Reading 69: The Theory of Active Portfolio Management Los c~Q determine, required, capital, returns, stocks

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LOS c: Describe how an analyst’s accuracy in forecasting alphas can be measured and how estimates of forecasting can be incorporated into the Treynor-Black approach.

Q1. Collette Gallant, CFA, employs the capital asset pricing model (CAPM) to determine the required returns for stocks. Gallant works for Trey-Black Inc. (TBI) which uses the Treynor-Black model for portfolio optimization. Gallant is deciding whether to include stock ABZ in the TBI’s actively managed portfolio. She forecasts that the ABZ stock return will be 15% next year. TBI provides Gallant with the following information.

• Expected return on the S&500 stock market index = 15%.
• 1-year Treasury bill rate = 5%.
• ABZ stock beta = 1.25.

TBI determines that Gallant’s forecast ability has been very poor. TBI also finds that the average alpha across stocks in their actively managed portfolio equals 1%. Determine if Trey-Black’s allocation to ABZ in its actively managed portfolio should be an above or below average, long or short position.

          Magnitude                           Position

 

A)   Below average                    Long

B)   Above average                    Short

C)   Below average                    Short

 

Q2. According to the Treynor-Black portfolio optimization model, assets are allocated to both a passively managed portfolio and to an actively managed portfolio. Which of the following is most likely to lead to a larger allocation to the actively managed portfolio?

A)   Unsystematic risk.

B)   Short sales prohibition.

C)   Market inefficiencies.

 

Q3. Frederick Kurzonkowski, CFA, employs the Treynor-Black portfolio optimization model at his firm, TBP, where he serves as portfolio manager. TBP recently decided against holding short positions in their portfolios. Kurzonkowski is asked to determine the most likely result of the short-sale prohibition on the weights allocated to the long positions in the active portfolio, and to the alpha on the active portfolio. Kurzonkowski should make the following predictions about the effects of the prohibition on short sales on the actively managed portfolio:

          Allocation  to long positions         Alpha

 

A)         Decreases                      Decreases

B)         Increases                        Decreases

C)         Decreases                      Increases

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