Unit 21 - Portfolio Management Styles, Strategies, and Techniques

Which of the following are asset classes? A) REITs B) Large cap stock funds C) Options D) Forward contracts

a

One of the most significant risks taken by bond investors is interest rate risk. All of these steps could be used to mitigate the effects of this risk except A) holding bonds to maturity B) laddering the portfolio C) buying bonds of highest quality D) buying bonds with short-term maturities

c

Which of the following bond diversification strategies involves purchasing only short-term and long-term bonds? A) Laddering strategy B) Bullet strategy C) Immunization D) Barbell strategy

d

In general, the most passive investment style for a portfolio would be A) buy and hold. B) value. C) contrarian. D) indexing.

d buy and hold still takes some setting up

The capital asset pricing model (CAPM) is an investment theory that serves as a model for A) pricing securities based on their systematic risk B) pricing securities based on their total risk C) pricing securities based on their unsystematic risk D) measuring the correlation between a security and the overall market

a

If a portfolio manager wished to reduce inflation risk, which of the following would be most appropriate to add to the portfolio? A) Fixed annuities issued by an insurance company with Best's highest rating B) AAA bonds C) Preferred stock D) Tangible assets

d

One of the asset allocation classes is fixed income securities. When an IAR is determining which securities to fill that portion of the client's portfolio, which of the following would not be included? A) Preferred stock B) Municipal bonds C) Mortgage-backed securities D) Treasury bonds

a

As a technique in portfolio management, portfolio diversification reduces A) unsystematic risk. B) interest rate risk. C) systematic risk. D) market risk.

a Unsystematic risk, such as business risk, can be almost eliminated with a well-diversified portfolio. Systematic risks, such as interest rate risk and market risk, are not helped by diversification. For example, no matter how many bonds you hold in your portfolio, if interest rates go up, they'll all drop in price. On the other hand, holding many bonds limits the overall loss should one or two issuers default.

A high-risk investment strategy is the short sale of stock. Each of the following is a method of offering some degree of protection except A) entering a buy stop order for the short stock. B) buying a put on the short stock. C) buying a call on the short stock. D) selling a put on the short stock.

b

An adviser who does not believe he can time the market, or pick those securities that will outperform their benchmarks, would have which of the following as the most important portfolio consideration? A) Maximizing current income to provide a solid base for total return B) Minimizing investment expense and proper asset allocation C) Looking for asset classes that will outperform their benchmarks D) Selecting stocks that are expected to outperform their benchmarks

b

Customer A and Customer B each have an open account in a mutual fund that charges a front-end load. Customer A has decided to receive all distributions in cash, while Customer B automatically reinvests all distributions. How do their decisions affect their investments? I. Receiving cash distributions may reduce Customer A's proportional interest in the fund. II. Customer A may use the cash distributions to purchase shares later at NAV. III. Customer B's reinvestments purchase additional shares at NAV rather than at the offering price. IV. Due to compounding, Customer B's principal will be at greater risk. A) II and III B) I and III C) II and IV D) I and IV

b If the customer elects to receive distributions in cash while other investors purchase shares through reinvestment, his proportional interest in the fund will decline. Automatic reinvestment is always at NAV.

Which of the following bond strategies is the least active? A) Barbell B) Bullet C) Yield curve D) Ladder

b The bullet strategy involves investing in bonds at various intervals with all of the bonds maturing at or about the same time (such as when a child is entering college). As such, the only activity is buying bonds every couple of years. Barbell and ladder strategies have bonds maturing at regular intervals requiring an active role in reinvesting the principal. All three of these require the investor to purchase bonds at different times, but the bullet strategy is the only one not concerned with the mechanics of collecting the matured principal and reinvesting it. Yield curve is not a specific strategy.

Which form of the efficient market hypothesis (EMH) states that excess returns cannot be obtained using technical analysis a) Semi-strong form b) Strong form c) Weak form d) all of these

c the weak form assumes that current stock prices fully reflect all currently available public information such as prices and volume. Because those are already figured into the stock's price, the EMH concludes that excess returns cannot be achieved using technical analysis (price and volume charts)

Which of the following describes an investment management style? A) Rebalancing B) Margin C) Current income D) Large capitalization

d

A technical analyst who wishes to smooth out the fluctuations of stock market prices would probably chart A) the short interest B) the trendlines C) the support and resistance levels D) the 100-day moving average

d A major benefit of charting moving averages is that it takes short-term market fluctuations and smooths them out.

According to the efficient market hypothesis, information found when reading the Wall Street Journal would be considered A) random walk. B) semi-strong form market efficiency. C) strong-form market efficiency. D) weak-form market efficiency.

d The closer to inside information, the stronger the information. Anything published in widely read media would be considered very weak.

