Q11. Michael Carr and Karen Bocock are analysts for the Portfolio Optimization Group. Carr and Bocock are discussing the firm’s mean variance optimization model for equity holdings and the pros and cons of using market model estimates or historical estimates as inputs to the model. ffice ffice" />
- Carr states, “One of the main concerns I have about the model is that whether we are using market model estimates or historical estimates, we are implicitly assuming that the historical relationship between the stock and the market is indicative of the future.”
- Bocock replies, “One of the main advantages to using the market model estimates is the fact that there are fewer parameters to estimate.”
With regard to their statements about methods for computing the inputs for a mean-optimization model:
A) both are incorrect.
B) both are correct.
C) only one is correct.
Correct answer is B)
Carr’s statement is correct. Using historical estimates and market model estimates both involve the implicit assumption that the historical relationship between a stock and the market is indicative of the future relationship. The historical estimate method uses direct historical means, variances, and correlations as inputs to the model. The market model method regresses historical returns against returns for the market and assumes that returns for each asset are correlated with returns to the market. Since both methods use some form of historical data, both assume that history is indicative of the future.
Bocock is also correct. The historical estimate method requires a large number of estimates, especially for computing the covariances between every stock in a portfolio. The market model estimate method simplifies the process significantly (resulting in fewer parameters) since all stock returns are assumed to be correlated with the market.
Q12. The single-factor market model assumes there are how many sources of risk in asset returns?
A) One.
B) Three.
C) Two.
Correct answer is C)
The market model assumes that there are two sources of risk in asset returns, unanticipated macroeconomic events and firm-specific events.
Q13. Bill Tanner is a new associate at Global Western Investments. Tanner approaches his supervisor, Eric Simms, with some questions about risk. Specifically, Tanner lacks a complete understanding of many portfolio concepts, including the following:
- How the presence of a risk-free asset will affect the efficient frontier.
- The difference between total risk, systematic risk, and unsystematic risk.
- Market and Macroeconomic models.
Tanner is concerned with providing the best investment advice possible for his clients. He seeks advice from some of his former Midwestern college friends who now happen to be CFA charterholders. One of his old roommates suggests that he look into using the market model or a multifactor model based on the arbitrage pricing theory (APT).
Tanner researches alternative pricing models and starts to become confused as all the equations look similar. He writes down the following notes from memory:
- The intercept for the market model is derived from the APT.
- The intercept for the APT is the risk free rate.
- The intercept for a macroeconomic factor model is the expected return on the stock when there are no surprises to the factors.
Simms makes the predictions for Tanner shown in Exhibit 1.
Exhibit 1: Simm’s Predictions for Tanner
|
Beta for Stock B |
1.10 |
|
Beta for Stock C |
1.50 |
|
Correlation between Stock A and the S& 500 |
0.50 |
|
Standard deviation for Stock A |
28% |
|
Standard deviation for the S& 500 |
20% |
|
1-year Treasure bill rate |
5% |
|
Expected return on the S& 500 |
12% |
Tanner uses the market model predictions (and the S& 500 as a proxy for the market portfolio) to calculate the covariance of Stock B and C at 0.33. Using the market model, he also determines that the systematic component of the variance for Stock B is equal to 0.048.
Next, he heads out to meet a friend, Del Torres, for lunch. Torres excitedly tells Tanner about his latest work with tracking and factor portfolios. Torres says he has developed a tracking portfolio to aid in speculating on oil prices and is working on a factor portfolio with a specific set of factor sensitivities to the Russell 2000.
Which of the following is the most appropriate response to Tanner’s question about the presence of a risk-free asset and the Markowitz efficient frontier? The presence of a risk-free asset changes the characteristics of the Markowitz efficient frontier by:
A) reducing the total risk and the systematic risk of the market portfolio.
B) allowing risk averse investors to include in their portfolios an asset that is negatively correlated with stocks, thereby reducing the risk related to investing in equities.
C) converting the Markowitz efficient frontier from a curve into a linear risk/return relationship.
Correct answer is C)
The presence of a risk-free asset changes the characteristics of the Markowitz efficient frontier by converting the Markowitz efficient frontier from a curve into a straight line called the capital market line (CML). (Study Session 18, LOS 66.d)
Q14. Which of the following statements best describes the concept of systematic risk? Systematic risk:
A) is approximately equal to total risk divided by unsystematic risk.
B) remains even for a well-diversified portfolio.
C) as measured by the standard deviation is the only risk rewarded by the market.
Correct answer is B)
Systematic risk remains even if a portfolio is well diversified. (Study Session 18, LOS 66.g)
Q15. Are Tanner’s notes on the intercepts for the pricing models correct?
A) No, because the intercept for the APT is the stock’s alpha.
B) No, because the intercept for the market model is the risk-free rate.
C) No, because the intercept for the market model is the return on the stock when the return on the market is zero.
Correct answer is C)
Tanner is incorrect with regards to the market model. The intercept is equal to the return when the market return is zero. Tanner’s other two comments on intercepts are correct. (Study Session 18, LOS 66.g)
Q16. The beta of Stock A is closest to:
A) 0.36.
B) 0.50.
C) 0.70.
Correct answer is C)
(Study Session 18, LOS 66.h)
Q17. According to the predictions of the market model, did Tanner correctly calculate the covariance of Stock B and C and Stock B’s systematic component of variance?
Covariance Systematic component
A) Yes Yes
B) Yes No
C) No Yes
Correct answer is C)
Tanner incorrectly calculated the covariance and correctly calculated the systematic variance component.
According to the market model, the covariance between any two stocks is calculated as the product of their betas and the variance of the market portfolio. Here, the S& 500 is a proxy for the market portfolio.
Here, CovB,C = 1.10(1.50)(0.2)2 = 0.066. Tanner incorrectly used the standard deviation of the market.
The variance of the returns on asset i consists of two components: a systematic component related to the asset’s beta, , and an unsystematic component related to firm-specific events,.
For Stock B, the systematic component = 1.102(0.2)2 = 0.048 (Study Session 18, LOS 66.a)
Q18. Did Torres correctly describe tracking and factor portfolios?
Tracking Factor
A) No No
B) Yes No
C) No Yes
Correct answer is A)
Torres reversed the concepts and is thus incorrect on both counts. A factor portfolio is a portfolio with a factor sensitivity of 1 to a particular factor and zero to all other factors. It represents a pure bet on one factor, and can be used for speculation or hedging purposes. A tracking portfolio is a portfolio with a specific set of factor sensitivities. Tracking portfolios are often designed to replicate the factor exposures of a benchmark index like the Russell 2000. (Study Session 18, LOS 66.m)
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发表于 2009-4-2 12:57
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