Reading 25: Asset Allocation－LOS a investor, function, strategic, management, allocation

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 7: Asset Allocation
Reading 25: Asset Allocation
LOS a: Summarize the function of strategic asset allocation in portfolio management and discuss its role in relation to specifying and controlling the investor's exposures to systematic risk.

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Which of the following statements regarding the strategic asset allocation process is least accurate?

A) Strategic asset allocation, similar to tactical asset allocation, employs a short-run capital market projection.

B) The strategic asset allocation review is typically performed once per year.

C) Strategic asset allocation is similar to a "constant mix" strategy.

D) The strategic asset allocation must be rebalanced periodically for changes in the valuation of the various asset classes in the portfolio.

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Answer and Explanation

Strategic asset allocation employs a long-term capital market projection.

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Each of the following statements concerns either strategic asset allocation or tactical asset allocation. Which of the following statements is least accurate?

A) Strategic asset allocation employs a long-run view of capital market conditions.

B) Tactical asset allocation is designed to take advantage of perceived inefficiencies in the asset markets.

C) Tactical asset allocation employs a long-run view of capital market conditions.

D) Strategic asset allocation is typically a constant mix strategy.

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Answer and Explanation

Tactical asset allocation is an attempt to take advantage of temporary capital market inefficiencies and takes a short-run view of market conditions. All of the other statements are true.

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In a market that can be characterized by up-down or down-up movements, rather than a sustained up or down trend, which of the following statements is least accurate with regard to the benefits of rebalancing the asset mix of a portfolio?

A) Under a buy and hold strategy, asset allocation changes occur solely in response to changes in relative market values.

B) Disciplined rebalancing strategies are superior to a buy and hold strategy.

C) Momentum-based rebalancing strategies outperform disciplined rebalancing strategies.

D) Market-timing strategies usually underperform disciplined rebalancing strategies.

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Answer and Explanation

Disciplined rebalancing (e.g., maintaining a 60% stock / 40% bond mix) is superior to a momentum-based rebalancing strategy when the market is not following a sustained trend.

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The first step in the portfolio construction process is called:

A) tactical asset allocation.

B) efficient frontier optimization.

C) capital market expectation.

D) strategic asset allocation.

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Answer and Explanation

Strategic asset allocation is the first step in the portfolio construction process. Tactical asset allocation is the subsequent deviation from the strategic asset allocation based on short-term capital market expectations. Capital market expectations are used for the generation of the efficient frontier.

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Assignment of asset class weights for a portfolio based on long-term capital market expectations is called:

A) tactical asset allocation.

B) strategic asset allocation.

C) portfolio optimization.

D) risk minimization.

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Answer and Explanation

Strategic asset allocation is the assignment of weights to different asset classes based on long-term capital market expectations. Tactical asset allocation is based on short-term capital market expectations.

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Strategic asset allocation is based upon:

A) short-term capital market expectations and the investment policy statement.

B) long-term capital market expectations and the investment policy statement.

C) long-term capital market expectations and risk/return preferences of the investor.

D) short-term capital market expectations and risk/return preferences of the investor.

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Answer and Explanation

Strategic asset allocation is based on long-term capital market expectations (which forms the basis for the generation of the efficient frontier) and the investment policy statement (IPS) of the investor. The IPS includes not only the risk/return objectives of the investor but also the investors constraints.

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According to the modern portfolio theory, which risk is rewarded?

A) Efficient risk.

B) Systematic risk.

C) Total risk.

D) Standard deviation.

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Answer and Explanation

According to modern portfolio theory, only systematic risk is rewarded. Total risk (may be measured by standard deviation) is comprised on systematic and unsystematic risk.

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Strategic asset allocation reflects what systematic risk exposure?

A) Asset class systematic risk.

B) One that lies on the efficient frontier.

C) Long-term systematic risk exposure.

D) Investors desired systematic risk exposure.

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Answer and Explanation

Strategic asset allocation reflects the investors desired systematic risk exposure.

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What does Strategic Asset Allocation allow managers to do with respect to systematic risk?

A) Reduce.

B) Monitor and control.

C) Eliminate.

D) Identify and minimize.

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Answer and Explanation

Strategic asset allocation reflects the investors desired systematic risk exposure and allows the manager to monitor and control risk not to reduce, eliminate or minimize it.