Bundle
Bundle for PORTFOLIO exam| verified
10 Items
Portfolio Management questions and answers, latest updated|100% accurate
Diversification of a portfolio among asset classes: A increases the rate of return achieved over the investment time horizon B reduces the rate of re... [Show More] turn achieved over the investment time horizon C reduces the variability of the rate of return over the investment time horizon D increases the variability of the rate of return over the investment time horizon C. Diversification reduces the variability of investment returns over the investment time horizon. In a diversified portfolio, some investments will be under-performing and some will be over-performing, tending to average out the rate of return. Thus, variability of the rate of return is reduced. The use of index funds as investment vehicles for asset classes increases: A diversification B expected rate of return C standard deviation of return D market risk A. Index funds are broadly diversified, since they hold all of the securities in the designated index. This reduces market risk or the standard deviation of returns. The impact of diversification on rate of return should be one of lowering the rate of return compared to the market average, along with lowering the risk associated with that rate of return. Which of the following would be least important in determining the level of diversification in a corporate bond portfolio? A Bond ratings B Industries represented in portfolio C Domicile of issuers D Maturities of the bonds in the portfolio C. The "domicile" of an issuer is the state where the issuer legally resides. It has no bearing on the quality of the issuer's securities. Bond rating, type of industry, and maturity would all be considered when examining the diversification of a bond portfolio. A customer holds a large portfolio of corporate bonds. The customer is worried about capital risk. Which diversification strategy would be least effective to minimize capital risk for this customer? A Diversification among differing issuers in differing states B Diversification among differing denominations C Diversification among differing industries D Diversification among differing maturities B. Effective methods of diversifying away the unsystematic risk of a portfolio would be to diversify among different issuers, different states, and different industries. Thus, if one issuer, industry or economic region has problems, this would only affect a small portion of the portfolio. Diversification among differing maturities also provides a measure of risk management. If market interest rates rise, short term maturities (under 1 year) will decline in price by a minimal amount compared with longer maturities. Thus, a mix of maturities helps to minimize capital risk. Bond denominations have no bearing on diversification. Passive portfolio management is: A buying and holding the investments chosen by the Registered Representative B determining the securities to be bought or sold based on investment research performed by the Registered Representative C managing a portfolio to meet the performance of a benchmark portfolio D managing a portfolio to exceed the performance of a benchmark portfolio C. Passive portfolio management is the management of a portfolio to meet the performance of a benchmark, such as a designated index. Active portfolio management attempts to beat the performance of the benchmark portfolio through better security selection and better investment timing. Review The portfolio management technique that uses a market index as a performance benchmark that the asset manager must exceed is called: A Passive asset management B Active asset management C Strategic asset management D Tactical asset management B. Active asset management is the management of a portfolio to exceed a benchmark return (say the return of a comparable index fund). The manager's "active" return is any incremental return achieved over the benchmark return. In contrast, passive asset management is simply the management of a portfolio to match the benchmark return (the "passive return"). Active managers believe that underpriced securities can be found in the market and that performance of the benchmark can be exceeded. Passive managers believe that the market is efficient at pricing securities and that one cannot do any better than the "market" return as measured by a relevant index. The setting of specific goals for an investment plan to be created for a customer is known as: A Strategic asset management B Tactical asset management C Dollar cost averaging D Portfolio rebalancing A. Strategic asset management is the setting of the investment "strategy" under an asset allocation scheme. Tactical asset management is the permitted variation to the established strategy, to take advantage of market opportunities. Dollar cost averaging is the periodic (say monthly) investment of a fixed dollar amount into a given security. By using dollar cost averaging, the average cost per share purchased can be lower than the arithmetical average cost of the security over the same time frame - as long as the security's price has been moving up and down (as the security's price drops, the fixed periodic dollar amount buys proportionately more shares than when the security's price rises). Portfolio rebalancing is used in an asset allocation scheme when a chosen asset class outperforms the others, so that its percentage allocation increases beyond the strategic limit. The excess in that class is sold off and the proceeds reinvested in the other asset classes to rebalance the portfolio back to its strategically set percentages. Tactical portfolio management is the selection of the: A securities in which to invest B asset classes in which to invest C target asset allocation for each asset class selected for investment D variation permitted in target asset allocation for each asset class selected for investment D. Strategic asset allocation is the determination of the target percentage to be allocated to each asset class (e.g., 25% Treasuries; 25% Corp. Debt; 50% Equities). Tactical asset allocation is the permitted variation around each of the chosen percentages - for example, even though Equities are targeted at 50%, this might be allowed to be dropped to as low as 40%, or as high as 60%, depending on market conditions. Which statements are TRUE about asset classes and investment time horizons? I Equity investments are the better choice for short term time horizons II Interest bearing investments are the better choice for short term time horizons III Equity investments are the better choice for long term time horizons IV Interest bearing investments are the better choice for long term time horizons A I and III B I and IV C II and III D II and IV C. Equity investments typically produce a higher rate of return with higher volatility - thus a long time horizon is needed to achieve consistent results with equity investments. Interest bearing investments produce a lower rate of return with lower volatility - thus they are suitable for portfolios with short time horizons. The time horizon to be used when constructing a portfolio to pay for college expenses for a person who is expected to start college in 10 years and finish college in 15 years is: A 5 years B 10 years C 12.5 years D 15 years D. If a portfolio is being constructed to fund a person's college education, it must be able to provide income to pay for college until schooling is finished. Review Value investors: A seek to find investments that are undervalued by the market B determine the value of a security through fundamental analysis C invest in securities included in the Value Line Index D make their investment decision based upon the market performance of the security A. Value investors believe that the market is not completely efficient at pricing securities and that undervalued securities can be found in the marketplace. Once the market realizes the true worth of these undervalued companies, their prices should rise at a greater rate than the general market. The investment strategy that involves paying a lower price for a security based on the expectation that the market is mispricing the issue is: A growth investing B value investing C passive investing D active investing B. Value investing is the selection of equity investments based on finding securities that are fundamentally undervalued in the marketplace. These tend to be solid companies that are currently "out of favor." Value investors look at such fundamental factors as the Price/Earnings ratio; and Price/Book Value ratio to find companies that are undervalued relative to their market sector. An investment strategy where a higher price is paid for a stock based upon expected returns is: A growth investing B value investing C conservative investing D passive investing A. A growth investor buys a stock based upon demonstrated growth in earnings or sales over time. The theory is that such companies can continue to grow rapidly, and therefore should command a higher market price. If one asset class greatly underperforms another class in an asset allocation plan, the portfolio must be: A renegotiated B rebalanced C repositioned D realigned B. When investment performance varies over time from one asset class to another, the target percentage allocations will shift from their optimal setting. To bring the portfolio back to these targets, it must be rebalanced - that is, a portion of the overperforming class(es) must be sold off and the proceeds reinvested in the underperforming class(es). Which bond portfolio where all investment is made up front would be LEAST negatively affected by a sharp rise in interest rates? A Ladder B Bullet C Barbell D Balloon A. Bullets, Bond Ladders, and Barbells are portfolio constructions that are used to limit interest rate risk. The idea behind a bond ladder is to spread bond maturities in a portfolio over fixed intervals, typically 10 maturities in intervals of 2 years each. A typical ladder might have 10 maturities ranging from 2 to 20 years, with an average maturity of around 10 years. Because of this broad diversification by maturity, a rise in interest rates will not impact the portfolio as negatively as compared to a bullet or barbell portfolio construction. If interest rates rise, the loss on the longer term bonds in the portfolio is offset by the fact that shorter term bonds are maturing soon and the proceeds can be reinvested at higher rates. A barbell portfolio only has 2 maturities - a very short term and a very long term - say 2 years and 20 years, for an average life around 10 years (actually 11 years here, but we are simplifying things). The longer term bonds give a higher yield but have higher interest rate risk. This risk is offset by the fact that the 2 year bonds will mature soon and the proceeds can be reinvested at higher rates. The big risk here is that long rates rise sharply as compared to short rates (a steepening of the yield curve). In this scenario, the loss on the long term bonds will be much greater than the fact that the short term bond proceeds can be reinvested in 2 years at somewhat higher rates. A bullet portfolio construction only has a single maturity, typically in an intermediate range of around 10 years. The way that interest rate risk is offset here is that all of the investment is not made at one time - rather, the investment is made in installments at fixed intervals. If market interest rates rise, new investment will be made at higher rates, offsetting any loss on the already purchased bonds. Also note that this cannot be a correct answer to the question because all investment is not made up front - rather, the investment is made in stages. A balloon is a type of bond issue structure, where most of the bonds mature as a "balloon" at a long term maturity date. It is not a type of bond portfolio construction. A registered representative has a client who is an