Portfolio Performance Unit 23

A portfolio manager whose universe of stocks is those with market caps of $4 - $6 billion would most likely be graded against A) S&P 400. B) Dow Jones Composite Average. C) S&P 500. D) Nasdaq 100.

A) S&P 400. Stocks with a market capitalization between $2 billion and $10 billion are considered mid-cap stocks. The S&P 400 is the index for those.

In general, the favored way of measuring the performance of a money manager is by A) comparing her performance to that of the investor. B) comparing her performance to a relevant benchmark. C) examining the tax efficiency of the portfolio. D) measuring the fees charged against the total return.

B) comparing her performance to a relevant benchmark. Although there are a number of ways of measuring a portfolio manager's performance, the most common one is to compare it to that of a benchmark portfolio or index that parallels the manager's style.

Given the following information, calculate the risk-adjusted return. 91-day T-bill rate: 4% Actual return: 14% Beta = 1.4 CPI: 3% Standard deviation: 5.0 A) 10 B) 5 C) 11 D) 2

D) 2 Any question asking about the risk-adjusted return is going to be referring to the Sharpe ratio. This is shown as a simple number and is calculated by subtracting the risk-free rate (91-day T-bill) from the actual return and dividing that remainder by the standard deviation. In this example, 14% − 4% = 10% divided by 5 = 2.

ABC's stock has paid a regular dividend every quarter for the past several years. If the price of the stock has remained the same over the past year, but the dividend amount per share has increased, it may be concluded that ABC's A) yield to maturity has gone up B) current yield per share has increased C) current yield per share has decreased D) current yield per share has been unaffected

B) current yield per share has increased The current yield would have increased because current yield is the income (dividend) divided by price. A higher dividend divided by the same price results in a higher yield. Stocks do not have a yield to maturity.

A bond of standard size has a nominal yield of 6%, paid in the customary fashion. The bond matures in 10 years, is callable at $105 in 5 years, and is currently priced at $110. An investor calculating the bond's yield to call would include A) the semiannual interest payments of $30. B) the loss of $100 at maturity. C) 20 payment periods. D) the gain of $50 when called.

A) the semiannual interest payments of $30 The yield to call computation involves knowing the amount of interest payments to be received, the length of time to the call, the current price, and the call price. A bond with a 6% coupon (nominal yield) will make $30 interest payments twice each year. Remember, unless otherwise stated, bonds have a par value of $1,000 and customarily pay interest semiannually. With a 5-year call, there are only 10 payment periods, not 20. The loss at call is $50 ($1,100 - $1,050); there is no gain and the loss at maturity of $100 is only relevant for YTM, not YTC.

An investor invests a total of $30,000 and creates a portfolio of 3 different stocks placing 1/3 of his investment into each security. From his holding in Company A, he receives a dividend of $600; from Company B, a dividend of $500; and from Company C, no dividend. One year later, the market price of the Company A stock has increased by 20%, Company B's stock increased by 10%; and Company C's stock has remained the same. What is the investor's total return on this portfolio? A) 10% B) 3.67% C) 4.56% D) 13.67%

D) 13.67% Total return includes both appreciation (growth) and income (dividends). Let's go step by step. Company A's $10,000 original investment increases by 20%, or $2,000 plus dividends of $600. Company B's $10.000 original investment increases by 10%, or $1,000 plus dividends of $500. Company C's $10,000 original investment is unchanged and there is no dividend. Therefore, we have appreciation of $3,000 plus dividend income of $1,100. That is a total return of $4,100 on an investment of $30,000, or 13.67%.

If a client in the 30% marginal income tax bracket can earn an after-tax rate of return of 7% when the estimated inflation rate during the holding period of an investment is 4%, the client's real rate of return is A) more than 7% B) 10% C) 7% D) less than 7%

D) less than 7% Real return reduces nominal return by an inflation factor. Thus, the client's real return must be less than 7%.

