LOS s: Discuss the issues involved in manager continuation policy decisions, including the costs of hiring and firing investment managers.

Q1. 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)   reduce both Type I and Type II errors.

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

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

Q2. 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 high and their Type II error rate is low.

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

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

Q3. Which of the following would NOT be a feature of a well formulated manager continuation policy?

A)   Decisions to replace managers should always be taken on a clear cost benefit analysis basis.

B)   A formalized, written manager continuation policy including goals and guidelines.

C)   Underperformance, in any circumstances, will lead to automatic replacement of the manager.

LOS s: Discuss the issues involved in manager continuation policy decisions, including the costs of hiring and firing investment managers. fficeffice" />

Q1. 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)   reduce both Type I and Type II errors.

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

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

Correct answer is B)

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.

Q2. 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 high and their Type II error rate is low.

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

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

Correct answer is B)

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.

Q3. Which of the following would NOT be a feature of a well formulated manager continuation policy?

A)   Decisions to replace managers should always be taken on a clear cost benefit analysis basis.

B)   A formalized, written manager continuation policy including goals and guidelines.

C)   Underperformance, in any circumstances, will lead to automatic replacement of the manager.

Correct answer is C)

Short periods of underperformance should not necessarily lead to automatic replacement of the manager. Underperformance for consecutive review periods should put the plan sponsor on notice of a potential problem.

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