exceptionally intelligent doctor of medicine. The doctor does most of his own investment research and makes many of his own investment decisions. The doctor is married, but his wife is not involved in the investment planning or decision-making process. When constructing a portfolio for this client, the registered representative should: A choose the investments in the portfolio based solely on the research conducted by the doctor B balance the portfolio in a manner that addresses the doctor's investment strategy and that customizes the strategy to meet the needs of the spouse C charge fees on the assets held in the portfolio that were chosen by the representative without using the doctor's research D disregard the doctor's research because the doctor is not properly licensed to act as a representative B. When constructing a portfolio for a client, the representative can take into account a customer's special expertise in a given area when selecting specific investments. For example, a doctor might have a special insight into the sales prospects for a medical device manufacturer, and could tell the representative that he wants to invest in this company. It is the role of the representative to review this investment decision and, if appropriate, to make sure that it is not overweighted in the portfolio. Because the doctor is married, the representative should construct the portfolio to meet both the needs of the doctor and his wife. An investor has a long-term investment time horizon, no liquidity needs and is very risk averse. Your main concern when making a recommendation to this client is: A preservation of capital B safety of principal C continuing income D adequate yield B. This client has no liquidity needs, so Choices C and D - continuing income and adequate yield, are not concerns. So it comes down to whether the main concern is preservation of capital or safety of principal. Preservation of capital is a concern for client who has no buffer if investment values decline. Such a client cannot afford to lose any money and should only be recommended CDs and money market funds as an investment. Because this client has "no liquidity needs," he or she is not in this situation. Safety of principal is the better answer as a "concern." This type of client doesn't want his or her principal put at risk - he or she is just averse to taking on risk, but can afford to do so. Such a client could be recommended CDs, money market funds, short term bonds and laddered bond portfolios. A new client with no other investment assets has just come into an inheritance of $500,000 of ABCD stock, a blue chip company listed on the NYSE. As the adviser to this customer, your IMMEDIATE concern should be: A whether the company is a candidate for delisting B the possibility that the value of ABCD stock may decline sharply C the lack of diversification of the customer's investment D whether the customer paid any estate tax liability due C. This is the client's sole investment. Because this is a blue chip company, it is not likely to be delisted. It is also not likely to suffer a sharp price decline, though this could occur. The immediate concern should be the customer's lack of diversification. If the customer were to sell a portion of the ABCD stock and reallocate it to other investments, the client will reduce overall risk. An individual who is 25 years from retirement has $500,000 to invest today. He is risk tolerant and is looking to withdraw $80,000 per year once he retires. Which asset allocation is BEST for this client? A 25% Stocks / 25% Bonds / 25% REITs / 25% Money Markets B 50% Stocks / 40% Bonds/ 10% Cash C 100% Bonds D 100% Stocks B. We are not given the age of this customer, but since he or she is 25 years from retirement, we can guess that the customer is around 40-50 years old. Based on the rule of thumb that "100% minus the customer's age" should be allocated to stocks for growth, a stock allocation of 40-50% is about right. This makes Choice B the best offered. No asset class diversification (Choices C and D) is not the way to go (100% stocks is too risky and 100% bonds is too conservative). The asset allocation offered in Choice A is not weighted heavily enough in stocks and is too conservative to meet the customer's goal. Also note, that while not relevant to the question, if the $500,000 invested earns 5% per year, after 25 years, the account will be worth about $1,700,000. If the customer is now age 65 or so, this would give retirement income for around 20 years at the rate of $80,000 per year. What portfolio construction is most appropriate for a retired doctor who is age 75? A 100% common stocks B 75% common stock / 25% bonds C 25% common stock / 75% bonds D 100% bonds C. As one gets older, portfolio composition should shift to "safer" assets that generate reliable income. The general rule is to take "100 minus the investor's age" to get the appropriate investment portion to be held in stocks. Since this investor is age 75, this gives 25% of the portfolio holding in stocks; with the remaining 75% of the holding in bonds. Note that a 100% bond holding is not appropriate because people are living much longer and they need the "extra return" that is provided by stocks that can grow in value, on top of the somewhat lower fixed return provided by bonds. A constant ratio investment plan requires: A that the same percentage amount be invested periodically in new equities purchases B that the same percentage amount be kept invested in equities C the constant reinvestment of all dividends and interest received in the percentage as the securities held in the portfolio D that a constant percentage amount be invested in U.S. securities B. Under a constant ratio plan, a portfolio manager sets a fixed percentage level (say 70% of total asset value) to be maintained in equity securities. If the value rises above 70%, the excess is sold, and invested in debt securities. Conversely, if the equity market value drops below 70% of the portfolio, bonds are liquidated and invested in equities to bring the equity balance to the constant 70%. Institutional portfolio managers have been allocating an increasing percentage of their funds to common stock positions. This is an indication that their market sentiment is: A bullish B neutral C bearish D cautious A. From a "market sentiment" standpoint, a portfolio manager will decrease the cash position and increase the portion of the portfolio invested in common stocks when he or she is bullish on the market. Conversely, if the manager is bearish on the market, he or she will increase the cash position; and decrease the portion of funds invested in securities. [Show Less]
- Exam
- $11.45
- 0
- 107
UNIT #23: Portfolio Performance Measures questions and answers |all correct
A stock is currently worth $75. If the stock was purchased one year ago for $60, and the stock paid a $1.50 dividend over the course of the year, what is t... [Show More] he holding period return? A) 22.0% B) 27.5% C) 24.0% D) 25.0% B *(75 − 60 + 1.50) ÷ 60 = 0.2750, or 27.5%. A client purchased a security for $60 and sold it 1 year later for $59. If he received 4 quarterly dividends of $0.50 each during the period, his total percentage return would be A) 3.30% B) 0% C) 1.67% D) 2% C *The total return on an investment is the sum of the capital gains/losses plus any income distribution such as dividends or interest. In this case, the client had a capital loss of $1 ($60 − $59 = $1), which was offset by $2 (4 × $0.50 = $2) in dividend distributions for a total dollar return of $1. In percentage terms, the return is calculated by dividing the dollar return amount by the total invested or $1 divided by $60 = 1.67%. 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) 70% B) 100% C) 200% D) 85% D *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. One of the important roles of an investment adviser representative is assisting clients in analyzing the performance of securities held in their portfolios. Which of the following is the best measurement of a security's performance? A) Total return B) Standard deviation C) Beta D) Yield A *Total return reflects the entirety of a security's performance because it includes both income and capital appreciation. Beta and standard deviation are risk measurements, and while they may be used to evaluate a security's performance when compared to the risk taken, they don't truly provide a measurement as does total return. 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) 9%. B) 5%. C) 4%. D) 7.5%. A *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%. 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) 2.13% C) 2% D) 6.34% C *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%. When an investor's original value is subtracted from the ending value, and then has the income received over that time period added to it, which is then divided by the original cost, the result is A) internal rate of return B) annualized return C) expected return D) holding period return D *This is the method of computing holding period return. An investment is made of $10,000. At the end of the year, $500 in nonqualifying dividends has been received and the value of the investment is $10,500. If the investor is in the 30% tax bracket, the after-tax yield is A) 3.5% B) 6.5% C) 8.5% D) 5.0% A *The only return (as far as yield is concerned) is the $500 of dividends. Remember, nonqualifying dividends do not "qualify" for the 15% rate. Subtracting 30% for taxes leaves $350 which, when divided by the $10,000 initial cost, is an after-tax yield of 3.5%. If the question had asked about total return, then the $500 unrealized profit would have been included, although there would have been no tax on it. 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 *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%. 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) There is no appropriate benchmark against which an investor can compare a portfolio of foreign securities. B) 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. C) No, it is preferable to compare the fund against the Russell 2,000 Index because it covers smaller corporation stocks. D) Yes, the S&P 500 is an appropriate benchmark against which to compare the performance of all equity funds. B *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. If you knew a given stock had a 40% chance of earning a 10% return, a 40% chance of earning −20%, and a 20% chance of earning −10%, the expected return would be equal to A) −6% B) 10% C) −10% D) 14% A *The expected return is computed by taking the probability of each possible return outcome, multiplying it by the return outcome itself, and then adding them all together. In this case, the math is as follows: (0.4 × 10%) + (0.4 × −20%) + (0.2 × −10%), or +4% − 8% − 2%, which equals -6%. Part of the trick here is catching the probable negative returns and the ridiculous assumption that an investor would consider looking at a stock with this kind of expected return. You can always count on NASAA to surprise you. If the return on Treasury bills is 3% and the equity risk premium is 4%, the expected equity returns should be A) 7% B) 1% C) 12% D) 4% A *The expected return on an equity investment is the risk-free (for example, T-bill) rate of return added to the equity risk premium (3% + 4% = 7%). This is the performance of your portfolio over the previous 4 years: -Year 1 - 10% -Year 2 - 45% -Year 3 + 20% -Year 4 + 35% In order for the portfolio to be equal to the starting investment, the return in Year 5 must be nearest to A) 33%. B) 25%. C) 0%. D) 20%. * -In Year 1, you lose 10%. Your portfolio is now worth $1,000 x (1 - 0.1) = $1,000 x 0.9 = $900. -In Year 2, you lose 45%. Your portfolio is now worth $900 x (1 - 0.45) = $900 x 0.55 = $495. -In Year 3, you gain 20%. Your portfolio is now worth $495 x (1 + 0.2) = $495 x 1.2 = $594. -In Year 4, you gain 35%. Your portfolio is now worth $594 x (1 + 0.35) = $594 x 1.35 = $801.9. -You would like to know by how much your portfolio needs to appreciate in Year 5 to be worth its original value of $1,000. Let's set "y" to be this number. Then we have: -$801.9 x (1 + y) = $1,000. Solving this equation for "y" gives: y = ($1,000 ÷ $801.9) - 1 = 0.247 = 24.7%. Rounding this answer in percentage terms (24.7%) to the nearest integer yields the desired answer of 25%. -Your portfolio thus needs to increase by nearly 25% in Year 5 for it to be worth its original value of $1,000. -Some might find it easier to look at the shortfall ($1,000 - $801.90) = $198.10. Divide that by the current value and you have 198.10 ÷ 801.90 = 24.7%. -Some might just look at the number and recognize that you are about $200 short on a value of $800 and that is 25%. Bill will put money into stocks only if he expects that stock returns, over time, will outpace bond returns by some amount that compensates him for the added volatility of owning stocks. This reflects A) premium priced bonds B) option premium C) risk premium D) time premium C *Investors will put money into stocks only if they expect that stock returns, over time, will outpace bond returns by some amount that compensates them for the added risk of owning stocks. This extra return from stocks is known as risk premium-literally, the premium an investor receives in exchange for owning a riskier, more volatile instrument. 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) 4% B) 11% C) 10% D) 14% B *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%. [Show Less]
