10.Q Portfolio Management
What is included in the general review of clients IPS ?
- Clarification of the client's financial goals on a periodic basis. - Ensuring asset allocation and investment selection are agreed. - Minimizing taxes. - Ensuring legal requirements have been met. - Reducing investment expenses. - Simplification - asset consolidation and elimination of overlapping holdings. - Optimizing the portfolio relative to tax, risk and return.
What do we do when monitoring and reviewing a portfolio ?
- General review. - Asset allocation review. - Security weights. - Performance review. - Performance measurement.
What are the steps in portfolio management process ?
1. Understanding the client (client profiling). 2. Understanding the market. 3. Developing an investment philosophy and an investment policy statement. 4. Constructing a portfolio. 5. Portfolio monitoring and revision.
What is risk appetite?
Amount of risk a client is willing to accept, e.g. high risk, medium risk, low risk.
What does EMH stand for?
Efficient market hypothesis
What does ESG stand for?
Environmental, Social, Governance.
[4047710] A client portfolio has 60% invested into a risk-free asset and 40% invested into a risky portfolio. This portfolio is most likely to lie on: A A capital allocation line. B The efficient frontier. C The security market line. D The minimum variance frontier.
Explanation - Correct Answer: A A capital allocation line shows the risk and return for portfolios invested between a risk-free asset and a risky portfolio. Reference: 10.5.2
[4047706] An investor buys a share of GCT stock for USD300 in 2017, and three additional shares at USD370 each in 2018. In 2019, the investor sells all his GCT shares for USD385 each. What is the money-weighted rate of return on this investment? A The return is 7.5%. B The return is 13.4%. C The return is 43.3%. D The return is 15.6%.
Explanation - Correct Answer: A Cash flow at T0 is -USD300, cash flow at T1 is -USD370 × 3 = -USD1,110 and the final cash flow at T2 is +USD385 × 4 = +USD1,540. By trial and error, the internal rate of return is 7.5%: (-300 - 1,110 / 1.075 + 1,540 / 1.075² = 0). Reference: 10.4.1
[296080] The client has come to you for advice on the potential returns from a security that is 20% more volatile than the market. If the market is returning 9% when the risk-free rate is 6% what return would you tell him to expect? A The expected return is 9.6%. B The expected return is 9.7%. C The expected return is 9.8%. D The expected return is 9.9%.
Explanation - Correct Answer: A If a security is 20% more volatile than the market then it has a beta of 1.2, beta being a measure of the risk relative to the market. The expected return may, therefore, be derived using the capital asset pricing model (CAPM) as: E (R) = Rf + B(Rm - Rf) = 6% + 1.2(9% - 6%) = 9.6%. Reference: 10.5.3
[296084] Based on the following information, which of the following is the Jensen measure for client portfolio A? Risk-free rate of return = 2%; Return on the market = 12%; Beta of portfolio A = 1.2; Standard deviation of portfolio A = 12%; Return on portfolio A = 14%. A The Jensen measure is 0%. B The Jensen measure is 1%. C The Jensen measure is 10%. D The Jensen measure is 100%
Explanation - Correct Answer: A Jensen = Actual return - CAPM return. CAPM return = 2% + 1.2(12% - 2%) = 14%, hence: Jensen = 14% - 14% = 0%. Reference: 10.6.3
[4047717] Which of the following is NOT a modern day assumption of technical analysis? A Markets are efficient. B History tends to repeat itself. C The market discount everything. D Prices move in trends.
Explanation - Correct Answer: A Markets are efficient is not one of the modern day assumptions (although it was a historical assumption). The modern day assumptions being that: the market discounts everything; prices move in trends; and history tends to repeat itself. Reference: 10.9.3
[4047705] You are discussing with a client their financial ability to withstand any losses that may arise. What term would you use to describe this ability? A Risk capacity. B Risk aversion. C Risk tolerance. D Risk appetite.
Explanation - Correct Answer: A Risk capacity is a term used to describe the financial capability of a client to withstand any losses that may arise. Reference: 10.1
[296058] Which of the following would you consider to be the best definition of risk capacity? A The financial capability of a client to withstand any losses that may arise. B The knowledge among investors that risk exists and a rational response to that risk. C A high level assessment of the risk levels that may be acceptable to a client. D A quantified assessment of the maximum variability in investment returns that is acceptable to a client.
