Reading 12- LOS h: Q5-12 money, black, company, management, class

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5．Miles Mason, CFA, works for ABC Capital, a large money management company based in New York. Mason has several years of experience as a financial analyst, but is currently working in the marketing department developing materials to be used by ABC’s sales team for both existing and prospective clients. ABC Capital’s client base consists primarily of large net worth individuals and Fortune 500 companies. ABC invests its clients’ money in both publicly traded mutual funds as well as its own investment funds that are managed in-house. Five years ago, roughly half of its assets under management were invested in the publicly traded mutual funds, with the remaining half in the funds managed by ABC’s investment team. Currently, approximately 75 percent of ABC’s assets under management are invested in publicly traded funds, with the remaining 25 percent being distributed among ABC’s private funds. The managing partners at ABC would like to shift more of its client’s assets away from publicly-traded funds into ABC’s proprietary funds, ultimately returning to a 50-50 split of assets between publicly traded funds and ABC funds. There are three key reasons for this shift in the firm’s asset base. First, ABC’s in-house funds have outperformed other funds consistently for the past five years. Second, ABC can offer its clients a reduced fee structure on funds managed in-house relative to other publicly traded funds. Lastly, ABC has recently hired a top fund manager away from a competing investment company and would like to increase his assets under management.
ABC Capital’s upper management requested that current clients be surveyed in order to determine the cause of the shift of assets away from ABC funds. Results of the survey indicated that clients feel there is a lack of information regarding ABC’s funds. Clients would like to see extensive information about ABC’s past performance, as well as a sensitivity analysis showing how the funds will perform in varying market scenarios. Mason is part of a team that has been charged by upper management to create a marketing program to present to both current and potential clients of ABC. He needs to be able to demonstrate a history of strong performance for the ABC funds, and, while not promising any measure of future performance, project possible return scenarios. He decides to conduct a regression analysis on all of ABC’s in-house funds. He is going to use 12 independent economic variables in order to predict each particular fund’s return. Mason is very aware of the many factors that could minimize the effectiveness of his regression model, and if any are present, he knows he must determine if any corrective actions are necessary. Mason is using a sample size of 121 monthly returns.
In order to conduct an F-test, what would be the degrees of freedom used (df_numerator; df_denominator)?
A)    12; 108.
B)    108; 12.
C)    120; 11.
D)    11; 120.

6．In regards to multiple regression analysis, which of the following statements is TRUE?
A)    Adjusted R-squared is less than R-squared.
B)    R-squared is less than adjusted R-squared.
C)    Adjusted R-squared always decreases as independent variables increase.
D)    Adjusted R-squared does not account for the number of observations.

7．Which of the following tests is used to detect autocorrelation?
A)    Durbin-Watson.
B)    Breusch-Pagan.
C)    Residual Plot.
D)    F-test.

8．One of the most popular ways to correct heteroskedasticity is to:
A)    adjust the standard errors.
B)    employ residual plots.
C)    use robust standard errors.
D)    improve the specification of the model.

9．Which of the following statements regarding the Durbin-Watson statistic is TRUE? The Durbin-Watson statistic:
A)    is approximately equal to 1 if the error terms are not serially correlated.
B)    can only be used to detect positive serial correlation.
C)    can only be used to detect negative serial correlation.
D)    only uses error terms in its computations.

10.If a regression equation shows that no individual t-tests are significant, but the F-statistic is significant, the regression probably exhibits:
A)    serial correlation.
B)    heteroskedasticity.
C)    multicollinearity.
D)    dummy variables.

11.A variable is regressed against three other variables, x, y, and z. Which of the following would NOT be an indication of multicollinearity? X is closely related to:
A)    3y + 2z.
B)    3.
C)    9y, and x is closely related to 4z.
D)    y².

12.An analyst is testing to see whether a dependent variable is related to three independent variables. He finds that two of the independent variables are correlated with each other, but that the correlation is spurious. Which of the following is TRUE? There is:
A)    evidence of multicollinearity and serial correlation.
B)    evidence of multicollinearity but not serial correlation.
C)    evidence of serial correlation but not multicollinearity.
D)    no evidence of multicollinearity and serial correlation.

