Portfolio Management
While assessing an investor's risk tolerance, a financial adviser is least likely to ask which of the following questions?
"What rate of investment return do you expect?"
What is the variance of a two-stock portfolio if 15% is invested in stock A (variance of 0.0071) and 85% in stock B (variance of 0.0008) and the correlation coefficient between the stocks is -0.04?
0.0007. [W12 σ12 + W22 σ22 + 2W1W2σ1σ2r1,2], or [(0.15)2(0.0071) + (0.85)2(0.0008) + (2)(0.15)(0.85)(0.0843)(0.0283)(-0.04)] = 0.0007.
Stock A has a standard deviation of 4.1% and Stock B has a standard deviation of 5.8%. If the stocks are perfectly positively correlated, which portfolio weights minimize the portfolio's standard deviation?
100%0%
The beta of Stock A is 1.3. If the expected return of the market is 12%, and the risk-free rate of return is 6%, what is the expected return of Stock A?
13.8%. Here, RRStock = 6 + (12 - 6) × 1.3 = 6 + 7.8 = 13.8%.
The expected rate of return is 2.5 times the 12% expected rate of return from the market. What is the beta if the risk-free rate is 6%?
4. 30 = 6 + β (12 - 6) 24 = 6β β = 4
Suppose there is an investment available to you with an expected return of 6% and a standard deviation (risk) of 10%. Suppose further that your risk aversion coefficient is 2. The minimum risk-free guaranteed return you require to get the same utility as the risky investment is closest to:
5%. Utility = U = E(r) − ½ × A × σ²= 0.06 − 0.5 × 2 × 0.10² = 0.05.
Which of the following behavioral biases is most likely related to information processing?
Anchoring and adjustment.
Brian Nebrik, CFA, meets with a new investment management client. They compose a statement that defines each of their responsibilities concerning this account and choose a benchmark index with which to evaluate the account's performance. Which of these items should be included in the client's Investment Policy Statement (IPS)?
Both of these items.
Which of the following actions is best described as taking place in the execution step of the portfolio management process?
Choosing a target asset allocation.
Which of the following are considered biases due to cognitive errors?
Conservatism, hindsight, and framing biases.
Which of the following is most appropriately termed a financial risk?
Credit risk.
Which of the following asset class specifications is most appropriate for asset allocation purposes?
Domestic bonds.
Which of the following is least likely to be considered an appropriate schedule for reviewing and updating an investment policy statement?
Frequently, based on the recent performance of the portfolio.
Which of the following statements is NOT consistent with the assumption that individuals are risk averse with their investment portfolios?
Many individuals purchase lottery tickets.
Which of the following is least likely an example of a portfolio constraint?
Minimum total return requirement of 8%.
Which of the following risks is most accurately classified as a non-financial risk?
Model risk.
Which of the following is an assumption of the Capital Asset Pricing Model (CAPM)?
No investor is large enough to influence market prices.
Which of the following statements about active and passive asset management is most accurate?
Passive management's share of industry revenues is smaller than its share of assets under management.
Which of the following is not necessarily included in an investment policy statement?
Procedures to update the IPS when circumstances change.
Which of the following types of investors is likely to have the shortest investment horizon?
Property and casualty insurance company.
Which of the following would most likely indicate that an investor is subject to an emotional bias?
Reacting spontaneously to a negative earnings announcement by quickly selling a stock.
Which of the following statements about risk and return is least accurate?
Risk and return may be considered on a mutually exclusive basis.
Which of the following are considered emotional biases?
Status quo and endowment biases.
Twenty years ago, Jane Ivy set up her initial asset allocation in her defined contribution plan by placing an equal amount in each asset class and never changed it. Over time, she increased her contribution by 1% per year until she reached the maximum amount allowed by law. Due to her steadfastness and good fortune, coupled with matching funds from her employer, she now finds herself in her early 40s with a million-dollar retirement account. Which of the following biases does Ivy most likely exhibit?
Status quo bias.
The top-down analysis approach is most likely to be employed in which step of the portfolio management process?
The execution step.
Which of the following statements about an organization's risk tolerance is most accurate?
The financial strength of an organization is one of the factors it should consider when determining its risk tolerance.
Which of the following would most likely be classified as an emotional bias?
The investor has a tendency to value the same assets higher if he owns them than if he does not own them.
