Gypsy

Which of the following indices would be biased towards small cap stocks?

A) A price-weighted index.

B) A value-weighted index.

C) An equal-weighted index.

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The equal-weighted index is biased towards small-cap companies because they will have the same weight as large-cap firms even though they have less liquidity. Many equal-weighted indices also have more small companies in them than large firms, creating a further bias towards small companies. Value-weighted indices are biased towards large cap stocks and price-weighted indices are biased towards high priced stocks.

Gypsy

Which of the following statements regarding a free float-adjusted market capitalization index is least accurate?

A) The float adjusted index is considered the best index type by many investors, because it is representative and can be mimicked with minimal tracking risk.

B) A free float-adjusted market capitalization index assumes the investor has bought all the publicly available shares of each company in the index.

C) The major value-weighted indices in the world have not been adjusted for free float.

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The major value-weighted indices in the world have been adjusted for free float.

Gypsy

An investor would like to diversify internationally. Compared to trading in the underlying, an equity total return swap usually has:

A) higher trading costs and lower taxes.

B) lower trading costs and lower taxes.

C) lower trading costs and higher taxes.

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The trading costs in an equity total return swap are usually lower than that from trading in the underlying asset. The investor is usually not responsible for foreign withholding taxes either because they will be the swap dealer’s responsibility, who may be in a tax advantaged position relative to the investor.

Gypsy

An investor would like to use tactical asset allocation to take advantage of short-term mispricing. Which of the following statements is most accurate regarding the use of either ETFs or equity index futures combined with basket trades?

A) If she uses ETFs, she will be able to invest longer-term and establish short positions more easily.

B) If she uses ETFs, she will be able to invest longer-term but will not be able to establish short positions as easily.

C) If she uses futures, she will be able to invest longer-term and establish short positions more easily.

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Equity futures contracts have a finite life and must be periodically rolled over into a new contract whereas ETFs have a theoretically infinite life.

Gypsy

An investor would like to track an index and is considering using optimization. Optimization is characterized by:

A) the use of a factor model and infrequent rebalancing.

B) the use of a matrix model and frequent rebalancing.

C) the use of a factor model and frequent rebalancing.

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An optimization approach uses a factor model to match the factor exposures of the fund and the index. Optimization must be updated to reflect changes in risk sensitivities from the factor model and this leads to frequent rebalancing.

Gypsy

A manager wishes to use a passive strategy to mimic the returns of a price-weighted stock index that consists of 50 stocks. Which of the following would be the best method to use in composing this portfolio?

A) Using the full replication method.

B) To compose a portfolio that consists of an equal number of shares of a sample of the stocks in the index.

C) To compose a portfolio that is equally weighted using a sample of stocks in the index.

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For indices with fewer than 1000 positions, full replication is possible and recommended.

Gypsy

An investor would like to track an index. Compared to stratified sampling and optimization, when would replication be favored? When the index has:

A) more than 1,000 stocks and liquid stocks.

B) less than 1,000 stocks and illiquid stocks.

C) less than 1,000 stocks and liquid stocks.

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Full replication is more likely to be used when the number of stocks in the index is less than 1,000 and when the stocks in the index are liquid.

Gypsy

An investor would like to track an index. Compared to optimization, stratified sampling:

A) assumes the covariances are zero and leads to higher tracking risk.

B) models the covariances and leads to lower tracking risk.

C) models the covariances and leads to higher tracking risk.

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In a stratified sampling procedure, it is implicitly assumed that the risk factors have a covariance of zero. An optimization approach accounts for the covariances between the risk factors. An optimization approach leads to lower tracking risk than a stratified sampling approach.

Gypsy

An investor would like to track an index. Comparing optimization, stratified sampling, and replication; in which of the following indexes would the investor be least likely to use replication?

A) A value-weighted index.

B) An equal-weighted index.

C) A free float-adjusted market capitalization index.

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An equal-weighted index usually has a large representation in small-cap stocks. Replication would involve purchasing all the stocks in the index and this would be less feasible when there are small-cap stocks involved. The reason is that small-cap stocks tend to have lower liquidity and higher trading costs.

Gypsy

Which of the following is the primary risk of a market-oriented equity investing approach?

A) The tilt to growth is too strong.

B) The tilt to value is too strong.

C) The portfolio must outperform broad market averages or investors will switch to low cost indexing strategies.

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Market-oriented investors have portfolios that resemble a broad market average over time. The risk for a market-oriented manager is that he or she must outperform a broad market index or investors will use lower cost indexing strategies. Although a poor growth at a reasonable price (GARP) model would be a concern for this subset of market-oriented equity investing, it is not the primary risk of market-oriented equity investing.