Portfolio Management【Reading 60】Sample 2012

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Mean-variance analysis assumes that investor preferences depend on all of the following EXCEPT:

A) correlations among asset returns.

B) skewness of the distribution of asset returns.

C) expected asset returns.

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Mean-variance analysis assumes that investors only need to know expected returns, variances, and covariances in order create optimal portfolios. The skewness of the distribution of expected returns can be ignored.

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Which of the following statements regarding the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is least accurate? APT:

A) does not identify its risk factors.

B) requires fewer assumptions than CAPM.

C) and CAPM assume all investors hold the market portfolio.

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CAPM assumes that all investors hold the market portfolio, APT does not make this assumption.

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Which of the following models is NOT consistent with the concept that investors can earn an additional risk premium for holding dimensions of risk unrelated to market movements?

A) The capital asset pricing model (CAPM).

B) The arbitrage pricing theory.

C) Macroeconomic multi-factor models.

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The CAPM suggests that security returns can be captured in a one-factor (market) model. Multifactor models allow us to capture other dimensions of risk besides overall market risk. Investors with unique circumstances that differ from the average investor may want to hold portfolios tilted away from the market portfolio in order to hedge or speculate on factors like recession risk, interest rate risk or inflation risk. In doing so they are able to earn a substantial premium for holding dimensions of risk unrelated to market movements.

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In the context of multi-factor models, investors with lower-than-average exposure to recession risk (e.g. those without labor income) can earn a risk premium for holding dimensions of risk unrelated to market movements by creating equity portfolios with:

A) greater-than-average exposure to the recession risk factor.

B) greater-than-average market risk exposure.

C) less-than-average exposure to the recession risk factor.

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Multifactor models allow us to capture other dimensions of risk besides overall market risk. Investors with unique circumstances different than the average investor may want to hold portfolios tilted away from the market portfolio in order to hedge or speculate on factors like recession risk, interest rate risk or inflation risk. An investor with lower-than-average exposure to recession risk can earn a premium by creating greater-than-average exposure to the recession risk factor. In effect, he earns a risk premium determined by the average investor by taking on a risk he doesn’t care about as much as the average investor does

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Which of the following is an implication of the capital asset pricing model for investor’s portfolio decisions?

A) Less risk-averse investors will hold less of a broadly based index and more of the risk-free asset.

B) All investors will hold some combination of a broadly based market index and the risk-free asset.

C) Less risk-averse investors will overweight high-beta stocks relative to the market portfolio.

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The CAPM suggests that all investors should hold some combination of the market portfolio and the risk-free asset. Less risk-averse investors will hold more of the market portfolio (and move farther up the CML) and more risk-averse investors will hold more of the risk-free asset (and move farther down the CML).

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An analyst is constructing a portfolio for a new client. A portfolio which has factor exposures matched to those of a benchmark is:

A) an arbitrage portfolio.

B) a tracking portfolio.

C) an efficient portfolio.

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A tracking portfolio has factor exposures matched to those of a benchmark.

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An analyst is constructing a portfolio for a new client. A portfolio which has factor exposures matched to those of a benchmark is:

A) an arbitrage portfolio.

B) a tracking portfolio.

C) an efficient portfolio.

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A tracking portfolio has factor exposures matched to those of a benchmark.

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An analyst is constructing a portfolio for a new client. A portfolio which uses multifactor models to create a portfolio with an exposure to only one type of risk is:

A) an efficient portfolio.

B) a tracking portfolio.

C) a factor portfolio.

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A factor portfolio is established to create exposure to a specific risk (i.e. inflation).

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The Real Value Fund is designed to have zero exposure to inflation. However its current inflation factor sensitivity is 0.30. To correct for this, the portfolio manager should take a:

A) 30% short position in the inflation tracking portfolio.

B) 30% long position in the inflation factor portfolio.

C) 30% short position in the inflation factor portfolio.

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To hedge inflation, the fund should take a 30% short position in the inflation factor portfolio. This short position will fully offset the fund’s positive exposure to inflation. Tracking portfolios are typically used for active asset selection and have multiple factor exposures which would prevent them from adequately hedging the inflation exposure of the fund.

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Sidney Peterson is starting a new fund that is designed to have the same factor exposures as the Dow Jones Industrial Average, but seeks to outperform the index by at least 2% annually thorough superior stock selection. To achieve this, the fund would most likely use a:

A) tracking portfolio.

B) bottom-up strategy.

C) pure factor portfolio.

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Tracking portfolios are typically used for active asset selection. A pure factor portfolio would be used to increase or decrease exposure to one specific factor, such as GNP. A bottom-up strategy is unsuitable because it solely focuses on a firm’s characteristics and fails to properly invest in the same industries as the index.