Explanation - Correct Answer: A Risk capacity is the financial capability of a client to withstand any losses that may arise. Reference: 10.7.3
[4047712] Which of the following statements regarding technical analysis is incorrect? A Technical analysis is a passive investment management technique. B Technical analysis may be used to generate trading (buy or sell) signals. C Most technical analysts rely wholly on their charts and chart analysis for their investment decisions. D Technical analysis may be applied to the assessment of any financial measure that has reliable historical market data.
Explanation - Correct Answer: A Technical analysis is an active (rather the passive) investment technique that seeks to identify favorable buying and selling opportunities by the statistical analysis of historical data and perceived data trends. Reference: 10.9.1
[296088] You are discussing various performance metrics with a client and observing that some simply measure the return, whereas others assess the return with respect to risk. Which of the following is not a risk-adjusted return measure? A Modified Dietz. B Treynor. C Jensen. D Sharpe.
Explanation - Correct Answer: A The Modified Dietz method simply measures returns and does not appraise them with respect to risk. Reference: 10.6.3
[296054] James McNaughton is a fund manager at Wimco, an investment management firm that specializes in enhanced indexed strategies. He has heard of two methods of enhanced indexing. A colleague, Rob Roy, attempts to describe the two methods with the following explanations: 'Stock-based enhanced indexing: It's all about stock selection. You have a diverse portfolio but it is not weighted like your index, so you tweak the weightings to generate beta. Derivatives-based: It's all about cash management. You get your market exposure from derivatives, then, with the cash portfolio, you actively manage it to get some excess returns over cash rates.' Which of these two explanations is (are) broadly correct? A Derivative based B Stock based C Derivative based and stock based D Neither
Explanation - Correct Answer: A The derivatives-based description is accurate. The stock-based description is incorrect as tweaking the weightings from benchmark is how Alpha is generated, not Beta. Reference: 10.3.3
[4047703] In relation to the efficient market hypothesis, if security prices reflect only past price and volume information, then the market will be identified as: A Weak-form efficient. B Semi-strong efficient. C Strong-form efficient. D Inefficient.
Explanation - Correct Answer: A This identifies weak-form efficiency. Reference: 10.2.1
[296070] Your client has expressed some concern regarding the risk in his portfolio and you have calculated that it has a 95% 7-day VaR of AUD1.7m. How would you describe the meaning of this to your client? A In any normal 7-day period there is a 5% chance that the portfolio will lose more than AUD1.7m. B In any normal 7-day period there is a 95% chance that the portfolio will gain more than AUD1.7m. C In any normal 7-day period there is a 95% chance that the portfolio will lose more than AUD1.7m. D In any normal 7-day period there is a 5% chance that the portfolio will lose less than AUD1.7m.
Explanation - Correct Answer: A VAR is an estimate of maximum loss that, to a given probability level, will be experienced over a fixed time horizon under normal market circumstances. If we have a 95% 7-day VaR of AUD1.7m there is a 95% chance that the maximum loss we will experience in any 7-day period under normal market conditions is AUD1.7m and only a 5% chance it will exceed that level. Reference: 10.4.3
[4047707] A fund starts the year with a value of €40m. The value grows to €44m halfway through the year when the client invests a further €3m. At the end of the year the fund has a value of €50m. What is the time weighted return for the fund? A The answer is: 17%. B The answer is: 16.8%. C The answer is: 16.5%. D The answer is: 16.3%.
Explanation - Correct Answer: A Where we are looking at returns for sub-periods of a single year, the time weighted rate of return (TWRR) can be calculated as: TWRR = ((End value₁/Start value₁) × (End value₂/Start value₂)) - 1. Hence for the year in question: TWRR = ((44/40) × (50/47)) - 1 = 0.1702 or 17.0%. Reference: 10.4.1
[296077] Assuming a strategic asset allocation for a particular client has allocated 20% to developed market equities, 20% to emerging market equities, 20% to government bonds and 20% to corporate bonds, which of the following will realistically describe your proposed boundary limits for any strategic asset allocation adjustments? A The boundary limits for the four asset classes would all be different, the ranking from largest to smallest being developed market equities, emerging market equities, government bonds, corporate bonds. B The boundary limits for the four asset classes would all be different, the ranking from largest to smallest being emerging market equities, developed market equities, corporate bonds, government bonds. C The boundary limits for the four asset classes would all be different, the ranking from largest to smallest being emerging market equities, developed market equities, government bonds, corporate bonds. D The boundary limits for the four asset classes would all be different, the ranking from largest to smallest being developed market equities, emerging market equities, corporate bonds, government bonds.
