hinsafdar

Which of the following statements is most accurate regarding comparing a 120/20 strategy versus combining a 100/0 strategy with a 20/20 strategy?

A) Combining a 100/0 strategy with a 20/20 strategy would result in a 120/20 short extension strategy.

B) The 120/20 strategy is managed as a single portfolio whereas the combination of the other strategies represents two separately managed portfolios.

C) Both strategies are essentially equivalent.

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A 120/20 strategy compared to combining a 100/0 with a 20/20 strategy are not the same thing. The 120/20 is a short extension strategy in which 20% of the long portfolio is shorted with the proceeds used to purchase an equivalent amount of equities with the resulting portfolio viewed as being managed as 1 portfolio. The 100/0 combined with a 20/20 strategy represents a 100% long portfolio combined with a market neutral strategy with each strategy representing separately managed portfolios. Also, the 20/20 market neutral strategy is constructed by shorting 20% of the available capital and using derivatives such as futures or swaps to gain market exposure whereas the short extension strategy does not use derivatives to gain market exposure.

hinsafdar

Which of the following provides the correct range of annual turnover in a value investor’s portfolio?

A) 0% to 20%.

B) 20% to 80%.

C) 80% to 150%.

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The frequency of buying and selling in a portfolio will be driven by the manager’s style. Value investors are typically long-term investors who buy undervalued stocks and hold them until they appreciate. Annual turnover for value managers usually varies from 20% to 80%. Growth managers base their decisions on earnings growth and are less patient. They often sell after the next earnings statement comes out. Thus it is not unusual to see annual turnover of 60% to several hundred percent for these investors.

hinsafdar

In which of the following selling disciplines would the investor sell the stock after it had reached its intrinsic value?

A) Up-from-cost.

B) Target price.

C) Valuation-level.

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In a target price sell discipline, the manager determines the stock’s fundamental value at the time of purchase and later sells the stock when it reaches this level.

hinsafdar

Which of the following selling disciplines would be best for an investor who is concerned about the tax implications of a trade?

A) Up-from-cost.

B) Opportunity cost.

C) Deteriorating Fundamentals.

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If an investor factors in the transactions costs and tax consequences of the sale of the existing security and the purchase of the new security, this approach is referred to as an opportunity cost sell discipline.

hinsafdar

Manager X follows the stocks in a broad market index and has made independent forecasts for 300 of them. Her information coefficient is 0.03. Manager Y has made independent forecasts for 100 stocks. His information coefficient is 0.05. Which manager has the better performance and why?

A) Manager Y because he has more accurate forecasts.

B) Manager Y because he has greater breadth.

C) Manager X because she has greater breadth.

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The information ratio for each manager is calculated as the information coefficient times the square root of the investor’s breadth:

Although Manager X’s depth of knowledge (as measured by the information coefficient) is not as great, she has better performance as measured by the information ratio because she has a greater breadth of decisions.

hinsafdar

Manager X follows the stocks in a broad market index and has made independent forecasts for 500 of them. Her information coefficient is 0.02. Manager Y has made independent forecasts for 175 stocks. His information coefficient is 0.04. Which manager has the better performance and why?

A) Manager Y because he has greater breadth.

B) Manager X because she has greater breadth.

C) Manager Y because he has more accurate forecasts.

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The information ratio for each manager is calculated as the information coefficient times the square root of the investor’s breadth:

The information coefficient is measured by comparing the investor’s forecasts against actual outcomes. More skillful managers will have a higher information coefficient. Manager Y’s depth of knowledge is greater which accounts for his greater information ratio and better performance.

hinsafdar

Which of the following concerning investment strategies is least accurate?

A) Stock-based enhanced indexing strategy can produce higher information ratios because investors can apply their knowledge to a large number of securities.

B) In a long-short, market neutral strategy the benchmark should be the risk-free rate.

C) If a manager does not have an opinion about an index stock in stock-based enhanced indexing strategy, they will not hold the stock.

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If a manager does not have an opinion about an index stock in a stock-based enhanced indexing strategy, they will hold the stock at the same level as the benchmark. Stock-based enhanced indexing strategies can produce higher information ratios because the investor can systematically apply his knowledge to a large number of securities, each of which would require independent decisions. Because a long-short, market neutral strategy has no systematic risk, its benchmark should be the risk-free rate (the return on T-bills).

hinsafdar

How is risk controlled in a stock-based enhanced indexing strategy?

A) Buying puts on equity indices.

B) Selling equity futures contracts.

C) Through monitoring factor risk and industry exposures.

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In a stock-based enhanced indexing strategy, risk is controlled by monitoring factor risk and industry exposures.

hinsafdar

In which of the following situations would an investor be most risk averse?

A) When allocating assets to stocks, bonds, and other assets.

B) When allocating funds to active equity managers.

C) When allocating funds to a passive index.

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At the asset allocation level, the focus is on maximizing expected return for a given level of risk. Once an investor has made a decision to invest in equity, the tradeoff focuses on active risk and active return. As one moves from passive management to enhanced indexing to active management, the expected active return and active risk increase.
Investors are more risk averse when facing active risk. To believe that an active return is possible, the investor must believe that there are active managers who can produce it and that the investor will be able to pick those successful managers. Second, an active equity style will also be judged against a passive benchmark. It is difficult to earn alpha and those investors who don’t will face pressure from their superiors. Lastly, higher active returns mean more is invested with the high return active manager, and this results in less diversification.

hinsafdar

Which of the following statements is least accurate? An investor’s utility of the active return:

A) increases as the investor’s risk aversion to active risk decreases.

B) increases as active risk decreases.

C) increases as the investor’s risk tolerance for active risk decreases.

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The utility function for active return is similar to the utility function for total return. The utility of the active return increases as active return increases, active risk decreases, and as the investor’s risk aversion to active risk decreases. Risk tolerance is the opposite of risk aversion. Lower risk tolerance would imply lower utility from a risky return.