Which of the following most accurately describes cognitive errors?
They are due primarily to faulty reasoning.
Which of the following activities is most likely to be performed as part of the execution step of the portfolio management process?
Top-down analysis based on macroeconomic conditions.
A manager who evaluates portfolios' investment performance adjusted for systematic risk is most likely to rank portfolios based on their:
Treynor measures.
When performing strategic asset allocation, properly defined and specified asset classes should:
approximate the investor's total investable universe as a group.
Hedge funds most likely:
are not offered for sale to the general public.
The execution step in the portfolio management process is most likely to include:
asset allocation and security analysis.
A return objective is said to be relative if the objective is:
based on a benchmark index or portfolio.
A client exhibits an above-average willingness to take risk but a below-average ability to take risk. When assigning an overall risk tolerance, the investment adviser is most likely to assess the client's overall risk tolerance as:
below average.
Measures of interest rate sensitivity least likely include:
beta.
When an investment advisor is developing return and risk objectives for a client:
both return and risk objectives may be stated in absolute or relative terms.
Compared to exchange-traded funds (ETFs), open-end mutual funds are typically associated with lower:
brokerage costs.
A pooled investment with a share price significantly different from its net asset value (NAV) per share is most likely a(n):
closed-end fund.
Examples of financial risks include:
credit risk, market risk, and liquidity risk.
In a defined contribution pension plan, the:
employee accepts the investment risk.
A long time horizon and low liquidity requirements best describe the investment needs of a(n):
endowment.
Risk governance should most appropriately be addressed within an organization the:
enterprise level.
A written investment policy statement should most appropriately:
establish a target asset allocation strategy.
A top-down security analysis begins by:
examining economic conditions.
For asset allocation purposes, asset classes should be specified such that correlations of returns are relatively:
high within each asset class and low among asset classes.
An endowment is required by statute to pay out a minimum percentage of its asset value each period to its beneficiaries. This investment constraint is best classified as:
legal and regulatory.
An individual investor specifies to her investment advisor that her portfolio must produce a minimum amount of cash each period. This investment constraint is best classified as:
liquidity.
Effective risk management would most likely attempt to:
maximize expected return for a given level of risk.
Portfolios that plot on the security market line in equilibrium:
may be concentrated in only a few stocks.
Rex Newman treats wages differently from bonuses when determining his savings and investment goals. As a result, he invests any available after-tax wages in low-risk investments while investing his bonuses in high-risk alternatives. Newman is most likely exhibiting:
mental accounting bias.
Abby Lane has investments scattered across many different accounts, from bank savings to before- and after-tax retirement accounts to taxable nonretirement accounts. She has multiple investing goals ranging from important short-term goals to longer-term "wish list" goals. She looks at her financial assets and views each holding as designed to meet specific goals. Lane has been very successful in her investment decisions for several decades and believes she can continue to achieve reasonable results. Lane most likely exhibits:
mental accounting.
In a defined benefit pension plan, the:
plan sponsor promises a predetermined retirement income to participants.
A risk management framework least likely includes:
risk mitigation, tracking the organization's risk profile, and establishing position limits.
An investor has the most control over her portfolio's:
risk.
Risk governance is best described as:
senior management's oversight of the organization's risk management.
Value-at-Risk (VaR) and Conditional VaR are best described as measures of:
tail risk.
All of the following affect an investor's risk tolerance EXCEPT:
tax bracket.
The halo effect suggests that investors tend to overvalue stocks:
that have experienced rapid growth and price appreciation.
Buying insurance is best described as a method for an organization to:
transfer a risk.
When developing the strategic asset allocation in an IPS, the correlations of returns:
within an asset class should be relatively high.
An investor has a two-stock portfolio (Stocks A and B) with the following characteristics: σA = 55% σB = 85% CovarianceA,B = 0.09 WA = 70% WB = 30% The variance of the portfolio is closest to:
0.25. s2 = [(0.72 × 0.552) + (0.32 × 0.852) + (2 × 0.7 × 0.3 × 0.09)] = [0.1482 + 0.0650 + 0.0378] = 0.2511.
An analyst has estimated the following: Correlation of Bahr Industries returns with market returns = 0.8 Variance of the market returns = 0.0441 Variance of Bahr returns = 0.0225 The beta of Bahr Industries stock is closest to:
0.57. Covariance of Bahr and the market = 0.8×√0.0225×√0.0441=0.02520.8×0.0225×0.0441=0.0252 Bahr beta = 0.0252/0.0441= 0.57
A cognitive error is most likely indicated by which of the following?
