Portfolio Management
Which of the following types of institutions is most likely to have the lowest risk tolerance?
commerical bank Banks typically need to maintain excess reserves in order to meet regulatory requirements. As a result, a bank must invest in assets that are more conservative than those invested by other types of financial institutions. An endowment will usually have significant long-term spending requirements in addition to its current expenses. Thus, a college endowment should accept higher risk in order to attain the returns indicated by its mandate. A mutual fund company may invest in many types of securities depending on the type of funds being managed. Investments may range from conservative money market funds to more aggressive derivatives. Therefore, a mutual fund company's level of risk tolerance may be greater than or less than those of a bank or endowment.
Which of the following possible portfolios is least likely to lie on the efficient frontier? Portfolio Expected Return/Standard Deviation X9% / 12% Y11% / 10% Z13% / 15%
portfolio x Portfolio X has a lower expected return and a higher standard deviation than Portfolio Y. X must be inefficient.
In extending the 3-factor model of Fama and French, the additional factor suggested by Carhart that is often used is:
price momentum. In addition to the three factors of the Fama and French model, market-to-book, firm size, and excess returns on the market, Carhart added a momentum factor based on prior relative price performance.
An analyst gathered the following data about three stocks: Stock / Beta / Estimated Return A / 1.5 / 18.1% B / 1.1 /15.7% C / 0.6 /12.5% If the risk-free rate is 8%, and the market risk premium is 7%, the analyst is least likely to recommend buying:
stock A Stock A: kA = 8% + 1.5(7%) = 18.5%. Because the estimated return of 18.1% is less than the required return of 18.5%, Stock A is overvalued. Stock B: kB = 8% + 1.1(7%) = 15.7%. Because the estimated return of 15.7% equals the required return of 15.7%, Stock B is properly valued. Stock C: kC = 8% + 0.6(7%) = 12.2%. Because the estimated return of 12.5% is greater than the required return of 12.2%, Stock C is undervalued.
Under which type of pension plan are retirement benefit payments an obligation of the sponsoring firm?
Defined benefit plan only. Promised retirement payments from a defined benefit pension plan are an obligation of the sponsoring firm. A defined contribution plan does not promise a specific periodic payment after retirement and the firm's obligations are limited to its promised contributions to current employees' accounts.
Which of the following equity securities is most likely to have a beta greater than one?
Homebuilder stock. Stocks of cyclical firms, such as homebuilders, tend to have high systematic risk (i.e., high beta). Stocks of noncyclical firms, such as utility or health care companies, tend to respond less to changes in systematic risk factors (i.e., they have low betas).
Marcia Kostner, CFA, is an advisor to individual investors. To determine each of her clients' risk tolerance objectively, Kostner uses a mathematical formula with inputs that include the client's age, family size, insurance coverage, liquidity, income, and net worth. What is the most likely shortcoming of Kostner's approach to assessing risk tolerance?
This approach does not consider the investor's attitude toward risk. When determining an investor's risk tolerance, an advisor should analyze the investor's personal situation, but should also gauge the investor's attitude toward risk. Risk tolerance is affected by the investor's psychological profile (i.e., willingness to take risk) as well as by the investor's ability to take risk. Age is an important influence on risk tolerance; younger investors generally are more able to withstand short-term losses because they have a longer time horizon in which to recover. Investors with high net worth are also more able to withstand short-term losses than investors with lower net worth, and thus tend to be more tolerant of risk.