Explanation - Correct Answer: B Boundary limits are typically higher for more volatile investments and lower for less volatile investments. Thus, emerging market equities would have the highest boundary limits, followed by developed market equities then corporate bonds, and finally government bonds would have the lowest boundary limits. . Reference: 10.8.5
[296063] You are discussing the pros and cons of active and passive investment management with one of your wealth clients. Which of the following approaches may be regarded as an approach that combines elements of both passive and active management? A Stock picking. B Enhanced indexing. C Index tracking. D Spread exploitation.
Explanation - Correct Answer: B Enhanced indexing is a hybrid investment management approach that combines elements of both passive and active management. Stock picking and spread exploitation are examples of active investment management styles and immunization is an example of passive management. Reference: 10.3.3
[296072] A client has been reading about the efficient frontier and the idea of dominance, and asks which of the following portfolios would not be on the efficient frontier. Which is a correct answer to provide? A Portfolio A with a return of 11% and a standard deviation of 13%. B Portfolio B with a return of 12% and a standard deviation of 17%. C Portfolio C with a return of 16% and a standard deviation of 20%. D Portfolio D with a return of 12% and a standard deviation of 15%.
Explanation - Correct Answer: B Portfolio B is dominated by Portfolio D so could not possibly be on the efficient frontier. Reference: 10.4.4
[4047720] You are given the following information for the market and for portfolio A: Risk-free rate of return = 2%; Return on the market = 12%; Beta of portfolio A = 1.2; Standard deviation of portfolio A = 12%; Return on portfolio A = 14%.Based on this information, which of the following is the Sharpe measure for portfolio A? A The Sharpe measure is 0. B The Sharpe measure is 1. C The Sharpe measure is 10. D The Sharpe measure is 100.
Explanation - Correct Answer: B Sharpe = (Return of portfolio - Risk-free rate) / Portfolio standard deviation. Sharpe = (14% - 2%) / 12% = 1. Reference: 10.6.3
[4047714] Which of the following statements is incorrect regarding the development of technical analysis? A Technological advancements have allowed technical analysts to quickly and conveniently undertake a thorough statistical analysis of large volumes of data. B Technical analysis was not used at all before the late 19th century when it was, due to technological circumstances, restricted to charts. C Hundreds of technical analysis patterns and signals have been identified and developed from market data over the years. D There is no universal agreement among technical analysts regarding which techniques should be applied and how they should be applied.
Explanation - Correct Answer: B Technical analysis has been used as a price forecasting tool for certain commodities since the 17th/18th century. Reference: 10.9.1
[4047719] Which of the following may be regarded as a major hurdle to the legitimacy of technical analysis? A The development of program trading. B The efficient market hypothesis. C The capital asset pricing model. D The development of the derivatives market.
Explanation - Correct Answer: B The efficient market hypothesis may be regarded as a major hurdle to the legitimacy of technical analysis. According to the EMH, in an efficient market the market price of a security reflects all information contained in current and past price movements, hence examining those movements will reveal no new information that may allow the technical analyst to identify mispricing and achieve outperformance. Reference: 10.9.5
[296062] You are explaining the stages of the general portfolio management process to one of your clients. Which of the following would you note to be the final stage in this general portfolio management process? A Developing the investment policy statement. B Monitoring and review. C Portfolio construction. D Client profiling.
Explanation - Correct Answer: B The general portfolio management process is: 1 Understand the client, i.e. analyse the client's profile (their objectives and constraints); 2 Develop an investment policy statement; 3 Portfolio construction, based on an analysis of the markets to establish a strategic asset allocation, followed by an analysis of investments for stock selection purposes; 4 Portfolio monotoring and review, performance must be analyzed at the end of the period to assess its adequacy and make any relevant portfolio adjustments. Reference: 10.1.5
[296059] You are discussing the relative advantages and disadvantages of active and passive investment management for a client's investment portfolio. Which of the following would you describe as one of the key advantages of passive investment management? A Due to their nature, passively managed funds have less stringent regulatory requirements than actively managed funds. B Passively managed funds have a lower investment management fees than actively managed funds. C Passive investment management offers a broader range of investment strategies than active investment management. D Passively managed investment funds consistently perform better than actively managed funds.
