manchester88

Which of the following would be least likely to be used in both returns based style analysis and fundamental factor model micro attribution?

A) The amount of leverage used in the fund.

B) The sensitivities of the portfolio to index returns.

C) The returns to a small-cap stock index.

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Both returns based style analysis and fundamental factor model micro attribution would utilize the returns to various indices as well as the sensitivities to the indices. However, returns based style analysis would not examine fundamental factors such as the leverage in the fund and the size of the stocks in the fund.

manchester88

Which of the following least accurately characterizes fundamental factor model attribution and allocation/selection attribution?

A) Allocation/selection attribution can lead to spurious correlations.

B) Allocation/selection attribution is relatively easy to calculate.

C) Security weights need to be determined at the start of the evaluation period in allocation/selection attribution.

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It is actually fundamental factor model attribution that can lead to spurious correlations because the analysis is quite complex.

manchester88

Which of the following statements in relation to the effect of the external interest environment is least accurate?

A) Return on the default-free benchmark assumes no change in the forward rates.

B) The return due to the external interest rate environment is estimated from a term structure analysis of AAA rate corporate securities.

C) The overall effect represents the performance of a passive, default free bond portfolio.

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The return due to the external interest rate environment is estimated from a term structure analysis of Treasury securities. We are trying to establish the return on a default free bond portfolio, therefore the use of corporate securities would be inappropriate.

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The following are a number of contributions to return for a fixed-income portfolio:

• Return on interest rate management
• Return on trading activity
• Return due to changes in forward rates
• Return on the default-free benchmark

Which of the above statements is (are) CORRECT?

Effect of External Interest Environment

Contribution of the Management Process

A) 3 and 4 1 and 2

B) 1 and 3 2 and 4

C) 3 1, 2 and 4

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Changes in forward rates and the return on the default free benchmark are outside of the manager’s influence and are therefore part of the external interest environment. Interest rate management and trading activity are an integral part of the role of the manager and are therefore part of the management process. Remember we could also include return from sector/quality management and return from the selection of specific securities.

manchester88

Bill Carter, CFA and Bob Walters, CFA are analyzing the recent return of several funds they have been assigned to manage. The funds are Fund A, Fund B, Fund C, and Fund D as indicated in the table below.

		Fund A	Fund B	Fund C	Fund D	Market
Return		7.80%	7.20%	8.20%	7.60%	7.00%
Beta		1.10	0.90	1.20	1.05	1.00
Return Std.Dev.		4.00%	3.44%	4.15%	3.50%	3.55%
Tracking Error*		0.82%	0.45%	1.02%	0.67%
*Tracking error is the standard deviation of the difference between the Fund Return and the Market Index Return

The risk-free rate of return for the relevant period was 3.5%.
The management of the firm that Carter and Walters works for is very proud of the fact that all of the four funds had a higher return than the overall market as indicated on the table. The firm’s management wants to advertise how, using the market as a benchmark, these funds have had returns higher than that benchmark. The firm’s management asks Carter and Walters to compute several performance measures such as the Treynor measure, the Sharpe ratio, and the M2 measure. The firm’s management also asks for the construction of quality control charts.
In going over the results, Carter is skeptical of the results and using the market as a benchmark because that benchmark was not specified in advance. Walters says that he is skeptical too because it is not clear if the market is an appropriate benchmark in all cases. They want to proceed cautiously because the firm’s management recently instituted policies for manager continuation. For each manager, the firm’s management has set up the null hypothesis that a manager has no skill and the alternative hypothesis is that the manager has skill in adding value.
Carter and Walters discuss constructing a custom benchmark for some of these or other funds they might manage. A few of these funds hold cash positions to take advantage of good investment opportunities when they arise. Carter says that the benchmark they construct should include cash in the weighting scheme. They set aside a few weeks to construct a preliminary benchmark for several funds. Walters wants to be thorough, because once they construct the benchmark, he doesn’t plan to make any modifications to the custom benchmark.The portfolio with the highest Sharpe ratio is:

A) Fund A.

B) Fund D.

C) Fund C.

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The formula for the Sharpe ratio is:

For funds A, B, C, and D, the respective Sharpe ratios are 1.075, 1.076, 1.134, and 1.171. Fund D is the highest calculated as: (7.6 – 3.5)/3.5 = 4.1/3.5 = 1.171. (Study Session 17, LOS 41.j, p)

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What is the M2 measure for fund D?

A) 11.26%.

B) 7.66%.

C) 6.76%.