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5．Miles Mason, CFA, works for ABC Capital, a large money management company based in New York. Mason has several years of experience as a financial analyst, but is currently working in the marketing department developing materials to be used by ABC’s sales team for both existing and prospective clients. ABC Capital’s client base consists primarily of large net worth individuals and Fortune 500 companies. ABC invests its clients’ money in both publicly traded mutual funds as well as its own investment funds that are managed in-house. Five years ago, roughly half of its assets under management were invested in the publicly traded mutual funds, with the remaining half in the funds managed by ABC’s investment team. Currently, approximately 75 percent of ABC’s assets under management are invested in publicly traded funds, with the remaining 25 percent being distributed among ABC’s private funds. The managing partners at ABC would like to shift more of its client’s assets away from publicly-traded funds into ABC’s proprietary funds, ultimately returning to a 50-50 split of assets between publicly traded funds and ABC funds. There are three key reasons for this shift in the firm’s asset base. First, ABC’s in-house funds have outperformed other funds consistently for the past five years. Second, ABC can offer its clients a reduced fee structure on funds managed in-house relative to other publicly traded funds. Lastly, ABC has recently hired a top fund manager away from a competing investment company and would like to increase his assets under management.
ABC Capital’s upper management requested that current clients be surveyed in order to determine the cause of the shift of assets away from ABC funds. Results of the survey indicated that clients feel there is a lack of information regarding ABC’s funds. Clients would like to see extensive information about ABC’s past performance, as well as a sensitivity analysis showing how the funds will perform in varying market scenarios. Mason is part of a team that has been charged by upper management to create a marketing program to present to both current and potential clients of ABC. He needs to be able to demonstrate a history of strong performance for the ABC funds, and, while not promising any measure of future performance, project possible return scenarios. He decides to conduct a regression analysis on all of ABC’s in-house funds. He is going to use 12 independent economic variables in order to predict each particular fund’s return. Mason is very aware of the many factors that could minimize the effectiveness of his regression model, and if any are present, he knows he must determine if any corrective actions are necessary. Mason is using a sample size of 121 monthly returns.
In order to conduct an F-test, what would be the degrees of freedom used (df_numerator; df_denominator)?
A)    12; 108.
B)    108; 12.
C)    120; 11.
D)    11; 120.
The correct answer was A)
Degrees of freedom for the F-statistic is k for the numerator and n – (k + 1) for the denominator.
k = 12
n – (k + 1) = 121 – (12 + 1) = 108
6．In regards to multiple regression analysis, which of the following statements is TRUE?
A)    Adjusted R-squared is less than R-squared.
B)    R-squared is less than adjusted R-squared.
C)    Adjusted R-squared always decreases as independent variables increase.
D)    Adjusted R-squared does not account for the number of observations.
The correct answer was A)
Whenever there is more than one independent variable, adjusted R-squared is less than R-squared. Adding a new independent variable will increase R-squared, but may either increase or decrease adjusted R-squared.
R-squared adjusted = 1 – [((n – 1) / (n – k - 1)) x (1 – R-squared)]
Where:
n = number of observations
K = number of independent variables
R-squared = unadjusted R-squared
7．Which of the following tests is used to detect autocorrelation?
A)    Durbin-Watson.
B)    Breusch-Pagan.
C)    Residual Plot.
D)    F-test.
The correct answer was A)
Durbin-Watson is used to detect autocorrelation. Breusch-Pagan and the residual plot are methods to detect heteroskedasticity, while the F-test is used to test whether at least one independent variable in a set of variables explains the variation in the dependent variable.
8．One of the most popular ways to correct heteroskedasticity is to:
A)    adjust the standard errors.
B)    employ residual plots.
C)    use robust standard errors.
D)    improve the specification of the model.
The correct answer was C)
Using generalized least squares and calculating robust standard errors are possible remedies for heteroskedasticity. Employing residual plots is a method to detect, not correct, heteroskedasticity. Improving specifications remedies serial correlation. The standard error cannot be adjusted, only the coefficient of the standard errors.
9．Which of the following statements regarding the Durbin-Watson statistic is TRUE? The Durbin-Watson statistic:
A)    is approximately equal to 1 if the error terms are not serially correlated.
B)    can only be used to detect positive serial correlation.
C)    can only be used to detect negative serial correlation.
D)    only uses error terms in its computations.
The correct answer was D)
The formula for the Durbin-Watson statistic uses error terms in its calculation. The Durbin-Watson statistic is approximately equal to 2 if there is no serial correlation. A Durbin-Watson statistic less than 2 indicates positive serial correlation, while a Durbin-Watson statistic greater then 2 indicates negative serial correlation.
10.If a regression equation shows that no individual t-tests are significant, but the F-statistic is significant, the regression probably exhibits:
A)    serial correlation.
B)    heteroskedasticity.
C)    multicollinearity.
D)    dummy variables.
The correct answer was C)
Common indicators of multicollinearity include: high correlation (>0.7) between independent variables, no individual t-tests are significant but the F-statistic is, and signs on the coefficients that are opposite of what is expected.
11.A variable is regressed against three other variables, x, y, and z. Which of the following would NOT be an indication of multicollinearity? X is closely related to:
A)    3y + 2z.
B)    3.
C)    9y, and x is closely related to 4z.
D)    y².
The correct answer was D)
If x is related to y², the relationship between x and y is not linear, so multicollinearity does not exist. If x is equal to a constant (3), it will be correlated with the intercept term.
12.An analyst is testing to see whether a dependent variable is related to three independent variables. He finds that two of the independent variables are correlated with each other, but that the correlation is spurious. Which of the following is TRUE? There is:
A)    evidence of multicollinearity and serial correlation.
B)    evidence of multicollinearity but not serial correlation.
C)    evidence of serial correlation but not multicollinearity.
D)    no evidence of multicollinearity and serial correlation.
The correct answer was B)
Just because the correlation is spurious, does not mean the problem of multicollinearity will go away. However, there is no evidence of serial correlation.