- Exam
- $13.45
- 0
- 173
Portfolio analysis questions and answers with verified content
Portfolio analysis it considers the determination of future risk and return while holding various blends of individual securities and assets If cor... [Show More] porate returns exceeds market's expectations, share price should _______________. rise Efficient portfolio one which minimises risk without impairing return, or maximize the return for given level of risk Portfolio theory provides _______________ to investors to make decisions to invest their wealth in assets or securities under risk. normative approach One important conclusion of the portfolio theory is if the investors hold a well-diversified portfolio of assets, then their concern should be the expected rate of return and risk of the portfolio rather than individual assets and the contribution of individual asset to the portfolio risk. Assumptions of portfolio theory Investors are risk-averse and rational being; the returns of assets are normally distributed. Foundations of portfolio decisions mean (the expected value) and variance (or standard deviation) analysis What is CAPM? We can extend the portfolio theory to derive a framework for valuing risky assets. This framework is referred to as the capital asset pricing model (CAPM). What is APT? An alternative model for valuation of risky asset is Arbitrage Pricing Theory. PORTFOLIO RETURN It is equal to the weighted average of the returns of individual assets (or securities) in the portfolio with weights being equal to the proportion of investment value in each asset. Given the expected returns of individual assets, the portfolio return depends on the weights (investment proportions) of assets. Formula for portfolio return In term of weight and probability Positive covariance Returns are above or below at the same time. Negative covariance Two returns are at opposite ends of the average returns What Is Co-variance? Co-variance measures the directional relationship between the returns on two assets. A positive co-variance means that asset returns move together while a negative co-variance means they move inversely. Relation between Covariance and Correlation Covariance X, Y = SD, X SD, Y Correlation XY Individual assets are more risky than the portfolio. True or False True. Returns on individual assets fluctuate more than the portfolio return. The portfolio variance or standard deviation depends on the co-movement of returns on two assets. Value of Correlation minus one to plus one Variance of two-asset IS NOT weighted average of the variance of asset. Why because they covary as well Variance of portfolio includes proportionate variance of individual securities and covariance of securities. Covariance depends upon correlation between the securities in the portfolio What Is a Minimum Variance Portfolio? A minimum variance portfolio is a collection of securities that combine to minimize the price volatility of the overall portfolio. Volatility is a statistical measure of a particular security's price movement (ups and downs). Optimum portfolio The minimum variance portfolio is also called the optimum portfolio. When diversification reduces the risk? diversification always reduces risk provided the correlation coefficient is less than 1. Why is that a perfect negative correlation will not generally be found in practice? Securities do have a tendency of moving together to some extent, and therefore, risk may not be totally eliminated. Special situation in Portfolio risk return analysis Perfectly positive correlation, Perfectly negative correlation and zero correlation Why is perfectly positive correlation not preferred? There is no advantage of diversification when the returns of securities have perfect positive correlation. Why is perfectly negative correlation preferred? In this the portfolio return increases and the portfolio risk declines. It results in risk-less portfolio. Zero Correlation means returns from two securities are independent of each other. The proportions of securities in the portfolio that would result in zero-standard deviation portfolio w'x = sigma y divided by (sigma x + sigma y) Investment Opportunity Set The investment or portfolio opportunity set represents all possible combinations of risk and return resulting from portfolios formed by varying proportions of individual securities. It presents the investor with the risk-return trade-off. What is it? Investment Opportunity Set Inefficient portfolios have lower return and higher risk An efficient portfolio An efficient portfolio is one that has the highest expected returns for a given level of risk. efficient frontier the frontier formed by the set of efficient portfolios inefficient portfolios All other portfolios, which lie outside the efficient frontier limits of diversification When there are just two securities, there are equal numbers of variance boxes and of covariance boxes. When there are many securities, the number of covariances is much larger than the number of variances. Thus the variability of a well-diversified portfolio reflects mainly the covariances. PORTFOLIO RISK: THE n-ASSET CASE Suppose we are dealing with portfolios in which equal investments are made in each of N stocks. The proportion invested in each stock is, therefore, 1/ N. So in each variance box we have (1/ N ) ^2 times the variance, and in each covariance box we have (1/ N )^2 times the covariance. There are N variance boxes and N ^2 - N covariance boxes. The variance of the portfolio is the weighted sum of average variance and the average covariance of securities. Portfolio variance = N * (1/N)^2 (average variance) + (N^2-N) (1/N)^2* (average covariance) When n approaches infinity (n → ∞), the weight of the average variance becomes zero and the weight of the average covariance term becomes 1. True or False: Portfolio variance (when n → ∞) = average covariance True True or False: The variance of securities diminishes as the number of securities increases True True or False: When more and more securities are included in a portfolio, the risk of individual securities in the portfolio is increased. False Systematic risk arises on account of the economy-wide uncertainties and the tendency of individual securities to move together with changes in the market. AKA market risk and uncontrollable risk Unsystematic risk arises from the unique uncertainties of individual securities. AKA Unique risk Key factors for systematic and unsystematic risk are Systematic->external and macro-economic factors Unsystematic->internal and micro-economic factors Protection from unsystematic risk Portfolio diversification Protection from systematic risk Asset allocation Range of affect of systematic risk Large number of securities in the market. Range of affect of unsystematic risk Only particular company. Examples of systematic risks the changes in government policy, the act of nature such as natural disaster, changes in the nation's economy, international economic components Three category of systematic risk Interest risk, Inflation risk and Market risk Interest risk Risk caused by the fluctuation in the rate or interest from time to time and affects interest-bearing securities like bonds and debentures. Inflation risk Alternatively known as purchasing power risk as it adversely affects the purchasing power of an individual. Such risk arises due to a rise in the cost of production, the rise in wages, etc. Two categories of unsystematic risk Business risk and financial risk Business risk The chance that the firm will be unable to cover its operating costs financial risk The chance that the firm will be unable to cover its financial obligations examples of unsystematic risk labor strikes, part shortages, expert resignation, loses contract, competitor enter market, Is Total risk not relevant for an investor who holds a diversified portfolio? Yes. Total risk of a security = Unsystematic risk + Systematic risk. And systematic risk is only the thing of concern for investor. How many securities should be held by an investor to eliminate unsystematic risk? In USA, it has been found that holding about fifteen shares can eliminate unsystematic risk.7 In the Indian context, a portfolio of 40 shares can almost totally eliminate unsystematic risk. A risk-free asset or security It has a zero variance or standard deviation. The risk-free security has no risk of default. [Show Less]
- Exam
- $11.45
- 0
- 117
FIN Unit 11 questions and answers with verified content
1. What are the portfolio weights for a portfolio that has 135 shares of Stock A that sells for $48 per share and 165 shares of Stock B that sells for $29 ... [Show More] per share? The portfolio weight of an asset is total investment in that asset divided by the total portfolio value. First, we will find the portfolio value, which is: Total value = 135($48) + 165($29) = $6,480 + $4,785 = $11,265 The portfolio weight for each stock is: WA = 135($48)/$11,265 = $6,480/$11,265 = 0.57523 = 57.52% WB = 165($29)/$11,265 = $4,785/$11,265 = 0.42477 = 42.48% 2. You own a portfolio that is 35% invested in Stock X, 20% in Stock Y, and 45% in Stock Z. The expected returns on these three stocks are 8%, 16%, and 11%, respectively. What is the expected return on the portfolio? The expected return of a portfolio is the sum of the weight of each asset times the expected return of each asset. So, the expected return of the portfolio is: E(RP) = w1 E(R1) + w2 E(R2) + w3 E(R3) = 0.35(0.08) + 0.20(0.16) + 0.45(0.11) = 0.02800 + 0.03200 + 0.04950 = 0.10950 = 10.95% 3. Based on the following information, calculate the expected return and standard deviation for the two stocks: Probability of State Economy Rate of Return Stock A Stock B Recession 15% 4% -17% Normal 55% 9% 12% Boom 30% 17% 27% The expected return of an asset is the sum of the probability of each return occurring times the rate of return occurring. So, the expected return of each stock asset is: E(RA) = p1 R1A + p2 R2A + p3 R3A = 0.15(0.04) + 0.55(0.09) + 0.30(0.17) = 0.00600 + 0.04950 + 0.05100 = 0.10650 = 10.65% E(RB) = p1 R1B + p2 R2B + p3 R3B = 0.15(-0.17) + 0.55(0.12) + 0.30(0.27) = -0.002550 + 0.0660 + 0.08100 = 0.12150 = 12.15% To calculate the standard deviation, we first need to calculate the variance. To find the variance, we find the squared deviations from the expected return. We then multiply each squared deviation by its probability, then add all of these up. The result is the variance: The standard deviation is So, the variance and standard deviation of each stock is: A2 = p1 (R1A - E(RA))2 + p2 (R2A - E(RA))2 + p3 (R3A - E(RA))2 = 0.15(0.04 - 0.1065)2 + 0.55(0.09 - 0.1065)2 + 0.30(0.17 - 0.1065)2 = 0.00066334 + 0.00014974 + 0.00120968 = 0.00202275 [Show Less]