A customer purchases stock for $40 per share and holds it for 1 year, selling it for $50 per share exactly 12 months after the date of purchase. Four quarterly qualifying dividends of $.50 were paid during the year. If the customer's tax bracket is 30%, what is the after-tax rate of return? A) 21.75% B) 21% C) 17.5% D) 18.40%

A) 21.75% The customer's return on the stock includes the $10 per share short-term capital gain ($50 − $40) plus the $2 qualifying dividend (quarterly dividend of $0.50 × 4). After-tax rate of return is found by computing the total after-tax earnings. Short-term gains are taxed at the same rate as ordinary income, and qualifying dividends are taxed at a maximum rate of 15% (except for very high income earners—not tested). The tax on the $10 gain is $3 ($10 × 30%), and the tax on the $2 qualifying dividend is $0.30 ($2 × 15%). The investor's total return is the $12 total minus the $3.30 in taxes, or $8.70; $8.70 divided by the original investment of $40 results in an after-tax return of 21.75%

One year ago, ABC Widgets, Inc., funded an expansion to its manufacturing facilities by issuing a 20-year first mortgage bond. The bond is secured by the new building and land and is callable at par 15 years after the issue date. The bond was issued with a 5.5% coupon and is currently rated Aa. If the current market price of the bond is $105, A) the yield to call is lower than the yield to maturity. B) the yield to maturity is higher than the current yield. C) the nominal yield is lower than the current yield. D) the yield to call is higher than the current yield.

A) the yield to call is lower than the yield to maturity. When a bond is selling at a premium, the order, from highest to lowest yield is: nominal (coupon) yield, current yield, YTM, and YTC. If the bond is callable at a premium, the order could be changed, but it is highly unlikely that the exam will present that situation in a question.

Which of the following is NOT related to the variability of a portfolio's returns? A) Asset allocation B) Security selection C) Total return D) Market timing

C) Total return Let's analyze the question. A portfolio's future returns can vary, that is, fluctuate based on investment decisions made by the investor or adviser. The way the portfolio assets are allocated between different classes of securities will have an impact on the returns. The same is true with the timing of purchases or sales (buying stock when bad economic news is announced is probably not a good time). Finally, the specific securities selected will certainly impact the returns of the portfolio. That leaves total return. Total return is a measurement of the investor's past return on the portfolio. It measures what has happened and has no effect on future variability.

An investor is reviewing his portfolio. To compute the real rate of return on an investment, it would be necessary to know all of the following EXCEPT A) the gain (or loss) recognized on the asset B) the rate of inflation C) the tax bracket of the investor D) the income received from holding the asset

C) the tax bracket of the investor An investor's real rate of return is computed by dividing the total return received by the cost and then subtracting the inflation rate. If there is no realized gain, it is simply the nominal return based on the income minus the inflation rate. The investor's tax bracket is needed to compute after-tax returns.

An investor purchases a 5% callable convertible subordinated debenture at par. Exactly one year later, the bond is called at $104. The investor's total return is: A) 5%. B) 4%. C) 9%. D) 7.5%

C) 9%Total return consists of income plus gain. Buying a bond at par and having it called at $104 results in a $40 gain. With a 5% coupon, there will be two semiannual interest payments of $25 in a one-year holding period. Adding the $40 + $50 = $90 total return on an investment of $1,000 which = 9%.

What is the total return on a bond that cost an investor $950, was sold for $1,000, and paid $50 in interest payments? A) 10% B) 5% C) The return cannot be determined from the information supplied D) 10.50%

D) 10.50% Total return is the sum of all payments ($50) plus the capital gains ($50) divided by the cost ($950). In this case, $50 + $50 ÷ $950 = 0.10526 or 10.5%.

Computing the Sharpe ratio for a specific stock requires using all of the following EXCEPT: A) the risk-free return available in the market. B) the standard deviation of the subject security. C) the actual rate of return for the subject security. D) the beta for the subject security.

D) the beta for the subject security. The formula for the Sharpe ratio is as follows: (actual rate of return minus the risk-free rate of return) divided by the standard deviation of the security. Beta is not a component.

