ikoreaii

Suppose that a portfolio management firm has decided that the costs of hiring and firing managers are excessive. Which of the following would be their most appropriate course of action? The firm should:

A) tolerate more Type I error to reduce Type II error.

B) reduce both Type I and Type II errors.

C) tolerate more Type II error to reduce Type I error.

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Type I error is retaining a poor manager and Type II error is firing a superior manager. If a firm wishes to reduce the costs of hiring and firing managers, then they should reduce staff turnover. So they should err on the side of retaining poor managers (Type I error) to reduce the chance of firing superior managers (Type II error). They might do this by relaxing the performance criteria managers must meet.

ikoreaii

Suppose that a portfolio management firm has abnormally high turnover in their staff. Which of the following is the most likely scenario?

A) The firm’s Type I error rate is low and their Type II error rate is high.

B) The firm’s Type I error rate is high and their Type II error rate is low.

C) The firm’s Type I error rate is high and their Type II error rate is high.

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Type I error is retaining a poor manager and Type II error is firing a superior manager. If a firm has high turnover in staff, it is unlikely they are retaining poor managers but more likely that they are firing good managers.

ikoreaii

Which of the following is NOT a conclusion regarding quality control charts and how they are typically used to evaluate manager performance?

A) This is a two-tailed test.

B) H0 will be that the manager adds no value; Ha is that the manager adds positive value.

C) Keeping a manager who generates no value added would be a Type I error.

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The test is set up as null, the manager generates no added value and the alternative is that the manager adds value. So we are looking for positive added value which is a one-tailed test. Therefore, the alternative will be that the manager generates positive value added.

ikoreaii

Jack Jensen is the president of Jensen Management. Jensen prides himself on the care of his employees. He states that in 30 years of portfolio management, he has only had to fire two employees. Tom Mercer is president of Analytical Investors. His policy has been to replace poorly performing managers, where poor performance equals underperforming their benchmark for two successive quarters. Which of the following best describes these managers’ continuation decisions?

A) Jensen is likely committing Type I error and Mercer is likely committing Type II error.

B) Jensen is likely committing Type II error and Mercer is likely committing Type I error.

C) Jensen is not likely to be committing any error and Mercer is likely committing Type II error.

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Type I error is retaining (or hiring) a poorly performing manager. Jensen is likely committing Type I error because he rarely fires anyone. Type II error is firing (or not hiring) a superior manager. Jensen is likely committing Type II error because he fires managers after only two quarters of underperformance. Two quarters is not enough time to properly evaluate a manager.

ikoreaii

Suppose that all of a firm’s managers are outperforming the benchmark, some by a little, some by a lot. If the confidence intervals for a quality control charts in portfolio management were widened, what would the most likely effect be?

A) Type I error would become more likely and Type II error would become more likely.

B) Type I error would become more likely and Type II error would become less likely.

C) Type I error would become less likely and Type II error would become more likely.

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Type I error is retaining a poorly performing manager. If the confidence intervals are widened and a poor manager is barely outperforming the benchmark, it is less likely that they will have statistically significant excess returns. We are thus more likely to fire them and hence less likely to commit Type I error. At the same time, we may be firing good managers who are outperforming the benchmark but yet do not have statistically significant excess returns. We are thus more likely to commit Type II error as Type II error is firing a superior manager.