Gypsy

A manager wishes to use a passive strategy to mimic the returns of a price-weighted stock index that consists of 50 stocks. Which of the following would be the best method to use in composing this portfolio?

A) Using the full replication method.

B) To compose a portfolio that consists of an equal number of shares of a sample of the stocks in the index.

C) To compose a portfolio that is equally weighted using a sample of stocks in the index.

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For indices with fewer than 1000 positions, full replication is possible and recommended.

Gypsy

An investor would like to track an index and is considering using optimization. Optimization is characterized by:

A) the use of a factor model and infrequent rebalancing.

B) the use of a matrix model and frequent rebalancing.

C) the use of a factor model and frequent rebalancing.

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An optimization approach uses a factor model to match the factor exposures of the fund and the index. Optimization must be updated to reflect changes in risk sensitivities from the factor model and this leads to frequent rebalancing.

Gypsy

An investor would like to use tactical asset allocation to take advantage of short-term mispricing. Which of the following statements is most accurate regarding the use of either ETFs or equity index futures combined with basket trades?

A) If she uses ETFs, she will be able to invest longer-term and establish short positions more easily.

B) If she uses ETFs, she will be able to invest longer-term but will not be able to establish short positions as easily.

C) If she uses futures, she will be able to invest longer-term and establish short positions more easily.

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Equity futures contracts have a finite life and must be periodically rolled over into a new contract whereas ETFs have a theoretically infinite life.

Gypsy

An investor would like to diversify internationally. Compared to trading in the underlying, an equity total return swap usually has:

A) higher trading costs and lower taxes.

B) lower trading costs and lower taxes.

C) lower trading costs and higher taxes.

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The trading costs in an equity total return swap are usually lower than that from trading in the underlying asset. The investor is usually not responsible for foreign withholding taxes either because they will be the swap dealer’s responsibility, who may be in a tax advantaged position relative to the investor.

Gypsy

Which of the following statements regarding a free float-adjusted market capitalization index is least accurate?

A) The float adjusted index is considered the best index type by many investors, because it is representative and can be mimicked with minimal tracking risk.

B) A free float-adjusted market capitalization index assumes the investor has bought all the publicly available shares of each company in the index.

C) The major value-weighted indices in the world have not been adjusted for free float.

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The major value-weighted indices in the world have been adjusted for free float.

Gypsy

Which of the following indices would be biased towards small cap stocks?

A) A price-weighted index.

B) A value-weighted index.

C) An equal-weighted index.

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The equal-weighted index is biased towards small-cap companies because they will have the same weight as large-cap firms even though they have less liquidity. Many equal-weighted indices also have more small companies in them than large firms, creating a further bias towards small companies. Value-weighted indices are biased towards large cap stocks and price-weighted indices are biased towards high priced stocks.

Gypsy

An investor believes markets are efficient and pursues an equity investment strategy consistent with their beliefs. Which of the following best characterizes their portfolio, relative to other possible equity strategies?

A) Low tracking risk and low information ratio.

B) High tracking risk and low information ratio.

C) Low tracking risk and high information ratio.

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If an investor believes markets are efficient, the investor will pursue a passive strategy. Relative to active and semiactive strategies, passive strategies are characterized by low expected active return, low tracking risk, and low information ratio.

Gypsy

Which of the following investors would be more likely to pursue passive equity management strategies?

A) A taxable investor who believes markets are efficient.

B) A nontaxable investor who believes markets are efficient.

C) A taxable investor who believes markets are inefficient.

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Passive strategies have low turnover, fewer realized capital gains, and hence lower associated taxes. If an investor believes markets are efficient, he or she would be more likely to pursue a passive strategy because the investor would not believe that beating the market was possible through an active strategy.

Gypsy

In which of the following situations should an equity investor generally consider a passive management strategy?

A) When investing in global markets.

B) When investing in large cap markets.

C) The manager should consider a passive strategy in both of these cases.

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Passive strategies are generally recommended in both of these situations. When investing in large cap stocks, a passive strategy is suitable because these markets are usually informationally efficient. In international equity markets, the foreign investor may be at an informational disadvantage compared to the local investor.

Gypsy

Which of the following equity strategies would provide the highest expected active return?

A) Active.

B) Enhanced indexing.

C) Risk-controlled active management.

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Active management will provide the highest expected active return. Semiactive management is also known as enhanced indexing or risk-controlled active management. A semiactive manager will have an expected active return between active and passive managers.