A client who initially resists recommendations to diversify the portfolio later thanks the manager for explaining the benefits of diversification.
Which of the following risk management strategies is most accurately described as shifting a risk?
A farmer takes a short position in a futures contract to deliver wheat.
Identifying a benchmark for a client portfolio is most likely to be part of the:
planning step.
Based on Capital Market Theory, an investor should choose the:
portfolio that maximizes his utility on the Capital Market Line.
Risk shifting is most likely achieved by:
using derivative securities.
Promised payments to pension beneficiaries are a responsibility of the plan sponsor in:
a defined benefit plan only.
Greg Brown receives new information regarding one of his stocks. This information appears to be reliable and conflicts with Brown's earlier forecast of what the stock should be trading for at this time. However, Brown does not revise his estimate of the stock's value. Brown is most likely exhibiting:
conservatism bias.
Compared to investing in a single security, diversification provides investors a way to:
decrease the volatility of returns.
Features of a risk management framework least likely include:
disciplining managers who exceed their risk budgets.
Portfolio diversification is least likely to protect against losses:
during severe market turmoil.
In the Markowitz framework, an investor should most appropriately evaluate a potential investment based on its:
effect on portfolio risk and return.
Based on a questionnaire about investment risk, an advisor concludes that an investor's risk tolerance is high, but based on an analysis of the client's income needs and time horizon, he concludes the investor's risk tolerance is low. The most appropriate action for the advisor is to:
emphasize bonds over stocks.
In a defined contribution pension plan, investment risk is borne by the:
employee
An analyst is most likely to be exhibiting availability bias when he:
estimates the probability of an outcome based on how easily information is recalled.
Which of the following statements would most likely be classified as a cognitive error? The investor:
has a tendency to place information into categories.
Operational risk is most accurately described as the risk that:
human error or faulty processes will cause losses.
Which of the following is NOT a rationale for the importance of the policy statement in investing? It:
identifies specific stocks the investor may wish to purchase.
An objective of the risk management process is to:
identify the risks faced by an organization.
In determining the appropriate asset allocation for a client's investment account, the manager should:
incorporate forecasts of future economic conditions.
Portfolios that plot inside the minimum-variance frontier represent:
inefficient portfolios.
Low risk tolerance and high liquidity requirements best describe the typical investment needs of a(n):
insurance company.
Risk management within an organization should most appropriately consider:
interactions among different risks.
According to Markowitz, an investor's optimal portfolio is determined where the:
investor's highest utility curve is tangent to the efficient frontier.
Which of the following inputs is least likely required for the Markowitz efficient frontier? The:
level of risk aversion in the market.
Private equity and venture capital funds:
play an active role in the management of companies.
A pooled investment fund buys all the shares of a publicly traded company. The fund reorganizes the company and replaces its management team. Three years later, the fund exits the investment through an initial public offering of the company's shares. This pooled investment fund is best described as a(n):
private equity fund.
Categories of investment constraints in an investment policy statement least likely include:
risk tolerance.
A portfolio manager uses a computer model to estimate the effect on a portfolio's value from both a 3% increase in interest rates and a 5% depreciation in the euro relative to the yen. The manager is most accurately described as engaging in:
scenario analysis.
Risk budgeting can best be described as:
selecting assets by their risk characteristics.
The investment policy statement is most accurately considered the:
starting point of the portfolio management process.
A portfolio manager who believes equity securities are overvalued in the short term reduces the weight of equities in her portfolio to 35% from its longer-term target weight of 40%. This decision is best described as an example of:
tactical asset allocation.
The major components of a typical investment policy statement (IPS) least likely include:
the investment manager's compensation.
The component of an investment policy statement that defines the investment objectives is most likely to include information about:
the investor's risk tolerance.
James Franklin, CFA, has high risk tolerance and seeks high returns. Based on capital market theory, Franklin would most appropriately hold:
the market portfolio as his only risky asset.
Which of the following portfolio constraints in the Investment Policy Statement of a local college's endowment most likely belongs in the "unique circumstances" category? The endowment is:
unwilling to invest in companies that sell weapons.