- Exam
- $10.45
- 0
- 110
investment and portfolio management, questions and answers 100% correct
investment current commitment of money or other resources in the expectation of future benefits real assets land, machinery, buildings, and knowle... [Show More] dge that can be used to produce goods financial assets the means by which individuals hold their claims on real assets (stocks and bonds). they are liabilities of the issuers of securities three types of financial assets fixed income, equity, and derivatives fixed income promise a fixed stream of income or a stream of income determined by a specific formula equity ownership share of a corporation receiving dividends and ownership of real assets derivative securities options and future contracts provide payoffs that are determined by the prices of other assets such as bond or stock prices portfolio an investor's collection of investment assets asset allocation choice among broad asset classes security selection choice of which particular securities to hold within each asset class security analysis involves the valuation of particular securities that might be included in the portfolio risk-return tradeoff higher-risk assets priced to offer higher expected returns than low-risk assets passive management calls for holding highly diversified portfolios without spending effort or other resources attempting to improve investment performance through security analysis active management the attempt to improve performance either by identifying mispriced securities or by timing the performance of broad asset classes three major players in financial markets 1)firms are net demanders of capital 2)households typically are net suppliers of capital 3)governments can be borrowers or lenders financial intermediaries brings together the suppliers of capital and the demanders of capital investment bankers advise the issuing corporation on the prices it can charge for the securities issued, appropriate interest rates, and so forth venture capital small companies rarely rely on bank loans or investors, instead they rely on wealthy individuals known as angel investors LIBOR rate banks borrow from each other treasury-bill rate U.S. government borrows (TED spread) tranches prioritizing claims on loan repayments by dividing pool into senior and junior slices senior tranches had first claim on repayments from the entire pool junior tranches would be paid only after the senior ones had received their cut systemic risk potential breakdown of the financial system when problems in one market spill over and disrupt others bank-discount method for a treasury bill ask rate * (days to maturity/days in a year) = X face value of treasury bill * (1-X) bond equivalent yield gain * 365/days to maturity certificate of deposit time deposit with a bank commercial paper short-term unsecured debt notes rather than borrowing directly from bank banker's acceptance an order to a bank by the bank's customer to pay a sum of money at a future date. when a payment is accepted the bank assumes responsibility for ultimate payment to the holder of acceptance repurchase agreements short-term, usually overnight, borrowing federal reserve banks banks maintain deposits of their own at this bank. funds are called federal funds municipal bonds similar to treasury and corporate bonds except their interest income is exempt from federal income taxation. capital gains taxes must be paid residual claim means that the stockholders are last in line of all those who have a claim on the assets or income of a company limited liability the most shareholders can lose in the event of failure of a corporation is their initial investment dow jones averages all stocks standard and poor's index averages stocks, but gives higher stocks a higher weight call option gives the option to purchase an asset for a specific price (exercise or strike price) put option gives the option for an owner to sell an asset for a specific price future contract calls for delivery of an asset at a specified delivery or maturity date for an agreed upon price [Show Less]
- Exam
- $10.95
- 0
- 163
Security Market Indices questions and answers latest updated
A security market index represents the: risk of a security market. security market as a whole. security market, market segment, or asset class. C... [Show More] is correct. A security market index represents the value of a given security market, market segment, or asset class. Security market indices are: constructed and managed like a portfolio of securities. simple interchangeable tools for measuring the returns of different asset classes. valued on a regular basis using the actual market prices of the constituent securities. A is correct. Security market indices are constructed and managed like a portfolio of securities. When creating a security market index, an index provider must first determine the: target market. appropriate weighting method. number of constituent securities. A is correct. The first decision is identifying the target market that the index is intended to represent because the target market determines the investment universe and the securities available for inclusion in the index. One month after inception, the price return version and total return version of a single index (consisting of identical securities and weights) will be equal if: market prices have not changed. capital gains are offset by capital losses. the securities do not pay dividends or interest. C is correct. The difference between a price return index and a total return index consisting of identical securities and weights is the income generated over time by the underlying securities. If the securities in the index do not generate income, both indices will be identical in value. The values of a price return index and a total return index consisting of identical equal-weighted dividend-paying equities will be equal: only at inception. at inception and on rebalancing dates. at inception and on reconstitution dates. A is correct. At inception, the values of the price return and total return versions of an index are equal. An analyst gathers the following information for an equal-weighted index comprised of assets Able, Baker, and Charlie: Security Beginning of Period Price (€) End of Period Price (€) Total Dividends (€) Able 10.00 12.00 0.75 Baker 20.00 19.00 1.00 Charlie 30.00 30.00 2.00 The price return of the index is: 1.7%. 5.0%. 11.4%. B is correct. The price return is the sum of the weighted returns of each security. The return of Able is 20 percent [(12 - 10)/10]; of Baker is -5 percent [(19 - 20)/20]; and of Charlie is 0 percent [(30 - 30)/30]. The price return index assigns a weight of 1/3 to each asset; therefore, the price return is 1/3 × [20% + (-5%) + 0%] = 5%. An analyst gathers the following information for an equal-weighted index comprised of assets Able, Baker, and Charlie: Security Beginning of Period Price (€) End of Period Price (€) Total Dividends (€) Able 10.00 12.00 0.75 Baker 20.00 19.00 1.00 Charlie 30.00 30.00 2.00 The total return of the index is: 5.0%. 7.9%. 11.4%. C is correct. The total return of an index is calculated on the basis of the change in price of the underlying securities plus the sum of income received or the sum of the weighted total returns of each security. The total return of Able is 27.5 percent; of Baker is 0 percent; and of Charlie is 6.7 percent: Able: (12 - 10 + 0.75)/10 = 27.5% Baker: (19 - 20 + 1)/20 = 0% Charlie: (30 - 30 + 2)/30 = 6.7% An equal-weighted index applies the same weight (1/3) to each security's return; therefore, the total return = 1/3 × (27.5% + 0% + 6.7%) = 11.4%. An analyst gathers the following information for a price-weighted index comprised of securities ABC, DEF, and GHI: Security Beginning of Period Price (£) End of Period Price (£) Total Dividends (£) ABC 25.00 27.00 1.00 DEF 35.00 25.00 1.50 GHI 15.00 16.00 1.00 The price return of the index is: -4.6%. -9.3%. -13.9%. B is correct. The price return of the price-weighted index is the percentage change in price of the index: (68 - 75)/75 = -9.33%. Security Beginning of Period Price (£) End of Period Price (£) ABC 25.00 27.00 DEF 35.00 25.00 GHI 15.00 16.00 TOTAL 75.00 68.00 An analyst gathers the following information for a market-capitalization-weighted index comprised of securities MNO, QRS, and XYZ: Security Beginning of Period Price (¥) End of Period Price (¥) Dividends per Share (¥) Shares Outstanding MNO 2,500 2,700 100 5,000 QRS 3,500 2,500 150 7,500 XYZ 1,500 1,600 100 10,000 The price return of the index is: -9.33%. -10.23%. -13.90%. B is correct. The price return of the index is (48,250,000 - 53,750,000)/53,750,000 = -10.23%. Security Beginning of Period Price (¥) Shares Outstanding Beginning of Period Value (¥) End of Period Price (¥) End of Period Value (¥) MNO 2,500 5,000 12,500,000 2,700 13,500,000 QRS 3,500 7,500 26,250,000 2,500 18,750,000 XYZ 1,500 10,000 15,000,000 1,600 16,000,000 Total 53,750,000 48,250,000 An analyst gathers the following information for a market-capitalization-weighted index comprised of securities MNO, QRS, and XYZ: Security Beginning of Period Price (¥) End of Period Price (¥) Dividends Per Share (¥) Shares Outstanding MNO 2,500 2,700 100 5,000 QRS 3,500 2,500 150 7,500 XYZ 1,500 1,600 100 10,000 The total return of the index is: 1.04%. -5.35%. -10.23%. B is correct. The total return of the market-capitalization-weighted index is calculated below: Security Beginning of Period Value (¥) End of Period Value (¥) Total Dividends (¥) Total Return (%) MNO 12,500,000 13,500,000 500,000 12.00 QRS 26,250,000 18,750,000 1,125,000 -24.29 XYZ 15,000,000 16,000,000 1,000,000 13.33 Total 53,750,000 48,250,000 2,625,000 -5.35 When creating a security market index, the target market: determines the investment universe. is usually a broadly defined asset class. determines the number of securities to be included in the index. A is correct. The target market determines the investment universe and the securities available for inclusion in the index. An analyst gathers the following data for a price-weighted index: Beginning of Period End of Period Security Price (€) Shares Price (€) Shares A 20.00 300 22.00 300 B 50.00 300 48.00 300 C 26.00 2,000 30.00 2,000 The price return of the index over the period is: 4.2%. 7.1%. 21.4%. A is correct. The sum of prices at the beginning of the period is 96; the sum at the end of the period is 100. Regardless of the divisor, the price return is 100/96 - 1 = 0.042 or 4.2 percent. An analyst gathers the following data for a value-weighted index: Beginning of Period End of Period Security Price (£) Shares Price (£) Shares A 20.00 300 22.00 300 B 50.00 300 48.00 300 C 26.00 2,000 30.00 2,000 The return on the value-weighted index over the period is: 7.1%. 11.0%. 21.4%. B is correct. It is the percentage change in the market value over the period: Market value at beginning of period: (20 × 300) + (50 × 300) + (26 × 2,000) = 73,000 Market value at end of period: (22 × 300) + (48 × 300) + (30 × 2,000) = 81,000 Percentage change is 81,000/73,000 - 1 = 0.1096 or 11.0 percent with rounding. An analyst gathers the following data for an equally-weighted index: Beginning of Period End of Period Security Price (¥) Shares Price (¥) Shares A 20.00 300 22.00 300 B 50.00 300 48.00 300 C 26.00 2,000 30.00 2,000 The return on the index over the period is: 4.2%. 6.8%. 