LOS d: Discuss the benefits and costs of rebalancing a portfolio to the investor’s strategic asset allocation.

Q1. All of the following are costs associated with rebalancing a portfolio EXCEPT:

A)   deferral costs.

B)   brokerage commissions.

C)   tax costs.

Q2. Which of the following statements correctly identifies a benefit of active management?

A)   Most portfolio managers can add value through active management.

B)   Trading provides liquidity to capital markets.

C)   Studies have shown more frequent rebalancing to increase portfolio returns.

Q3. Which of the following statements regarding rebalancing and correlation is TRUE?

A)   Negatively correlated asset classes need rebalancing more frequently than positively correlated asset classes.

B)   Perfect positive correlation between asset classes implies the greatest need for rebalancing.

C)   The need to rebalance is independent of the correlation between the securities or the asset classes.

Q4. Which of the following costs are NOT considered component costs of trading prompted by portfolio revisions?

A)   Opportunity costs.

B)   Brokerage fees.

C)   Interest expense.

Q5. Which of the following statements about trading strategies is TRUE?

A)   A disciplined rebalancing strategy typically underperforms a buy and hold strategy.

B)   A buy and hold strategy may not satisfy the current asset allocation needs of a client.

C)   A buy and hold strategy is best with respect to asset allocation because it has the lowest trading costs.

LOS d: Discuss the benefits and costs of rebalancing a portfolio to the investor’s strategic asset allocation. fficeffice" />

Q1. All of the following are costs associated with rebalancing a portfolio EXCEPT:

A)   deferral costs.

B)   brokerage commissions.

C)   tax costs.

Correct answer is A)

Tax costs are the key costs associated with rebalancing a portfolio and are often underestimated. Investors focus on brokerage commissions and forget trading costs such as market impact, trade execution inefficiencies and opportunity costs.

Q2. Which of the following statements correctly identifies a benefit of active management?

A)   Most portfolio managers can add value through active management.

B)   Trading provides liquidity to capital markets.

C)   Studies have shown more frequent rebalancing to increase portfolio returns.

Correct answer is B)

After costs, it has been shown that few portfolio managers add value through active management. Studies have shown that more frequent rebalancing can increase portfolio returns, but only before costs. After costs, increasing rebalancing frequency has a detrimental effect on returns.

Q3. Which of the following statements regarding rebalancing and correlation is TRUE?

A)   Negatively correlated asset classes need rebalancing more frequently than positively correlated asset classes.

B)   Perfect positive correlation between asset classes implies the greatest need for rebalancing.

C)   The need to rebalance is independent of the correlation between the securities or the asset classes.

Correct answer is A)

Because the denominator and the numerator (the value of the individual asset class divided by the total value of the portfolio) both change in the same direction when asset classes (and securities) are positively correlated, the portfolio manager needs to rebalance less frequently. However, negatively correlated assets require more rebalancing. In this case the numerator and the denominator might change in opposite directions.

Q4. Which of the following costs are NOT considered component costs of trading prompted by portfolio revisions?

A)   ffice:smarttags" />Opportunity costs.

B)   Brokerage fees.

C)   Interest expense.

Correct answer is C)

Brokerage fees, spreads, trader timing costs, and opportunity costs are component costs of trading.

Q5. Which of the following statements about trading strategies is TRUE?

A)   A disciplined rebalancing strategy typically underperforms a buy and hold strategy.

B)   A buy and hold strategy may not satisfy the current asset allocation needs of a client.

C)   A buy and hold strategy is best with respect to asset allocation because it has the lowest trading costs.

Correct answer is B

Buy and hold strategies “drift” over time. Because of this, initial asset allocation decisions may not be evident in the resulting portfolio. Disciplined rebalancing performs better than buy and hold strategies in a flat but oscillating market.