Explanation - Correct Answer: B The key advantages of passive investing are that it is cost efficient (lower management charges), transparent and makes it easier to control risk. Reference: 10.3.2
[296068] If a fund starts the year with a value of €60m, has €3m withdrawn in the middle of the year and ends the year with a value of €63m, what is its money weighted return of the fund? A The money weighted return is 9.87%. B The money weighted return is 10.25%. C The money weighted return is 10.63%. D The money weighted return is 10.81%.
Explanation - Correct Answer: B The money weighted return is the internal rate of return of an investment, i.e. when the present value of inflows (initial cash received) equal the present value of the outflows (mid-year withdrawal and end value). The calculation here is, therefore: 60 = 3/(1 + r)⁰˙⁵ + 63/(1 + r). Through trial and error we can establish that the rate that works is 10.25%. Reference: 10.4.1
[306967] A portfolio is invested 25% in Security A, 35% in Security B and 40% and Security C. If Security A is returning 12%, Security B is returning 14% and Security C is returning 11%, what will be the return on the portfolio overall? A The portfolio return will be 12.1%. B The portfolio return will be 12.3%. C The portfolio return will be 12.5%. D The portfolio return will be 12.7%.
Explanation - Correct Answer: B The overall portfolio return will be: Return = 0.25 × 12% + 0.35 × 14% + 0.40 × 11% = 12.3%. Reference: 10.4.1
[296078] Which of the following is NOT a commonly used multi-factor model? A Statistical factor model. B Management factor model. C Fundamental factor model. D Macroeconomic risk factor model.
Explanation - Correct Answer: B The three types of model are: Fundamental, statistical and macroeconomic. Multi-factor models are empirically derived models that seek to identify those systematic risk factors that explain observed returns in the market. Management is a specific factor that can be diversified away and is therefore irrelevant. Reference: 10.5.4
[296056] Felix is an investment analyst. During an internal training session, he explains to his colleagues that he believes that although share prices adjust to publicly available new information very rapidly, and in an unbiased fashion, fundamental analysis can support price prediction. Which of the following statements best represents Felix's view of market efficiency? A Weak form efficiency. B Semi-strong form efficient. C Strong form efficiency. D Fundamental inefficiency.
Explanation - Correct Answer: B There are three forms of market efficiency: (1) Weak-form efficiency: Future prices cannot be predicted by analyzing prices from the past. (2) Semi-strong form efficiency: Prices adjust to publicly available new information very rapidly and in an unbiased fashion, such that no excess returns can be earned by trading on that information; fundamental analysis can support price prediction. This is Felix's view.(3) Strong-form efficiency: Share prices reflect all information, public and private, and no excess returns can be earned on the basis of information (not even insider information). Because of market inefficiencies and the illegality of insider dealing, this is unlikely to ever be the situation. Reference: 10.2.1
[296087] Which of the following statements regarding tracking error is true? A It is most relevant for actively managed funds. B A low tracking error means the portfolio is closely following its benchmark. C It is also known as passive risk. D It is the variance of the difference between the performance of a portfolio and the performance of a benchmark index.
Explanation - Correct Answer: B Tracking error measures the standard deviation of the spread or difference between the portfolio's return and the benchmark's return, hence a low tracking error means a portfolio is closely following its benchmark. It is primarily used for passive funds, however it can also be calculated for active funds. Tracking error is alternatively known as active risk and is the denominator to the information ratio. Reference: 10.6.2
[296086] Which of the following statements is false regarding compliance with GIPS? A The transparent comparison of risk and return should include the currency in which performance is reported. B Verification is optional: Firms do not need to show whether they are verified or not. C Risk metrics should be the annualized three-year standard deviation. D If a firm is going to comply with GIPS, it must do so on a firm-wide basis.