7.1%. C is correct. With an equal-weighted index, the same amount is invested in each security. Assuming $1,000 is invested in each of the three stocks, the index value is $3,000 at the beginning of the period and the following number of shares is purchased for each stock: Security A: 50 shares Security B: 20 shares Security C: 38.46 shares. Using the prices at the beginning of the period for each security, the index value at the end of the period is $3,213.8: ($22 × 50) + ($48 × 20) + ($30 × 38.46). The price return is $3,213.8/$3,000 - 1 = 7.1%. Which of the following index weighting methods requires an adjustment to the divisor after a stock split? Price weighting. Fundamental weighting. Market-capitalization weighting. A is correct. In the price weighting method, the divisor must be adjusted so the index value immediately after the split is the same as the index value immediately prior to the split. If the price return of an equal-weighted index exceeds that of a market-capitalization-weighted index comprised of the same securities, the most likely explanation is: stock splits. dividend distributions. outperformance of small-market-capitalization sto C is correct. The main source of return differences arises from outperformance of small-cap securities or underperformance of large-cap securities. In an equal-weighted index, securities that constitute the largest fraction of the market are underrepresented and securities that constitute only a small fraction of the market are overrepresented. Thus, higher equal-weighted index returns will occur if the smaller-cap equities outperform the larger-cap equities. A float-adjusted market-capitalization-weighted index weights each of its constituent securities by its price and: its trading volume. the number of its shares outstanding. the number of its shares available to the investing public. C is correct. "Float" is the number of shares available for public trading. Which of the following index weighting methods is most likely subject to a value tilt? Equal weighting. Fundamental weighting. Market-capitalization weighting. B is correct. Fundamental weighting leads to indices that have a value tilt. Rebalancing an index is the process of periodically adjusting the constituent: securities' weights to optimize investment performance. securities to maintain consistency with the target market. securities' weights to maintain consistency with the index's weighting method. C is correct. Rebalancing refers to adjusting the weights of constituent securities in an index to maintain consistency with the index's weighting method. Which of the following index weighting methods requires the most frequent rebalancing? Price weighting. Equal weighting. Market-capitalization weighting. B is correct. Changing market prices will cause weights that were initially equal to become unequal, thus requiring rebalancing. [Show Less]
- Exam
- $10.45
- 0
- 134
Chapter Two: Modern Portfolio Theory questions and answers 2023
Define modern portfolio theory An investment framework that is useful in diversifying the risk when allocating assets in a financial, liquid (tradable) po... [Show More] rtfolio in order to maximise the potential return given a specified level of risk appetite or tolerance. Modern portfolio theory (MPT) is born out of investment common sense. The rationale is that minimising risk and maximising the potential return should be something that logical humans have in mind when allocating assets across a portfolio. The well-worn tenet that states 'the higher the risk, the higher the potential reward' is cast in an intelligent framework within MPT where the combination of holdings in a portfolio is assessed by what? how they perform in relation to one another (correlation) and the risk and return characteristics of each, collectively. MPT is essentially an investment framework that is useful in diversifying therisk when allocating assets in a financial, liquid (tradable) portfolio in order to maximise the potential return given a specified level of risk appetite or tolerance. In other words, by spreading risks across multiple investment holdings, the risk of potential loss can be minimised without necessarily reducing the returns from a portfolio. If only one investment is purchased, the portfolio will have the risk and return characteristics of that holding. Each single investment exhibits is own particular risk and return characteristics. What MPT looks to do is what? Quantify the risk mathematically and eliminate or reduce this specific risk by adding other assets that perform dissimilarly to the investment basket. The portfolio is constructed so that when some assets fall in value, other assets rise and balance is maintained. When markets in general rise, the investment portfolio gains in value. MPT uses mathematics to intelligently construct an investment portfolio. The steps involved include? valuing the investments that could be included in the portfolio; calculating the asset allocation (or number and type of investments); optimising the portfolio to get the maximum amount of return for the minimum amount of risk; and monitoring the portfolio to see if it meets performance expectations from both a risk and return perspective, making changes when market conditions warrant a change. MPT was first introduced in 1952 in a paper titled Portfolio Selection, published by the Journal of Finance and written by Harry Markowitz, an American economist who was awarded Nobel Laureate status for his work. Markowitz's studies demonstrated that investing should not be about trying to pick future high-performing stocks, but that the combination of the investments chosen was more important in terms of reward for the level of risk taken. By adding assets that are uncorrelated or inversely correlated, the overall risk in a portfolio is what? Diversified across all the different 'eggs in the basket' and risk is reduced and can be quantified. This measuring of risk becomes extremely useful when considering purchases and sales within the investment basket. In 1958 James Tobin added leverage to MPT by including an investment that pays a risk-free rate of return, which allowed the construction of portfolios whose risk-return profiles were capable of what? Outperforming Markowitz's Efficient Frontier. Define financial or capital markets Where governments andcompanies raise financevia the sale and purchaseof fixed income securities,often called bonds orequities, more commonlyknown as shares via a stockmarket. he market is used to trade new issues of either bonds or shares, which are known as primary, or already existing securities, known as the secondary market. Typical capital market instruments include what? Equities, bonds, foreign exchange markets, derivatives (futures and options) as well as insurance contracts, mortgages and other tradable securities. An efficient capital market is where the prices of these instruments reflect information accurately and in real time. New information about a company will be analysed and the future value of cash flow expected from the security will what? Change the current share price to accommodate this change in fundamental value. The prices of securities fluctuate and market participants, such as traders and stockbrokers, will trade them competitively to try to achieve maximum profit. Funds from savers and investors (corporate or individual) are expected to flow into the financial markets intent on seeking out the best places to invest and, therefore, you can see that information available and its ability to impact of share prices is of the utmost importance. If stocks are efficiently priced with all information about the underlying company known, investors can what? Feel confident about the choices they make for their portfolios Define diversification How risk in a portfolio is reduced. A portfolio which is constructed of a number of different asset classes suchas equities, bonds, cash, property and commodities will blend low-risk cash deposits and bonds with higher risk equities and commodities, for instance. The asset class could then be diversified further with what? Different managers, industry sectors and geographies selected. The proportions allocated will depend upon the investor's risk preference and the prevailing market condition Risk, in its simplest form, can be divided between systematic and unsystematic, or specific, risk. Specific risk is that associated with a particular individual investment. A specific risk is diversifiable by adding what? Other diverse holdings to the portfolio, provided that the risks of the other holdings are not directly correlated. Systematic risk is that of the portfolio or market and cannot be diversified away through the addition of other assets, and is due to outside factors such as what? The economy performing poorly or international tensions, etc. Systematic risk affects the whole market or 'system'. The risk for investors is that the return from an investment will be lower than expected. MPT is interested in the amount that this return deviates from the average return and quantifies this risk accordingly, measuring it as 'standard deviation'. Every holding has its own mean and therefore deviation from it can be measured specifically. MPT assesses the likely profitability of investments from a basis of weighting the expected returns on a 'normal' distribution, the familiar bell-shaped curve when drawn graphically. Therefore, risk is measured by what? The standard deviation of returns and the expected portfolio return is measured by the weighted average of individual investments within it. In considering risk, it is the effect that an investment will have on the overall risk of the portfolio that is important, not the risk of the investment in isolation. The amount of diversification of risk available will depend upon the degree to which returns from different investments move in line with each other or the degree to which they are 'correlated'. An investor can reduce the risk in a portfolio by holding several investments that are not perfectly (positively) correlated. Highly correlated shares for instance may occur from companies in the same industry or sector; if the oil price moves, oil companies' shares will tend to move in the same direction. Negative correlation is viewed when prices tend to what? Move in opposite directions If no discernible relationship can be observed with prices bearing no relationship to each other, there is no correlation between the assets. Correlation is measured on a scale of +1 to -1. A correlation coefficient of 1 between two assets (perfect) means whatever one asset does will predict the movement of the other. One asset's gain of 10% will be matched by the other asset's gain of 10%, therefore. Minus one is perfect inverse and is equally predictive but opposite. This means that if investment 'a' increases by 10%, investment 'b' will decrease by 10%. Ignoring the sign, the greater the number, the greater the strength of the relationship between the two. A correlation of zero means returns are completely independent and no relationship exists between the two. Anything less than 1 means that investors can what? Diversify the risk in portfolios. Proportionate reduction of risk, relative to return is therefore available in almost all portfolios with two or more investments. Eggs (risk) will be in different baskets (investments). The correlation between investments varies over time and reassessment of data leading to rebalancing of the investments in the portfolio may be necessary. This is a criticism levelled at MPT but the theory is often not what? Perfectly replicable in practice The expected return from a portfolio is therefore the weighted average of the expected returns of the two investments where the weights are the proportions of the available cash invested in each holding. Markowitz defined the proportionate risk of the two-asset portfolio as 'variance'. What is the calculation for this? R(P) = xRa +(1-x)Rb Where:R(P) is the expected return from the portfolio X is the percentage invested R(a) is the expected return from 'a' R(b) is the expected return from 'b' Define portfolio variance