Reading 25: Asset Allocation－LOS g class, whether, specified

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 7: Asset Allocation
Reading 25: Asset Allocation
LOS g: Evaluate whether an asset class or set of asset classes has been appropriately specified.

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Which of the following characteristics of asset classes is most desirable? Asset classes should:

A) be mutually exhaustive.

B) have an index.

C) be negatively correlated.

D) be positively correlated.

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Answer and Explanation

One of the desired characteristics of asset classes is that they should be mutually exhaustive- or cover most of the investable assets. They also should not be highly (positively or negatively) correlated with each other.

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Which of the following statements regarding the characteristics of asset classes is most correct? Asset classes should:

A) not be highly correlated.

B) have an index.

C) be negatively correlated.

D) be positively correlated.

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Answer and Explanation

Asset classes should not be highly correlated with each other is a desired characteristic. Furthermore, asset classes should be mutually exclusive and collectively mutually exhaustive.

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Which of the following would indicate that the asset classes used for describing the returns of a portfolio are desirable?

A) Low R-squared and easily measured manager asset proportions.

B) High R-squared and easily measured manager asset proportions.

C) High R-squared and large confidence intervals.

D) Low R-squared and large confidence intervals.

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Answer and Explanation

Desirable asset classes would explain a high proportion of portfolio returns and thus have a high R-squared. The asset mix proportions for each manager should be easily measured.

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Which of the following characteristics of asset classes is most desirable? Asset classes should:

A) have an index.

B) be negatively correlated.

C) be positively correlated.

D) be mutually exclusive.

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Answer and Explanation

One of the desired characteristics of asset classes is that they should be mutually exclusive. They also should not be highly (positively or negatively) correlated with each other.

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Which of the following is NOT a desirable characteristic of an asset class used for describing the returns on a portfolio?

A) The asset classes used should explain a large part of the variability of portfolio returns.

B) The residual from the regression model of returns should be heteroskedastic.

C) Asset mix proportions should be easily measured.

D) It should be easy to construct a bogey portfolio for each class.

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Answer and Explanation

The asset classes used should explain a large part of portfolio return variability, the asset mix proportions should be easily measured, and it should be easy to construct a bogey portfolio for each class. Heteroskedasticity refers to a non-constant variance of the error terms in a regression, which makes the regression model unreliable.

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Which of the following would indicate that an asset class is useful for describing the returns of a portfolio?

A) The error term is high.

B) The standard error of the beta estimates are large.

C) The intercept term is significantly different from zero.

D) The R-squared of the model is high.

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Answer and Explanation

A high R-squared would indicate that the model explains a good proportion of portfolio returns.