Explanation - Correct Answer: B Verification is optional, however firms must disclose whether they are verified or not. Reference: 10.6.4
[296057] You are explaining to your client that a well-designed portfolio strategy will include an investment philosophy, i.e. a set of core principles, tools and frameworks that guide the investment decision process for the client. Which one of the following research methods best describes an active fund manager who will look for trends and patterns within stock markets? A Quantitative analysis. B Fundamental analysis. C Technical analysis. D Inherent valuation.
Explanation - Correct Answer: C Active managers often try to identify and capture market inefficiencies through fundamental research. For equity investors, this process means conducting a detailed and thorough analysis of the business model and prospects of the company and of its financial situation. Some managers try to build statistical models that identify shares likely to outperform. By analyzing data, they identify characteristics that have typically been associated with share price outperformance. Managers using this approach are often called 'quants', after the quantitative models they use. Some managers take what is known as a 'technical' approach, seeking to assess price and trading volume trends within the stock market to identify shares that will outperform. Reference: 10.2.1
[296082] A stock was bought for USD 332 and sold for USD 395 the following year. During this period, the stock paid USD 7 in dividends. The total return over the holding period is closest to: A The total return over the holding period is 14%. B The total return over the holding period is 19%. C The total return over the holding period is 21%. D The total return over the holding period is 10%.
Explanation - Correct Answer: C HPR = ((Ve - Vs) + D)/VsHPR = ((395 - 332) + 7)/332 = 0.21 or 21%. Reference: 10.4.1
[4047715] Which of the following terms would you associate with technical analysis rather than fundamental analysis? A Sector analysis. B Financial statement analysis. C Price analysis. D Business analysis.
Explanation - Correct Answer: C Price analysis is associated with technical analysis because it involves identifying trading opportunities through the analysis of statistical trends gathered from trading activity, such as price movement and volume. Reference: 10.9.2
[296075] Systematic risk is also known as: A Firm-specific risk. B Diversifiable risk. C Market risk. D Unique risk.
Explanation - Correct Answer: C Systematic risk is also referred to as non-diversifiable risk and market risk. Reference: 10.4.7
[4047718] Which of the following statements regarding the modern assumptions of technical analysis is INCORRECT? A Only technical analysts believe that market psychology and behavioral issues such as loss aversion, regret aversion, herding etc. may result in repeated patterns. B Technical analysts believe that fundamental analysis drivers are already factored into existing prices due to the actions of fundamental analysts. C Technical analysts believe that only short-term trends can be identified. D Technical analysts believe that charts help identify price patterns, providing evidence of future price movements.
Explanation - Correct Answer: C Technical analysts believe that short-term, medium-term and long-term trends can be identified. Reference: 10.5.5
[296079] Which of the following represents the y-value of the security market line (SML)? A Alpha. B Beta. C Return. D Risk premium.
Explanation - Correct Answer: C The SML expresses CAPM as a straight line (expected return as a function of Beta risk). CAPM = Risk-free rate + Beta (Return on market - Risk-free rate). Formula for a straight line: y = a + bx. CAPM = y-value. Risk-free rate = a = Intercept of y-axis. Beta = x-value. Return on market - Risk-free rate = Market risk premium = b = Slope. Reference: 10.5.3
[306966] A client has 40% of their total portfolio invested in fund A, with the remaining 60% split equally between funds B and C. If the returns on the funds are 8%, 10% and 12% respectively, what is the client's overall portfolio return? A The overall return is 10.4%. B The overall return is 10.1%. C The overall return is 9.8%. D The overall return is 9.6%.
Explanation - Correct Answer: C The client's overall portfolio return is the weighted average of the individual fund returns, i.e. Portfolio return = (8% × 0.40 + 10% × 0.30 + 12% × 0.30) = 9.8%. Reference: 10.4.1
[4047704] The efficient market hypothesis considers the way in which new information is assimilated into the market price of instruments and describes three different forms of market efficiency. Which of the following is NOT one of those levels? A Strong form. B Semi-strong form. C Semi-weak form. D Weak form.
