Reading 46: Monitoring and Rebalancing Los f~Q1-3

factors, manager, change, including

LOS f: Discuss the key determinants of the optimal corridor width of an asset class in a percentage-of-portfolio rebalancing program, including transaction costs, risk tolerance, correlation, asset class volatility, and the volatility of the remainder of the portfolio, and evaluate the effects of a change in any of these factors.

Q1. Stuart Steinberg, a portfolio manager for Weber Capital Advisors, uses a percentage-of-portfolio rebalancing approach when rebalancing his client portfolios, but is unsure how to set the optimal corridor width for each asset class. Steinberg is evaluating the following factors for a particular asset class.

Factor 1:	The asset class has a tendency to be extremely volatile.
Factor 2:	The asset class has a low trading volume and a high bid-ask spread.
Factor 3:	When comparing the asset class to the rest of the portfolio, the volatility for the rest of the portfolio is high.

Which of the factors would lead Steinberg to set a large corridor for the asset class?

A) Factors 1 and 2 only.

B) Factor 2 only.

C) Factors 2 and 3 only.

Q2. Rebecca Riley and Daniel Gray are portfolio managers for Silver Wolf Asset Management. The firm believes that rebalancing a portfolio is important for maintaining an investor’s exposure to systematic risk factors and follows a percentage-of-portfolio approach to rebalancing. Riley and Gray each recently brought a new client to the firm and are starting to establish guidelines for investing their portfolios. Riley states, “My client has a low tolerance for risk, so I am setting wide tolerance corridors for rebalancing. If the market takes a downturn, the client will not want his fixed income assets sold to purchase more equities.” Discussing his client, Gray says, “My client’s portfolio consists largely of small-cap domestic equities, emerging market equities, and high yield bonds. Since the asset classes in his portfolio are relatively volatile, I am also setting wide tolerance corridors, or else I would be rebalancing his portfolio practically all the time.”

With regard to their statements about the effects of factors on the width of the tolerance corridors:

A) Riley’s statement is incorrect; Gray’s statement is incorrect.

B) Riley’s statement is incorrect; Gray’s statement is correct.

C) Riley’s statement is correct; Gray’s statement is correct.

Q3. The model portfolio for Yazbeck Capital Management consists of the following allocation:

Asset Class	Allocation
Intermediate U.S. Government bonds	45%
Intermediate U.S. Corporate bonds	45%
Large Cap U.S. equities	10%

One of the primary tenets of Yazbeck’s Investment Process is to rebalance portfolios based on a percentage-of-portfolio approach with tolerance corridors for each asset class. Two of Yazbeck’s portfolio managers, Justin Croniser and Kevin Hopkins are discussing the size of the corridor width for each asset class. Croniser states, “The high correlation between U.S. Government bonds and U.S. Corporate bonds implies that both asset classes should stay within acceptable limits even if we decide to set relatively small corridors.” Hopkins replies, “Even if that were true, the high liquidity of U.S. Government bonds implies that the corridor for that asset class should be relatively wide.”
The founder of Yazbeck Capital Management, Shadya Yazbeck is listening to their conversation. Yazbeck should:

A) disagree with Croniser’s statement and disagree with Hopkins’ statement.

B) agree with Croniser’s statement and agree with Hopkins’ statement.

C) agree with Croniser’s statement, but disagree with Hopkins’ statement.