During your annual review with a client, you go over all the year's transactions. The beginning of the year balance in the account was $3,000. The client purchased 100 shares of ABC on February 1 at $30 per share and sold it on June 1 at $33 per share. During that period, ABC paid 1 quarterly dividend of $.30. The client used the proceeds of the ABC sale to purchase 66 shares of DEF on June 15 at $50 per share and sold it on December 15 at $60 per share. DEF pays quarterly dividends of $0.25 on the 1st of each month on a cycle beginning with February. Based on this information, you would inform the client that the account's total return is A) 34.10% B) 102.70% C) 46% D) 100%

A) 34.10% Total return in an account is computed by taking all income plus capital gains and dividing that by the original investment. In this example, the client received a $0.30 dividend on 100 shares ($30) and two $0.25 dividends (August 1 and November 1) on 66 shares ($33). Add that $63 of income to the gain of $300 on the first transaction, and $660 on the second, to come up with a total of $1,023 divided by $3,000, which equals a total return of 34.1%.

On June 20, 2016, an investor in the 30% marginal federal tax bracket acquired a growth stock paying no dividend for $10 per share. On June 22, 2017, the investor sold the stock for $20 per share. Presuming capital gains rates are 15%, the investor's after-tax rate of return is closest to A) 85% B) 70% C) 100% D) 200%

A) 85% Although the stock grew at a 100% rate of return (by doubling), the investor must pay capital gains tax on the investment at 15%, and the investor realizes an after-tax rate of return of approximately 85%. Because the investor held the stock for more than 1 year, the sale is taxed at a favorable capital gains rate rather than at the investor's ordinary income tax rate.

If an investor buys a utility stock with a stable 5% dividend, and after a year the investor's total return in the stock is 10%, the most likely reason for this is A) the stock appreciated by 5% B) the investor reinvested the quarterly dividends C) the company doubled its dividend payment D) the stock price declined

A) the stock appreciated by 5% The most likely cause for the total return was an increase in the stock price.

A hedge fund with a 2-plus-20% fee structure has equal probabilities of a 10% loss or a 30% gain in its first year. The probable return to an investor in the fund for the first year is closest to A) 17.6%. B) 5.2%. C) -2.0%. D) 8.8%.

B) 5.2% To our knowledge, the exam has never asked a question this complicated. But, things can always change so we wanted you to get the "flavor" of combining probable return (which is tested) with hedge fund performance fees. With a 30% gain, the fund would earn fees of 2% + 0.20(30% - 2%) = 2% + 0.20 (28%) = 2% + 5.6% = 7.6%. With a 10% loss, the fund would only earn its management fee of 2%. To the investor, the expected return is 0.5(-10% - 2%) = 0.5 (-12%) = -6% + 0.5(30% - 7.6%) = -6% + 0.5 (22.4%) = -6% + 11.2% = 5.2%.

An investor is of the opinion that the recent bull market has run its course, and she wants to protect her portfolio consisting largely of equities with a market cap of less than $1 billion. Her best choice would be to A) sell futures on the Russell 2000. B) sell puts on the S&P 500. C) buy puts on the Russell 2000. D) buy puts on the S&P 500.

C) buy puts on the Russell 2000 When a bull market runs out of steam, a decline usually follows. The best way to protect her positions is purchasing a put option on a benchmark that represents her holdings. Because this investor's portfolio is so heavily invested in small-cap stocks, the appropriate benchmark for hedging would be the Russell 2000.

One measure of an investor's total return is called holding period return. The computation includes both income and appreciation and is used for both debt and equity securities. An investor's holding period return would be less than the bond's yield to maturity if A) the bond was redeemed at a premium B) the investor purchased a put option on the bond C) the bond was called at a discount D) the coupons were reinvested at a rate below the yield to maturity

D) the coupons were reinvested at a rate below the yield to maturity The calculation of yield to maturity assumes reinvestment of the bond's interest at the coupon rate. Therefore, if the investor was only able to do less than that, the holding period return would be decreased. This is part of the concept of internal rate of return (IRR), which takes into consideration the time value of money (compounding). It is tempting to choose the answer "a call at a discount," but bonds are never called at a price below par. Just keep it simple: If the question says you can earn less than the YTM, your return will be lower than the quoted YTM.