A measurement of how the aggregate returns of a number of securities making up a portfolio fluctuate over time. This portfolio variance is calculated using the standard deviations of each security in the portfolio as well as the correlations of each security pair in the portfolio. Portfolio variance looks at the covariance or correlation coefficients for the investments in the portfolio. Generally speaking, a lower correlation between securities in a portfolio results in a lower portfolio variance. MPT states that portfolio variance can be reduced how? By choosing asset classes with a low or negative correlation, as we have seen from diversification Portfolio variance is a weighted combination of the individual variances of each of the assets adjusted by their covariances. This means that the overall portfolio variance is lower than a simple weighted average of the individual variances of the stocks in the portfolio. Variance is often calculated using the standard deviation of the portfolio, which is simply the square root of variance. Variance measures the variability (or volatility) from an average or mean and volatility is a measure of risk; variance will help an investor determine what? The risk they might take on when assessing a new investment. A variance value of zero means that all values within a group of numbers are the same and that all variances that are non-zero will be positive numbers (because they have been squared). A large variance indicates that numbers in the set are far from the mean and each other (high volatility), while a small variance indicates what? Little volatility Covariance is used in portfolio theory to determine what assets to include in the portfolio. Covariance is a statistical measure of the directional relationship between two asset prices. Portfolio theory uses this statistical measurementto reduce the overall risk for a portfolio. A positive covariance means that assets generally move in the same direction. Negative covariance means assets generally move in opposite directions. Covariance is an important measurement in MPT. MPT attempts to determine an efficient frontier for a mix of assets in a portfolio. The efficient frontier seeks to optimise what? The maximum return against the degree of risk for all the combined assets in the portfolio. The aim is to select investments for the portfolio that have a lower standard deviation than the standard deviation of the individual assets, thereby helping to reduce the volatility of the portfolio. MPT tries to create an optimal blend of higher-volatility assets with lower-volatility assets and, by diversifying the assets in a portfolio, risk can be reduced but still achieve a positive return. In the construction of a portfolio, it is important to attempt to reduce overall risk by including assets that have a negative covariance with each other. Analysts use historical price data to determine the measure of covariance between different stocks. This assumes that the same statistical relationship between the asset prices will continue into the future, which is not always the case. By including assets that show a negative covariance, the risk of a portfolio is minimised. Covariance can be used to maximise diversification in a portfolio by adding investments with a negative covariance to a portfolio which reduces what? The overall risk. Covariance provides a statistical measurement of the risk for a mix of different investments and is calculated by formulae. Covariance only measures the directional relationship between two investments. It does not show the strength of the relationship between assets as the correlation coefficient does.Markowitz looked to achieve the optimum portfolio from the basis of two investments. The two investments generate differing returns in dissimilar environments or market conditions. Markowitz taught that there was an alternative strategy to selecting either investment because their returns do not move in unison (positive correlation) depending on the scenarios present. This relates once again to not putting all eggs in one basket, or all investment money in one holding and produces a portfolio with what? The same overall return but reduces the risk taken to zero The three significant conclusions that can be derived from Markowitz's two- asset portfolio, what are these? Risky investments can be combined into a less risky (or even risk-free) portfolio. This can be viewed as putting 'eggs into different baskets', diversifying the specific risk of each investment. Rational investors would not hold one investment exclusively as the return can be maintained but the risk reduced by holding both 'a' and 'b'. The risk and return performance data for each individual holding should not be analysed in isolation due to the fact that when one is performing well, the other is performing badly - it can be said that they are inversely correlated. There are two main formulae which allow intelligent combining of risks and returns, provided the correlation coefficient is known. From these formulae, it can be observed that the return is derived from the combination on a simple weighted average basis, and that the effect of combing risks is attributable to the correlation coefficient. What are these and how are they calculated? Return of portfolio: ra+b = Para + Pbrb Risk of portfolio σa+b2 = Pa2σa2 + Pb2σb2 + 2PaPbσaσbCorab The correlation coefficient is the keyto the extent that a portfolio of two investments can achieve diversification of risk. To be able to calculate the proportionate allocation of multiple investments in a portfolio, the risk-return profiles of combinations of investments must be what? Established, given the different correlation coefficients. With perfect positive correlation, the two chosen investments move in unison and there is no benefit from diversification. The resulting risk and return performance are what? The weighted average of the two investment risks and returns. With perfect negative correlation, the two investments move in opposite directions to each other, there will be an asset allocation available that completely what? Diversifies away the risk It is highly improbable that the two investments are perfectly positively correlated (+1) or perfectly negatively correlated (-1). Imperfect correlation, somewhere between -1 and +1, is what? The most likely situation In efficient capital markets where returns from investments are normally distributed (symmetrical bell curve standard deviation), the rational, risk-averse investor can minimise their utility preferences by diversification. Most investors will look to diversify further than the two-asset combination will allow and include what? Numerous investments within a portfolio Given the universe of investments that could be included in a portfolio, technology is obviously very important in obtaining the possible combinations that could make up the efficient frontier. As mentioned before, Markowitz had proffered the theory in 1952 but the practical application was lengthy and based upon trial and error. Size will be a factor as a small portfolio will incur proportionately higher fees than a large portfolio, in practice. A diversified portfolio of 30 shares has been deemed to diversify away roughly 90% of the average shares' diversifiable risk. Large numbers of holdings do not need to be incorporated into a portfolio therefore and there is little risk reduction in holding 150 shares over a basket of only 50. In fact the costs associated with holding that many investments could what? Start to outweigh the benefits [Show Less]
- Exam
- $11.45
- 0
- 161
Corporate Finance: What is an Investment? - Definition & Overview questions and answers
Which of the following is NOT a type of government investment? Interest payments Infrastructure Research Subsidies How does investment a... [Show More] ffect the economy? It usually leads to economic growth. It always helps an economy. It hurts the economy because it takes away from consumption. It has no effect because if people aren't investing, they're consuming. Which of the following terms basically describes activity that is the opposite of investment? Spending Liability Loss Consumption Why do governments usually invest? To finance national debts To help stimulate economic growth To provide pork to constituents As an excuse to spend Which of the following is the BEST explanation of investment? Spending money to make money Buying assets and commodities Buying stocks and bonds Hiring people Which of the following is true regarding the investment planning process? None of these answers is true. Time horizon of investment depends only on returns. In the rational portfolio approach for goal setting, the chronological order of the goals is important. In the rational portfolio approach for goal setting, the priorities of the goals are important. Individuals in the accumulation stage are able to invest in _____, taking more risks. high growth stocks balanced mutual funds government bonds None of these answers is correct. Which of the following is NOT a decision made in the execution stage of investment planning? Asset mix Portfolio goals Security selection Risk parameters An investor, aged 57 years, wants to save for his retirement. What type of assets should the investment manager choose? High growth stocks Mutual funds High yield junk bonds Government bonds Which of the following is NOT necessary for investment planning? Financial goals of the investor Time specificity Asset mix Life stage of the investor If you have a portfolio with stocks from the energy industry and bonds from the same sector, what is your investment portfolio lacking? Objectives Balance Nothing Diversification You have decided it will be best to balance your portfolio with 60% stocks and 40%bonds. You have $30,000 in stocks and $20,000 in bonds. After six months, you analyze your portfolio and see that stocks have had a strong six months and have increased to$38,000 of your portfolio, while bonds have increased to $21,000. Which of the following actions would you take, to rebalance to your 60/40 asset allocation? Rebalance your portfolio by selling $2,600 of stocks and buying $2,600 in bonds so that you are back to a60%/40$ allocation. Don't do anything until you redefine the objectives of your investment portfolio. You should sell $8,000 of your stocks and $1,000 of your bonds; leave the profits as cash. Nothing. You don't want to react too quickly. Which term can be defined as how you divide your portfolio into different types of investments? Risk appetite Asset allocation Bond/stock division Balancing Which of the following is the MOST important part of developing an investment portfolio? Always having some percentage of your portfolio in cash or investments easily turned into cash Making sure that you follow your portfolio performance daily Not exceeding more than (100 - your age) percent of stocks in your portfolio Making sure you specifically have objectives for your investment portfolio Which term describes the action of buying and/or selling certain assets in your portfolio to make sure your asset allocation matches your investment objectives? Meeting your risk appetite Assigning asset allocation Diversifying your portfolio Rebalancing Which of these investments offers built-in diversification? Cash Mutual fund Bond Stock Why should investors periodically rebalance a portfolio? To maintain the desired asset allocation To buy more of an investment that has dramatically risen in value To get the greatest possible return in a short amount of time To avoid paying taxes Which of the following is a benefit of diversification? The portfolio is less prone to highly volatile swings in value. Diversification reduces the number of investments the investor has to keep track of. Diversification offers the best potential to make money fast. The investor reduces the amount of commissions paid to brokers. Which of the following is a type of asset class? Mutual fund Stock 401(k) IRA Why would asset allocation plans include cash as an investment? Cash investments have a guaranteed rate of return. Cash investments provide a volatile element to the asset allocation mix. Cash investments are not subject to taxes. Cash investments act as a cushion to reduce volatility. You own the following portfolio investments: -$4,000 of Stock A -$6,000 of Stock B -$3,000of Stock C What is the value weight of Stock B? 31% 46% 23% 44% The weight of an investment portfolio refers to: The percent of money an investment will make. The percent of an investment portfolio that is held by a single asset. How much an investment is worth in the market. How much return it will receive. A(n) _____ is a collection of financial assets or investments such as stocks, bonds, and cash. Investment collection Portfolio Market Asset Stock D has a 40% chance of producing a 30% profit and a 60% chance of producing a 15% loss. What is the expected return for this stock? 