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The formula for the M2 measure is:

M2Portfolio D = 7.659% = 3.5% + (7.6% − 3.5%) × (3.55%/3.5%).
(Study Session 17, LOS 41.p)

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If the returns of each fund were plotted over a quality control chart using the market as a benchmark, the final point of the value-added line would be above zero, i.e., above the horizontal axis for:

A) all of the funds.

B) all of the funds except C only.

C) none of the funds.

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Since all of the funds’ returns are higher than the benchmark for the period, all of the funds would have a positive end point for the cumulative value-added line. (Study Session 17, LOS 41.r)

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With respect to the reasons for Carter and Walters being skeptical of using the market as a benchmark:

A) both Carter and Walters are wrong.

B) both Carter and Walters are correct.

C) Carter is wrong and Walters is correct.

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Their objections are both justified. A benchmark should be specified in advance and deemed appropriate for the style of the fund. (Study Session 17, LOS 41.j)

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With respect to the considerations that Carter and Walters put into preparing a custom benchmark, including a weighting for cash and not making modifications:

A) Carter is wrong and Walters is correct.

B) Carter and Walters are both correct.

C) Carter is correct and Walters is wrong.

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Carter is correct in that a custom benchmark should include an appropriate weight for cash holdings. Walters is wrong in that a benchmark should be modified on a preset schedule. (Study Session 17, LOS 41.l)

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The firm that Carter and Walters work for have set up a null hypothesis for each manager. In such a case, the firm would make a type II error if it:

A) fires a skilled manager.

B) keeps an unskilled manager.

C) hires a second manager to help a doubtful manager.

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In this case, we assume a manager does not add value and try to gather information that the manager does. Without sufficient evidence to prove value is added, the manager would be fired. Random noise could lead to this conclusion even though the manager does add value. (Study Session 17, LOS 41.t)

manchester88

An analyst has gathered the following information about the performance of an equity fund and the S&P 500 index over the same time period.   

                                                      Equity Fund            S&P 500

                  Return                                  27%                   29%         

                  Standard Deviation                33%                    20%

                  Beta                                    0.95                   1.00

                  Risk-free rate is 4.00%

The Treynor measure and the Sharpe ratio, in that order, for the S&P 500 are:

A) 0.33 and 0.97.

B) 0.25 and 1.25.

C) 0.18 and 1.11.

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Treynor measure: (0.29 – 0.04)/1.00 = 0.25
Sharpe ratio: (0.29 – 0.04)/0.20 = 1.25

manchester88

An analyst has gathered the following information about the performance of an equity fund and the S&P 500 index over the same time period.   

                                                         Equity Fund            S&P 500

                           Return                           32%                    26%            

                           Standard Deviation          41%                    29%

                           Beta                            0.98                    1.00

                           Risk-free rate is 6.00%

The difference between the Sharpe ratio for the equity fund and the Sharpe ratio for the S&P 500 is the:

A) S&P 500 is 0.04 lower.

B) equity fund is 0.06 lower.

C) S&P 500 is 0.09 higher.

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The equity fund Sharpe ratio: (0.32 – 0.06)/0.41 = 0.63
The S&P 500 Sharpe ratio: (0.26 – 0.06)/0.29 = 0.69
The equity fund is (0.63 – 0.69) = -0.06 lower

manchester88

An analyst has gathered the following information about the performance of an equity fund and the S&P 500 index over the same time period.   

                                                         Equity Fund            S&P 500

                    Return                                -12%                    -16%         

                    Standard Deviation                15%                     19%

                    Beta                                  1.18                     1.00

                    Risk-free rate is 6.00%

The difference between the Treynor measure for the equity fund and the Treynor measure for the S&P 500 is:

A) 0.15.

B) 0.07.

C) 0.17.

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The equity fund: (-0.12 – 0.06)/1.18 = -0.15
The S&P 500: (-0.16 – 0.06)/1.00 = -0.22
The equity fund is (-0.15 – (-0.22) = 0.07 higher

manchester88

Jensen’s alpha for a portfolio measures the:

A) fund’s return in excess of the required rate of return given the unsystematic risk of the portfolio.

B) difference between a fund’s return and the market return.

C) fund’s return in excess of the required rate of return given the systematic risk of the portfolio.

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Jensen’s alpha measures the return above the required rate of return based on the fund’s systematic risk. Said differently, Jensen’s alpha is the amount of return earned by the fund over and above the return predicted for the fund based on the capital asset pricing model, given the fund’s systematic risk.

manchester88

The Treynor measure is correctly defined as a measure of a fund’s:

A) return earned compared to its systematic risk.

B) excess earned compared to its systematic risk.

C) return earned compared to its unsystematic risk.

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The Treynor measure is defined as a fund’s excess return (fund’s return minus the risk-free rate) divided by its systematic risk (beta).