An investor purchased stock for $50 per share at the beginning of the year. In December, the investor liquidated his stock for $55 per share, while also receiving dividends of $2 per share during the year. Assuming an inflation rate of 3%, what is the investor's real rate of return? A) 11% B) 4% C) 14% D) 10%

A) 11% Given the fact the client liquidated his shares at a price of $55, we can conclude that he attained a 10% ($5 profit ÷ $50 initial investment) return based on capital appreciation of the stock. He also received dividends of $2 per share giving him an additional return of 4% ($2 ÷ $50). By adding these 2 percentages together, we can conclude that his total return is 14%, less an inflation rate of 3%, which would give a real rate of return of 11%

A company currently has earnings of $4 and pays a $0.50 quarterly dividend. If the market price is $40, what is the current yield? A) 5% B) 1.25% C) 10% D) 15%

A) 5% The quarterly dividend is $0.50, so the annual dividend is $2.00; $2 ÷ $40 (market price) = 5% annual yield (current yield).

If an agent recommends that a client invest a portion of his portfolio in an international stock fund and is asked whether she should compare the performance of the fund against the S&P 500 Index, how should the agent respond? A) No, it is preferable to compare the fund against the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index because it covers international securities. B) Yes, the S&P 500 is an appropriate benchmark against which to compare the performance of all equity funds. C) There is no appropriate benchmark against which an investor can compare a portfolio of foreign securities. D) No, it is preferable to compare the fund against the Russell 2,000 Index because it covers smaller corporation stocks.

A) No, it is preferable to compare the fund against the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index because it covers international securities. It is important that a particular mutual fund be compared against the appropriate benchmark. An international fund's performance should be compared against an index of foreign stocks such as the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index.

An investor purchases 100 shares of Shilaf Baby Products, Inc. (SBPI) at $60 per share. SBPI pays quarterly dividends of $.55. One year after the purchase, SBPI is at $66 per share, and after the second year, its market price is $63 per share. If the investor were to close out the position at this time, the total return would be A) 17.33%. B) 12.33%. C) 6.83%. D) 8.67%

B) 12.33% Total return combines income and gains. In this question, the total income for the two-year holding period is $440 ($.55 per quarter = $2.20 per year x 100 shares). The sale is at $63 which is a $3 per share gain. That makes the total return $440 + $300 which equals $740. Dividing that by the original $6,000 cost results in a total return of 12.33%.

During the past year, the market price of Kapco common stock has increased from $47 to $50 per share. Over that period, Kapco's earnings per share (EPS) have increased from $2.00 to $2.50 per share, and their dividend payout ratio has decreased from 50% to 40%. Based on this information, the current yield on Kapco common stock is A) 4.26% B) 2% C) 6.34% D) 2.13%

B) 2% The current yield on a stock is computed by dividing the annual dividend rate by the current market price. With EPS of $2.50 and a 40% payout ratio, the annual dividend is $1.00. This dollar divided by the current market price of $50.00 results in a current return of 2%.

An investor purchases 100 shares of Kapco stock at $50 per share. At the time of the purchase, the stock is paying a quarterly dividend of $0.25. The dividend increases 5% each year over the next 5 years. The purchaser sells the 100 shares 5 years after purchase for $82 per share. What is the total return for the investor over the 5 years holding period? A) 10% B) 11% C) 75% D) 74%

C) 75% Total return includes capital appreciation plus income. The capital gain realized was $32 per share. The income was $1.00 per share (four quarterly dividends of $0.25) the 1st year, 5% higher the 2nd year ($1.05) and 5% higher each successive year. The total of the dividends received is $5.53. Adding that to the $32, we compute by dividing $37.53 by $50 resulting in a 75% total return.