5% 22% 3% 21% The amount an investor anticipates he or she will receive on an investment is called the: Investor return Market rate Expected return Money rate Which of the following is true regarding standard deviation? All returns lie within one standard deviation. Standard deviation is always calculated using predicted data. It is not possible to compare standard deviations of stocks from different industries. Investment returns can be represented by a normal distribution. Which of the following is used in calculating standard deviation? Mean Median Mode Maximum John is evaluating four stocks and wants to choose the one with the highest potential return. The average return for each stock is: Stock A: 10% per annum (p.a.), Stock B: 11%p.a., Stock C: 8% p.a., and Stock D: 15% p.a. The standard deviations are as follows: Stock A:10% p.a., Stock B: 8% p.a., Stock C: 15% p.a., Stock D: 5% p.a. Which stock would offer the potential for the highest return? Stock A Stock D Stock C Stock B [Show Less]
- Exam
- $10.45
- 0
- 129
Security Analysis & Portfolio Management questions answers with compete answers
Real Assets Used to produce goods and services: Property, plants and equipment, human capital, etc. Financial Assets Claims on real assets or inco... [Show More] me generated by them. It is the _ALLOCATION_ of income or wealth among investors: Cash, stocks, bonds...etc... This course is on Financial Assets •Performance of financial assets depends on underlying real assets All Financial Assets (owner of the claim) Are offset by a financial liability (issuer of claim): when you own a stock/bond issued by a firm, the stock/bond is a liability of the firm. Net Wealth of economy = Only the sum of Real Assets 1. Identify Real and Financial Asset that are created, destroyed, or traded hands. Toyota takes out a bank loan to finance the construction of a new factory: 1. Toyota created a Real Asset: The Factory 2. The loan is a financial asset that is created in the transaction owned by the bank 2. Toyota pays off the loan When the loan is paid, the financial asset is destroyed, but the real asset continues to exist. Three Major Classes of Financial Assets 1. Fixed income Securities 2. Common Stock (equity) 3. Derivatives Fixed income Securities Various types of debt which promises to pay a fixed stream of income over a per-determined period. •Money Market Instruments: very short term and low risk •Bonds: longer term Common Stock (equity) An Ownership stake in a corporation, residual cash flow, riskier than debt securities Derivatives Contract, value derived from underlying market condition of other financial assets. •Options •Futures •CDS (Credit Default Swap) What are the roles and basic properties of financial markets? •Allocate resources the places where it generates highest returns. •Smooth consumption over time •Risk Allocation: investors can choose different instruments with different risk levels to suit their needs Role Of Financial Markets Separation of management and ownership: good for business and investors, but also creates agency problems Solution to Agency Problems: Corporate Governance •Performance based pay •Shareholders elect board of directors to represent themselves •Threat of takeovers Sarbanes-Oxley Act: 2002 -Requires more independent directors on company boards -Requires CFO to personally verify the financial statements -Created new oversight board for the accounting/audit industry -Charged board with maintaining a culture of high ethical standards 1. Basic Properties of financial Markets -There is always a risk-return tradeoff •higher return = higher risk •no such thing as free lunch Example: •S&P500 Index for stocks •10-year & 3-month T-Bills are both issued by US government. Fixed income instruments with different maturities •3-month T-Bill rate is normally considered as the risk free rate 2. Basic Properties of financial Markets Passive Investment Philosophy: Active Investment Philosophy: Passive Investment Philosophy: "Indexing" The market is very efficient, thus investors buy and hold a diversified portfolio "Indexing" Active Investment Philosophy: "Stock Picking" or "Market Timing" The market is not so efficient, thus investors try to identify mispriced securities and profit from it. Primary Market Where firms issue new securities (stocks or bonds) to raise capital from public or private investment firms -They need help pricing and selling the securities: investment bankers provide those services called "underwriting" Secondary Market Where already existing securities are traded among investors. Example: NYSE Investment Banks -Separated by law in US from 1933-1999 -Sep 2008: all major investment banks were absorbed by commercial banks, declared bankruptcy, or reorganized as commercial banks "Top Down" Approach Allocate capital among broad asset classes "Bottom-Up" Approach Choice of securities within each asset class. After you choose which Asset class to buy, you need to pick which ones to buy. (Active or passive investments_ Fixed Income Market (Debt) ... Characteristics of a debt instrument: -Who is the borrower: federal Government (T-bills or bonds), or Corporations (corporate bond, bank loan) -Maturity: short or long term -Liquidity -Risk: Default risk -Coupon rate -Denomination -Yield: rate of return investing on debt We can categorize all fixed income instruments into two groups based on: -Length of Maturity -Risk -Liquidity The Money Market: (Debt) -Short Term, marketable, low risk, "cash equivalents" -Lower return -Not directly available to individual investors, but can access it through money market mutual funds The Bond Market: (Debt) -Longer term, not as liquid, higher risk -Higher return The Money Market Instruments: • Treasury Bills • Certificates of Deposit • Commercial Paper • Bankers' Acceptances • Eurodollars • Federal Funds • LIBOR (London Interbank Offer Rate) • Repos Treasury Bills: • Treasury" = issued by federal Government • "Bills" means "short term", maturity is 4, 13, 26, or 52 weeks. • Denomination: $100, commonly $10,000 • High liquidity • No default risk • No coupon payment, sold at discount. • Taxation: interest income only taxable at the exempt from state and local levels Certificates of Deposit (CD) • Issuer: Commercial Banks • Denomination: Any • Maturity: varies, typically 14day minimum • Liquidity: CDs of 3 months or less are liquid • Default: First $250,000 insured by FDIC, just like bank deposits • Taxation: Interest income fully taxable Commercial Paper • Issuer: Large creditworthy corporations, financial institutions • Denomination: Minimum $100k • Maturity: Maximum 270 days, usually 1-2 months • Liquidity: CP of 3 months or less is liquid if marketable • Default: Unsecured, rated, mostly high quality • Interest Type: Discount • Taxation: Interest income fully taxable • New Innovation: Asset-backed commercial paper Bankers' Acceptances - Originate when a purchaser authorizes a bank to pay a seller for goods at a later date (time draft) - When purchaser's bank "accepts" draft, it becomes contingent liability of the bank and a marketable security -Basically a postdated check Eurodollars - Dollar-denominated (time) deposits at foreign banks or foreign branches of US banks -Eurodollar CD: Pay higher interest rate than U.S. deposits, but less liquid and riskier Federal Funds -Commerical banks must maintain a minimum reserve deposits with Federal Reserve Bank. One can borrow from another bank if the balance is short. Typically overnight loans. • Fed Fund Rate: the interest rate on such loans. Why should average investors care? -its an important benchmark rate, an important tool of federal monetary policy LIBOR (London Interbank Offer Rate) - Rate at which large banks in London (and elsewhere) lend to each other -The premier short-term interest rate in European Money Market - Base rate for many loans and derivatives. Important benchmark rate Example: student loans even in the US are normally LIBOR plus 3%. Repurchase Agreements (RPs) - Short-term sales of securities with an agreement to repurchase the securities at higher price - RP is a collateralized loan; many RPs are overnight, though "term" RPs may have a 1-month maturity Reverse RPs lending money and obtaining security title as collateral The Money Market: Summary • T-bills are the safest, the most liquid, as it's issued by US government, considered risk free. • Other money market instruments are also pretty safe, but not risk free like can still go to bankruptcy.) The Bond Market •Treasury Bonds and notes • Corporate Bonds • Municipal Bonds • Mortgage Securities • Federal Agency Debt Treasury Bonds and notes debt obligations of the federal government with original maturities of one year or more Corporate Bonds Bonds issued by corporations to fund operating expenses Mortgage Securities secured by a mortgage on the real property of the borrower Equity Securities •Common stocks •Preferred stocks •Stock market indexes Common stocks • Represents a fraction of ownership in a corporation. • The right to vote, and the right to receive quarterly dividends. • Dividends are not mandatory for common stocks. Preferred stocks • Although a "stock", but more like debt • Promises a fixed stream of dividends every year, infinitely. not an obligation, but has to be paid before common stock A lthough dividends. Stock market indexes • Basically a portfolio consisting of all stocks. • We use stock market index to measure the overall performance of the whole market. • Performance is measured by rate of return. Price weighted • Invests equal number of shares in each proportional to the price of each firm. stock, or $ amount • Price weighted index level = average price of all stocks Market value weighted • Invests $ amount proportional to the market value (price * number of shares outstanding) of each firm. • Market value weighted index level = average market value of all stocks. Equally-weighted • Invests equal $ amount in each stock. • Return on an Equally-weighted index = average return of all stocks. Stock Market Index -Dow Jones: 30 large, blue chip corporations, **price-weighted -S&P500: 500 firms, ***market value weighted -NASDAQ: more than 3000 stocks traded, ***market value weighted Derivative asset -Security with payoff that depends on the price of other securities Call options the right to BUY a stock at a pre-specified price, the option expiration date on or before the expiration date -you must pay to buy options [Show Less]
- Exam
- $13.45
- 0
- 164
CFA 44: Basics of Portfolio Planning questions and answers graded A+