Explanation - Correct Answer: C The efficient market hypothesis examines three forms of market efficiency: Weak form; semi-strong form; and strong form. Reference: 10.2.1
[296060] You are meeting a new client for the first time and discussing the general portfolio management process to be employed in establishing and managing an investment portfolio on their behalf. Which of the following would be correct for you to state? A The first stage in the process is to determine your objectives and investment constraints. Once we have undertaken this we can move on to developing a strategic asset allocation and select the specific stocks to hold in your portfolio before finalizing the investment policy statement. B The first stage in the process is to develop an investment policy statement based on an analysis of the current market circumstances which leads to us developing a strategic asset allocation and selecting the stocks to hold in your portfolio. C The first stage in the process is to determine your objectives and investment constraints. Once we have undertaken this we can move on to developing an investment policy statement that we will use to determine a strategic asset allocation and select the stocks to hold in your portfolio. D The first stage in the process is to develop an investment policy statement. We will then move on to analyzing your objectives and constraints which will allow us to develop a strategic asset allocation and select the stocks to hold in your portfolio.
Explanation - Correct Answer: C The general portfolio management process is: 1 Understand the client, i.e. analyse the client's profile (their objectives and constraints); 2 Develop an investment policy statement; 3 Portfolio construction, based on an analysis of the markets to establish a strategic asset allocation, followed by an analysis of investments for stock selection purposes; 4 Portfolio monitoring and review, performance must be analyzed at the end of the period to assess its adequacy and make any relevant portfolio adjustments. Reference: 10.1
[296065] You are meeting a client for the first time with the aim of developing and constructing an investment portfolio. Which of the following will be the first area for you to consider? A Portfolio construction and management. B Development of investment policy statement. C Profiling and client analysis. D Portfolio monitoring and review.
Explanation - Correct Answer: C The general portfolio management process is: 1. Understand the client, i.e. analyze the client's profile (their objectives and constraints); 2. Develop an investment policy statement; 3. Portfolio construction, based on an analysis of the markets to establish a strategic asset allocation, followed by an analysis of investments for stock selection purposes; 4. Portfolio monitoring and review, performance must be analyzed at the end of the period to assess its adequacy and make any relevant portfolio adjustments. Reference: 10.1
[296055] When engaging in business with a potential client it is important to assess their risk tolerance. This can be achieved by: A Interviewing their bank manager about financial capacity and their family and friends to assess the appetite for risk. B Ensuring they are certified by their employer as a sophisticated investor and they have a large disposable income. C Using questionnaires to gauge the investor's attitudes and reactions to hypothetical losses. D Assessing the client's deviation from a 60/40 equity debt split.
Explanation - Correct Answer: C The investor's risk tolerance is their willingness to take risk which is related to the investor's psychology and may be assessed using questionnaires completed by the investor. Reference: 10.1
[296069] As an investment manager for a Welsh client you have no control over the cash inflows and outflows from the client's portfolio. Which of the following measures would you consider to be most appropriate for assessing your performance? A The portfolio's annualized geometric mean return. B The portfolio's average holding period return. C The portfolio's time weighted return. D The portfolio's money weighted return.
Explanation - Correct Answer: C The time weighted return is commonly used to assess fund manager performance as it removes the impact of capital contributions or withdrawals made by the investor during the investment period that are not gains or losses attributable to the fund manager. Reference: 10.4.1
[296064] A fund starts the year with a value of £100m which grows by 15% over the first half of the year when a further £15m is invested. If at end of the year the fund is worth £150m what is the time weighted return of the fund? A The time weighted return is 28.6%. B The time weighted return is 31.2%. C The time weighted return is 32.7%. D The time weighted return is 34.4%.
Explanation - Correct Answer: C Where we are looking at returns for sub-periods of a single year, the time weighted rate of return (TWRR) can be calculated as: TWRR = ((End value₁/Start value₁) × (End value₂/Start value₂)) - 1. Hence for the year in question: TWRR = (£115m/£100m × £150m/£130m) - 1 = 0.327 or 32.7%. Reference: 10.4.1
[296081] You are managing the assets in a client's investment portfolio by reference to the securities market line. Which of the following statements would be true in respect of your approach? A A security that lies above the securities market line is overvalued, providing a positive Alpha. B A security that lies above the securities market line is overvalued, providing a negative Alpha. C A security that lies below the securities market line is overvalued, providing a positive Alpha. D A security that lies below the securities market line is overvalued, providing a negative Alpha
Explanation - Correct Answer: D A security that lies above the securities market line is undervalued, providing a positive Alpha, and if it is expected that this will continue the security should be considered a BUY. In contrast, a security that lies below the securities market line is overvalued, providing a negative Alpha, and if this is expected to continue the security should be considered a SELL. Reference: 10.5.3
[4047709] A client has determined that the annual volatility of his portfolio is 12% but wishes to know from you the monthly volatility. Which of the following would be the correct figure for you to provide? A The monthly volatility is 1%. B The monthly volatility is 1.41%. C The monthly volatility is 2.83%. D The monthly volatility is 3.46%.