Among the popular methods of valuing equity securities is the dividend growth model. One could expect to see an analyst using this to value any of these except a) common stock b) ADRs representing common stock in a foreign company c) preferred stock d) none of these

c in order to use the dividend growth model, there must be a possibility of dividend growth. Because preferred stock dividends are fixed, this tool would not make any sense

An investor has set up an automatic bank draft to purchase $200 of the KAPCO Balanced Fund every month. Over the past 5 months, per share prices when the purchases were executed were $10, $12, $15, $14, and $11. Using the dollar-cost averaging program resulted in an average cost per share of a) $12 b) $12.13 c) $12.40 d) $82.47

b Take the number of shares purchased (20+16.667+13.333+14.286+18.182) = 82.468 1000/82.468 = 12.13

An investor does not wish to attempt to time the market, so she invests $300 each month into the GEMCO Growth Fund. Over the past 5 months, her purchase prices have been $10, $12, $15, $20, and $25. On the basis of this information, if she were to stop investing at this point and sell her shares 2 months from now when the NAV is $15 per share and the public offering price is $15.79, it would be correct to state that her A) realized loss would be $1.40 per share. B) proceeds were $15.79 per share. C) average cost per share was $16.40. D) cost basis for tax purposes was $14.71.

d 1500/102 = 14.71, she would redeem at NAV

Which of the following statements regarding a bond ladder strategy is Correct? a) a bond ladder strategy involves the purchase of very long-term and very short-term bonds b) a laddered portfolio of bonds will provide lower yields than a portfolio consisting entirely of long-term bonds c) a bond ladder strategy is generally more aggressive than a bond barbell strategy d) a bond ladder strategy is a relatively easy way to immunize a portfolio against interest rate risk

d By holding many positions across the yield curve, the individual is diversified in the event that yields behave differently in one part of the curve than in another. The laddered portfolio will generally provide higher (not lower) yields than a portfolio consisting entirely of short-term bonds. Purchasing very long-term and very short-term bonds describes the bond barbell strategy, a more aggressive strategy than the bond ladder strategy.

Your client's child is entering college next year. Which of the following would be the most appropriate recommendation? A) A zero-coupon bond maturing in five years B) A large-cap growth fund C) A U.S. Treasury note mutual fund D) A five-year laddered portfolio of U.S. Treasury notes

d Most would agree that with a regularly scheduled commitment for tuition and other expenses associated with a college education, there is a need for not only income, but also (and perhaps more importantly) assurance that when the bills are due, the principal will not have fluctuated. That would be best accomplished through a laddered portfolio where each year there are T-notes maturing. The growth fund would be attractive if the time horizon was long (this one is very short). The zero-coupon bond will not provide any money until five years from now, and this client needs cash flow starting in one year. The mutual fund does not offer the guaranteed repayment of principal that the ladder does.

Amie Lear is a securities analyst employed by Empyreal Benefits, Inc., a registered broker-dealer. She is assigned to cover a number of different equity and debt investments. One of the investments is Taylor, Inc. (Taylor), a manufacturer of a wide range of children's toys. Based on her extensive analysis, she determines that her expected return on the stock, given Taylor's risks, is 10%. However, when applying the capital asset pricing model (CAPM), the result is a 12% rate of return. Based on Lear's analysis, Taylor's stock is A) overvalued. B) undervalued. C) neither overvalued nor undervalued. D) correctly valued.

a The CAPM gives us the expected rate of return on an investment. It is sometimes referred to as the required rate of return. That is, based on the risks, the CAPM reveals the return that should be earned. In this example, that return is 12%.Lear's computation expects the return to be only 10%. Therefore, Lear is showing that instead of providing the required return of 12%, she believes the stock will only return 10%. That makes the stock overpriced (a lower price will generate a higher rate of return). As a result, Lear would not recommend this stock because her calculations indicate it will not return as much as it should for the risk being taken.

The use of futures to hedge against a price increase is best referred to as A) a trimmed hedge. B) a neutral hedge. C) a long hedge. D) a short hedge.

c Just as with stock options, the strongest hedge is always accomplished by buying (going long) on the opposite side. When the investor is afraid the price will rise, going long (benefits if the price does rise) fixes the purchase price regardless of how high the price might rise.

An investor owns 100 shares of Lockstone Pipeline Incorporated (LPI) and is concerned that the stock's price has downside volatility. Without a cash outlay, this investor could partially hedge the position by a) buying an LPI call b) buying an LPI put c) selling an LPI put d) selling an LPI call

d the only possible answers are option writers. Buying an option requires a cash outlay, while selling one brings in cash premium. When an investor is long a stock, the partial hedge position is the short call. When one is short the stock, the partial hedge is the short put. Remember, hedging means taking an opposite position. When you are writing a call, you are bearishly neutral.