Which of the following is least important as a reason for a written investment policy statement (IPS)? The IPS may be required by regulation. Having ... [Show More] a written IPS is part of best practice for a portfolio manager. Having a written IPS ensures the client's risk and return objectives can be achieved. C is correct. Depending on circumstances, a written IPS or its equivalent may be required by law or regulation and a written IPS is certainly consistent with best practices. The mere fact that a written IPS is prepared for a client, however, does not ensure that risk and return objectives will in fact be achieved. Which of the following best describes the underlying rationale for a written investment policy statement (IPS)? A written IPS communicates a plan for trying to achieve investment success. A written IPS provides investment managers with a ready defense against client lawsuits. A written IPS allows investment managers to instruct clients about the proper use and purpose of investments. A is correct. A written IPS is best seen as a communication instrument allowing clients and portfolio managers to mutually establish investment objectives and constraints. A written investment policy statement (IPS) is most likely to succeed if: it is created by a software program to assure consistent quality. it is a collaborative effort of the client and the portfolio manager. it reflects the investment philosophy of the portfolio manager. B is correct. A written IPS, to be successful, must incorporate a full understanding of the client's situation and requirements. As stated in the reading, "The IPS will be developed following a fact finding discussion with the client." The section of the investment policy statement (IPS) that provides information about how policy may be executed, including investment constraints, is best described as the: Investment Objectives. Investment Guidelines. Statement of Duties and Responsibilities. B is correct. The major components of an IPS are listed in Section 2.2 of the reading. Investment Guidelines are described as the section that provides information about how policy may be executed, including investment constraints. Statement of Duties and Responsibilities "detail[s] the duties and responsibilities of the client, the custodian of the client's assets, the investment managers, and so forth." Investment Objectives is "a section explaining the client's objectives in investing." Which of the following is least likely to be placed in the appendices to an investment policy statement (IPS)? Rebalancing Policy. Strategic Asset Allocation. Statement of Duties and Responsibilities. C is correct. The major components of an IPS are listed in Section 2.2 of the reading. Strategic Asset Allocation (also known as the policy portfolio) and Rebalancing Policy are often included as appendices to the IPS. The Statement of Duties and Responsibilities, however, is an integral part of the IPS and is unlikely to be placed in an appendix. Which of the following typical topics in an investment policy statement (IPS) is most closely linked to the client's "distinctive needs"? Procedures. Investment Guidelines. Statement of Duties and Responsibilities. B is correct. According to the reading, "The sections of an IPS that are most closely linked to the client's distinctive needs are those dealing with investment objectives and constraints." Investment Guidelines "[provide] information about how policy may be executed, including investment constraints." Procedures "[detail] the steps to be taken to keep the IPS current and the procedures to follow to respond to various contingencies." Statement of Duties and Responsibilities "detail[s] the duties and responsibilities of the client, the custodian of the client's assets, the investment managers, and so forth." An investment policy statement that includes a return objective of outperforming the FTSE 100 by 120 basis points is best characterized as having a(n): relative return objective. absolute return objective. arbitrage-based return objective. A is correct. Because the return objective specifies a target return relative to the FTSE 100 Index, the objective is best described as a relative return objective. Risk assessment questionnaires for investment management clients are most useful in measuring: value at risk. ability to take risk. willingness to take risk. C is correct. Risk attitude is a subjective factor and measuring risk attitude is difficult. Oftentimes, investment managers use psychometric questionnaires, such as those developed by Grable and Joo (2004), to assess a client's willingness to take risk. Which of the following is best characterized as a relative risk objective? Value at risk for the fund will not exceed US$3 million. The fund will not underperform the DAX by more than 250 basis points. The fund will not lose more than €2.5 million in the coming 12-month period. B is correct. The reference to the DAX marks this response as a relative risk objective. Value at risk establishes a minimum value of loss expected during a specified time period at a given level of probability. A statement of maximum allowed absolute loss (€2.5 million) is an absolute risk objective. In preparing an investment policy statement, which of the following is most difficult to quantify? Time horizon. Ability to accept risk. Willingness to accept risk. C is correct. Measuring willingness to take risk (risk tolerance, risk aversion) is an exercise in applied psychology. Instruments attempting to measure risk attitudes exist, but they are clearly less objective than measurements of ability to take risk. Ability to take risk is based on relatively objective traits such as expected income, time horizon, and existing wealth relative to liabilities. After interviewing a client in order to prepare a written investment policy statement (IPS), you have established the following: The client has earnings that vary dramatically between £30,000 and £70,000 (pre-tax) depending on weather patterns in Britain. In three of the previous five years, the after-tax income of the client has been less than £20,000. The client's mother is dependent on her son (the client) for approximately £9,000 per year support. The client's own subsistence needs are approximately £12,000 per year. The client has more than 10 years' experience trading investments including commodity futures, stock options, and selling stock short. The client's responses to a standard risk assessment questionnaire suggest he has above average risk tolerance. The client is best described as having a: low ability to take risk, but a high willingness to take risk. high ability to take risk, but a low willingness to take risk. high ability to take risk and a high willingness to take risk. A is correct. The volatility of the client's income and the significant support needs for his mother and himself suggest that the client has a low ability to take risk. The client's trading experience and his responses to the risk assessment questionnaire indicate that the client has an above average willingness to take risk. After interviewing a client in order to prepare a written investment policy statement (IPS), you have established the following: The client has earnings that have exceeded €120,000 (pre-tax) each year for the past five years. She has no dependents. The client's subsistence needs are approximately €45,000 per year. The client states that she feels uncomfortable with her lack of understanding of securities markets. All of the client's current savings are invested in short-term securities guaranteed by an agency of her national government. The client's responses to a standard risk assessment questionnaire suggest she has low risk tolerance. The client is best described as having a: low ability to take risk, but a high willingness to take risk. high ability to take risk, but a low willingness to take risk. high ability to take risk and a high willingness to take risk. B is correct. On the one hand, the client has a stable, high income and no dependents. On the other hand, she exhibits above average risk aversion. Her ability to take risk is high, but her willingness to take risk is low. A client who is a 34-year old widow with two healthy young children (aged 5 and 7) has asked you to help her form an investment policy statement. She has been employed as an administrative assistant in a bureau of her national government for the previous 12 years. She has two primary financial goals—her retirement and providing for the college education of her children. This client's time horizon is best described as being: long term. short term. medium term. A is correct. The client's financial objectives are long term. Her stable employment indicates that her immediate liquidity needs are modest. The children will not go to college until 10 or more years later. Her time horizon is best described as being long term. The timing of payouts for property and casualty insurers is unpredictable ("lumpy") in comparison with the timing of payouts for life insurance companies. Therefore, in general, property and casualty insurers have: lower liquidity needs than life insurance companies. greater liquidity needs than life insurance companies. a higher return objective than life insurance companies. B is correct. The unpredictable nature of property and casualty (P&C) claims forces P&C insurers to allocate a substantial proportion of their investments into liquid, short maturity assets. This need for liquidity also forces P&C companies to accept investments with relatively low expected returns. Liquidity is of less concern to life insurance companies given the greater predictability of life insurance payouts. A client who is a director of a publicly listed corporation is required by law to refrain from trading that company's stock at certain points of the year when disclosure of financial results are pending. In preparing a written investment policy statement (IPS) for this client, this restriction on trading: is irrelevant to the IPS. should be included in the IPS. makes it illegal for the portfolio manager to work with this client. B is correct. When a client has a restriction in trading, such as this obligation to refrain from trading, the IPS "should note this constraint so that the portfolio manager does not inadvertently trade the stock on the client's behalf." Consider the pairwise correlations of monthly returns of the following asset classes: Brazilian Equities East Asian Equities European Equities US Equities Brazilian equities 1.00 0.70 0.85 0.76 East Asian equities 0.70 1.00 0.91 0.88 European equities 0.85 0.91 1.00 0.90 US equities 0.76 0.88 0.90 1.00 Based solely on the information in the above table, which equity asset class is most sharply distinguished from US equities? Brazilian equities. European equities. East Asian equities. A is correct. The correlation between US equities and Brazilian equities is 0.76. The correlations between US equities and East Asian equities and the correlation between US equities and European equities both exceed 0.76. Lower correlations indicate a greater degree of separation between asset classes. Therefore, using solely the data given in the table, returns on Brazilian equities are most sharply distinguished from returns on US equities. Returns on asset classes are best described as being a function of: the failure of arbitrage. exposure to the idiosyncratic risks of those asset classes. exposure to sets of systematic factors relevant to those asset classes. C is correct. Strategic asset allocation depends on several principles. As stated in the reading, "One principle is that a portfolio's systematic risk accounts for most of its change in value over the long run." A second principle is that, "the returns to groups of like assets... predictably reflect exposures to certain sets of systematic factors." This latter principle establishes that returns on asset classes primarily reflect the systematic risks of the classes. [Show Less]
- Exam
- $10.45
- 0
- 112
Purchase the bundle to get the full access instantly
- 3 Million+ Study Documents
- 100% Money Back Guarantee
- Immediate Download Access
Add To Cart
Reviews 0
Bundle Details
$27.95
- Trusted by 800,000+ Students
- 24/7 Money Back Guarantee
- Download is directly available
285
0
Seller Details