Explanation - Correct Answer: D Annualized portfolio volatility = σ√T where σ is the volatility for the period assessed (the time horizon over which returns are computed) and T is a number of periods per annum. If the annual volatility is 12% and we are looking to assess the monthly volatility the relationship we need to solve is: 12% = σ*√12, so σ = 0.12/ √12 = 0.034641 or 3.4641%. Reference: 10.4.5
[4047711] Which of the following is a technique for testing technical analysis strategy against historical data? A Regression analysis. B Stochastic oscillators. C Correlations. D Back testing.
Explanation - Correct Answer: D Back testing is a technique for testing a technical analysis strategy against historical data. Reference: 10.9.4
[4047702] Which of the following will you not need to consider when conducting the client analysis and profiling stage of the UBS wealth management framework? A Liquidity requirements. B Investment horizon. C Risk tolerance. D Economic circumstances.
Explanation - Correct Answer: D Client analysis examines: Client goals and required returns; clients' risk aversion/tolerance; liquidity requirements; investment time horizon; financial circumstances; and other requirements (such as tax and ethical investing). Economic circumstances would be part of market analysis during the information gathering stage of the portfolio management process. Reference: 10.7.2
[296076] A client is concerned about the level of risk in their portfolio and enquires into the adequacy of the diversification that you have achieved. Which of the following responses would be correct for you to provide? A Virtually all of the systematic risk of a portfolio can be diversified away through holding just 50 securities. B Virtually all of the systematic risk of a portfolio can be diversified away through holding just 20 securities. C Virtually all of the unsystematic risk of a portfolio can be diversified away through holding just 50 securities. D Virtually all of the unsystematic risk of a portfolio can be diversified away through holding just 20 securities.
Explanation - Correct Answer: D It has been mathematically proven that virtually all of the non-systematic risk can be diversified away with a portfolio of just 20 securities. Reference: 10.4.7
[4047716] Which of the following is NOT a modern day assumption of technical analysis? A The market discounts everything. B Prices move in trends. C History tends to repeat itself. D Market prices follow a random walk.
Explanation - Correct Answer: D Market prices follow a random walk is not one of the modern day assumptions, which are that: the market discounts everything.; prices move in trends; and history tends to repeat itself. Reference: 10.9.3
[4047713] Which of the following statements regarding technical analysis is invalid? A As a tool for general financial markets and instruments, technical analysis was proposed by Charles Dow. B In its original form for use in financial markets, technical analysis concentrated on analyzing trends and identifying patterns of price movements through the use of charts. C Advances in technology have aided the development of technical analysis techniques and will probably continue to do so. D Technical analysis is a totally objective analysis technique that produces consistently reliable trading signals.
Explanation - Correct Answer: D Technical analysis is a quite subjective (rather than totally objective) analysis technique and consequently does not produce consistently reliable trading signals. Reference: 10.9.1
[296066] Which of the following is NOT TRUE of the normal distribution? A It is a bell-shaped distribution. B The total area above the mean is 0.5. C It is a symmetrical distribution. D The total area below the distribution is 0.5.
Explanation - Correct Answer: D The normal distribution is a symmetrical bell-shaped distribution with a total area of 1, hence the area above the mean is 0.5, as is the area below the mean. Reference: 10.4.3
[296071] You are explaining the issue of rational risk aversion to a client, which of the following would NOT be acceptable to a rational, risk averse investor? A A higher return the same risk. B The same return at a lower risk. C A higher return at a lower risk. D A lower return at a higher risk.
