Reading 42: Monitoring and Rebalancing －LOS h buying, holding, insurance

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 15: Monitoring and Rebalancing
Reading 42: Monitoring and Rebalancing
LOS h: Explain the performance consequences, in up, down, and nontrending markets, of (1) rebalancing to a constant mix of equities and bills, (2) buying and holding equities, and (3) constant-proportion portfolio insurance (CPPI).

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Which of the following statements regarding the risk consequences of asset allocation strategies is FALSE?

A) Constant proportion portfolio insurance (CPPI) actively assumes risk tolerance is directly related to wealth.

B) Constant mix actively assumes risk tolerance is directly related to wealth.

C) Buy and hold passively assumes risk tolerance is directly related to wealth.

D) With a buy and hold strategy, the investor's tolerance for risk is zero if the value of the investor's assets falls below the floor value.

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Answer and Explanation

CPPI, not constant mix, assumes risk tolerance is directly related to wealth. A constant mix strategy assumes that risk tolerance is constant regardless of wealth levels.

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In a trending market, which asset allocation strategy outperforms?

A) Constant proportion portfolio insurance (CPPI).

B) Buy and hold.

C) Constant mix.

D) Cannot be determined.

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Answer and Explanation

In a trending market, CPPI outperforms a comparable buy and hold, which, in turn, outperforms a constant mix strategy.

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In a flat but oscillating market, which asset allocation strategy outperforms?

A) Buy and hold.

B) Constant proportion portfolio insurance (CPPI).

C) Cannot be determined.

D) Constant mix.

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Answer and Explanation

In a flat but oscillating market, constant mix outperforms a comparable buy and hold strategy, which, in turn, outperforms a CPPI strategy.

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A constant mix strategy will outperform a buy and hold strategy in a(n):

A) downward oscillating market.

B) upward oscillating market.

C) flat but oscillating market.

D) never.

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Answer and Explanation

Constant mix strategies underperform when there are no reversals and outperform when there are up-down oscillations.

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Which of the following strategies is also referred to as insured asset allocation?

A) Constant proportion portfolio insurance (CPPI).

B) Concave strategy.

C) Buy and hold.

D) Constant mix.

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Answer and Explanation

CPPI is the term used by Perold and Sharpe. It is referred to as insured asset allocation and momentum based by Maginn and Tuttle. CPPI is a momentum based strategy that aggressively increases exposure to risky assets in a rising market.

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Which of the following statements about constant proportion rebalancing strategies is FALSE?

A) It is a concave strategy.

B) The strategy is protected on the downside.

C) The strategy does well in a bull market.

D) The strategy performs worse than a constant mix strategy in a flat, oscillating market.

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Answer and Explanation

Constant proportion is a convex strategy.

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Which of the following statements regarding a constant mix portfolio strategy is FALSE?

A) The slope of the exposure diagram (y-axis = desired stock position, x-axis = asset value) for a constant mix strategy is between zero and one.

B) The slope of the exposure diagram (y-axis = desired stock position, x-axis = asset value) for a constant mix strategy increases as investor risk tolerance increases.

C) Under a constant mix strategy, stocks are purchased as the stock market falls.

D) Under a constant mix strategy, stocks are purchased as the stock market rises.

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Answer and Explanation

With a constant mix strategy, stocks must be sold as the market rises in order to maintain the ratio of stock to total assets.

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Which of the following statements about constant mix rebalancing is FALSE?

A) As stock prices rise, the stock to total assets ratio, increases so stocks should be sold.

B) As stock prices fall, the stock to total assets ratio decreases, so stocks must be purchased.

C) The clients' level of risk aversion determines the slope coefficient.

D) As stock prices rise, the stock to total assets ratio increases, so stocks should be purchased.

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Answer and Explanation

To maintain the constant mix, when stock prices rise, stocks must be sold.

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Which of the following statements about asset allocation strategies is TRUE?

A) Constant mix outperforms buy and hold when stock market reversals occur.

B) Constant mix outperforms buy and hold when stock market reversals do not occur.

C) Constant mix is a convex strategy.

D) Buy and hold is a concave strategy.

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Answer and Explanation

Constant mix is a concave strategy while buy and hold is a linear strategy.