purchases fewer shares when stock prices are low and more shares when stock prices are high.

False

A Long futures positions in the S&P500 has the effect of ____ portfolio exposure to equities, while short futures positions in the S&P500 has the effect of ____ portfolio exposure to equities. a. Increasing, decreasing. b. Decreasing, increasing, c. Increasing, increasing. d. Decreasing, decreasing. e. None of the above.

A

If the annual geometric mean for the equity risk premium is 8.4 percent, what percentage of the equity risk premium is consumed by trading costs of 1.2 percent? a. 7.20% b. 9.60% c. 9.70% d. 10.08% e. 14.29%

E

Following an earnings momentum strategy, an investor acquires stocks that have enjoyed above-market stock price increases.

False

The following is an example of a fundamental active equity portfolio management strategy. a. Contrarian investing. b. Earnings momentum investing. c. Low P/E and low P/BV investing. d. Bottom up investing. e. Investing on the basis of calendar effects.

D

Which of the following is not considered an asset allocation strategy? a. Integrated asset allocation b. Strategic asset allocation c. Tactical asset allocation d. Insured asset allocation e. None of the above (that is, all are asset allocation strategies)

E

____ is a strategy used because the market seems to reward companies that have steady, above average earnings growth, or whose prices are rising because of market optimism. a. Relative strength b. Asset momentum c. Rotational attribution d. All of the above. e. None of the above.

E

Exhibit 16.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A portfolio manager is trying to establish a strategic asset allocation for two different clients, Bob Bowman and Tom Luck. Bob Bowman has a risk tolerance factor of 22 and Tom Luck has a risk tolerance factor of 6. The characteristics of the three model portfolios under consideration are provided in the table below. Asset Mix Expected Portfolio Stock Bond Return Variance A 0.75 0.25 0.12 0.45 B 0.4 0.6 0.08 0.16 C 0.3 0.7 0.05 0.06 Refer to Exhibit 16.1. The recommended portfolio for Tom Luck is a. Portfolio A because it has expected utility of 9.95 b. Portfolio A because it has expected utility of 4.5 c. Portfolio B because it has expected utility of 5.33 d. Portfolio B because it has expected utility of 7.27 e. Portfolio C because it has expected utility of 6.75

ANS: C The appropriate portfolio for Tom Luck is portfolio B with expected utility of 5.33.

Style investing involves constructing portfolios in such a way as to capture one or more of the characteristics of equity securities.

True

In ____ strategy, certain economic sectors or industries are overweighted relative to the benchmark in anticipation of the next phase of the business cycle. a. Sector rotation b. Price momentum c. Earnings momentum d. Return rotation e. None of the above

A

Which of the following statements concerning active equity portfolio management strategies is true? a. The goal of active equity portfolio management is to earn a portfolio return that exceeds the return of a passive benchmark portfolio (net of transaction costs) on a risk-adjusted basis. b. An actively managed equity portfolio has lower total transaction costs. c. An actively managed equity portfolio has lower risk than the passive benchmark. d. A key to success for an actively managed equity portfolio is to maximize trading activity. e. All of the above

A

Exhibit 16.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A portfolio manager is trying to establish a strategic asset allocation for two different clients, Bob Bowman and Tom Luck. Bob Bowman has a risk tolerance factor of 22 and Tom Luck has a risk tolerance factor of 6. The characteristics of the three model portfolios under consideration are provided in the table below. Asset Mix Expected Portfolio Stock Bond Return Variance A 0.75 0.25 0.12 0.45 B 0.4 0.6 0.08 0.16 C 0.3 0.7 0.05 0.06 Refer to Exhibit 16.1. The expected utilities of Portfolios A, B and C for Bob Bowman are a. Portfolio A = 9.95, Portfolio B = 7.27, Portfolio C = 4.73 b. Portfolio A = 4.5, Portfolio B = 5.33, Portfolio C = 4.0 c. Portfolio A = 7.95, Portfolio B = 5.33, Portfolio C = 4.73 d. Portfolio A = 3.5, Portfolio B = 7.27, Portfolio C = 4.73 e. Portfolio A = 5.33, Portfolio B = 7.27, Portfolio C = 4.73

ANS: A Expected Utilities for Bob Bowman are provided below: Portfolio Investor A B C Bowman 0.099545 0.072727 0.047273

In equity portfolio management, tracking error occurs when a. The managed portfolio outperforms the benchmark portfolio. b. The managed portfolio under performs the benchmark portfolio. c. The return volatility of the managed portfolio is positively correlated with the return volatility of the benchmark portfolio. d. The return volatility of the managed portfolio is negatively correlated with the return volatility of the benchmark portfolio. e. The return volatility of the managed portfolio is not correlated with the return volatility of the benchmark portfolio.

E

Exhibit 16.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A portfolio manager is trying to establish a strategic asset allocation for two different clients, Bob Bowman and Tom Luck. Bob Bowman has a risk tolerance factor of 22 and Tom Luck has a risk tolerance factor of 6. The characteristics of the three model portfolios under consideration are provided in the table below. Asset Mix Expected Portfolio Stock Bond Return Variance A 0.75 0.25 0.12 0.45 B 0.4 0.6 0.08 0.16 C 0.3 0.7 0.05 0.06 Refer to Exhibit 16.1. The recommended portfolio for Bob Bowman is a. Portfolio A because it has expected utility of 9.95 b. Portfolio A because it has expected utility of 4.5 c. Portfolio B because it has expected utility of 5.33 d. Portfolio B because it has expected utility of 7.27 e. Portfolio C because it has expected utility of 6.75

ANS: A The appropriate portfolio for Bob Bowman is portfolio A with expected utility of 9.95.

Exhibit 16.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A portfolio manager is trying to establish a strategic asset allocation for two different clients, Bob Bowman and Tom Luck. Bob Bowman has a risk tolerance factor of 22 and Tom Luck has a risk tolerance factor of 6. The characteristics of the three model portfolios under consideration are provided in the table below. Asset Mix Expected Portfolio Stock Bond Return Variance A 0.75 0.25 0.12 0.45 B 0.4 0.6 0.08 0.16 C 0.3 0.7 0.05 0.06 Refer to Exhibit 16.1. The expected utilities of Portfolios A, B and C for Tom Luck are a. Portfolio A = 9.95, Portfolio B = 7.27, Portfolio C = 4.73 b. Portfolio A = 4.5, Portfolio B = 5.33, Portfolio C = 4.0 c. Portfolio A = 7.95, Portfolio B = 5.33, Portfolio C = 4.73 d. Portfolio A = 3.5, Portfolio B = 7.27, Portfolio C = 4.73 e. Portfolio A = 5.33, Portfolio B = 7.27, Portfolio C = 6.75

ANS: B Expected Utilities for Tom Luck are provided below: Portfolio Investor A B C Luck 0.045 0.053333 0.04

Which of the following is considered a strategy for timing the market and adding value to actively managed portfolios? a. Time the markets by shifting between different types of securities based on market forecasts and estimated risk premiums. b. Shift funds between the various equity sectors, industries, investment styles, etc., in order to take advantage of the "hot" concept before the remainder of the market does. c. Individual stockpicking in order to buy low and sell high. d. Choices a and b only e. All of the above

E