Explanation - Correct Answer: D The risk return framework would suggest that a rational investor would always choose a portfolio that provides a higher expected return at the same risk, the same return at lower risk, or a higher return at a lower risk. They would never accept a lower return at a higher risk. Reference: 10.4.4
[4047708] You are determining asset allocations for a number of clients, which of the following allocation decisions is most likely to be correct? A You will allocate more to real estate than to developed equity markets for aggressive investors. B You will allocate more to alternatives than to emerging markets for balanced investors. C You will allocate more to corporate bonds than to government bonds for balanced investors. D You will allocate more to bonds than to equities for cautious investors.
Explanation - Correct Answer: D The statement that is most likely to be correct is that you will allocate more to bonds than to equities for cautious investors. Reference: 10.8.2
[296061] You are undertaking the portfolio monitoring and revision phase of the general portfolio management process with your client. Which of the following will you not be undertaking at this stage? A General review. B Asset allocation review. C Performance review. D Portfolio objectives review.
Explanation - Correct Answer: D There are four reviews undertaken during the portfolio monitoring and revision process, specifically: a general review of the client's objectives and constraints; an asset allocation review; a securities weightings review; and a performance review. Where relevant, stock selection decisions should be undertaken on an ongoing basis, not simply on a periodic basis. Reference: 10.1.5
[296085] Based on the following information, which of the following is the Treynor measure for client portfolio A? Risk-free rate of return = 2%; Return on the market = 12%; Beta of portfolio A = 1.2; Standard deviation of portfolio A = 12%; Return on portfolio A = 14%. A The answer is: -1%. B The answer is: 0. C The answer is: 1%. D The answer is: 10%.
Explanation - Correct Answer: D Treynor = (Return of portfolio - Risk-free rate) / Portfolio betaTreynor = (14% - 2%) / 1.2 = 10%. Reference: 10.6.3
[296074] You are discussing the concept of diversification and portfolio risk with one of your clients who has become a little confused about the distinction between volatility and variance. In this context, which of the following statements is true? A There is no distinction between the two ideas, volatility and variance are identical. B Volatility is the square of the variance and is used to calculate expected risk from a portfolio. C Variance is the square of volatility and is used to calculate the expected return of a portfolio. D Variance is the square of volatility and is used to calculate the expected risk of a portfolio.
Explanation - Correct Answer: D Variance is the square of volatility (standard deviation) and is used to calculate the expected risk of a portfolio. Reference: 10.4.3
What is the top-down approach?
From macroeconomics to industry to company analysis
What is risk tolerance?
How much risk can the client tolerate. The maximum volatility an investor is emotionally capable of tolerating, the "losses" that the investor is comfortable to experience.
Total return =
Income + Gain/capital growth
What does IPS stand for ?
Investment Policy Statement
What is rational risk aversion?
Investors are aware that investment risk exists and respond rationally to it, i.e. If they face a higher risk they demand a higher return
What are return requirements ?
Is the client seeking income, capital appreciation or some combination ?
What are the hard facts in understanding the client ?
Objective facts such as age, income, wealth, family circumstances, tax residence, etc.
What is the management style ?
Passive management, active management, or some combination of both.
What does SAA stand for ?
Strategic Asset allocation
What are the soft facts in understanding the client ?
Subjective opinions and feelings on issues such as their risk tolerance, i.e. how much risk they can emotionally withstand.
What does TAA stand for ?
Tactical Asset Allocation
What is risk capacity ?
The financial capability of client to withstand any losses that may arise.
What is normal risk ?
The potential variability in the returns of any investment, probability of unwanted outcomes.
What is utility?
Utility is a measure of satisfaction that an investor derives from different portfolios. Using utility, the investor is able to rank investments.
What are the 5 categories of portfolio constraints ?
■ Liquidity. ■ Time horizon. ■ Taxes. ■ Legal and regulatory environment. ■ Unique circumstances.
What does the questionnaire usually cover ?
■ Personal goals - e.g. house purchase vs. renting or early retirement ■ Financial goals - e.g. asset growth or income needs ■ Risk appetite and loss tolerance ■ Liquidity needs ■ Investment time horizon and/or age ■ Financial expertise ■ Personal preferences - e.g. involvement in the investment decision process, frequency of contact with the financial advisor, asset classes and sophistication of investment instruments they are comfortable with, etc. ■ Overall costs of the investment plan
