hinsafdar

A recession is expected in an economy within the next year. Portfolio Manager A has shifted more of their stocks from the financial industry to the health care industry. Portfolio Manager B has shifted more of their stocks from the technology industry to the utility industry. Which of the following statements is most accurate regarding the performance of each manager?

A) Portfolio Manager A is expected to underperform the broad market while Portfolio Manager B is expected to outperform the broad market.

B) Portfolio Manager A is expected to outperform the broad market and Portfolio Manager B is expected to outperform the broad market.

C) Portfolio Manager A is expected to outperform the broad market while Portfolio Manager B is expected to underperform the broad market.

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Both managers are exhibiting style drift with both being beneficial to performance. Value managers tend to have greater representation in the non-cyclical utility and cyclical financial industries whereas growth managers tend to have higher weights in the cyclical technology and non-cyclical health care industries. Growth stocks are more likely to outperform during a recession as there are few other firms with growth prospects and a premium would be placed on growth stocks’ valuation. Since the financial and technology industries are cyclical they will tend to under-perform during a recession whereas the healthcare and utility industries are non-cyclical and should outperform during a recession compared to cyclical stocks.

hinsafdar

Which of the following is least likely to be a reason pricing inefficiencies exist on the short-side?

A) The securities exchanges in the developed world prohibit short sales.

B) There are more potential buyers than sellers of stock.

C) Management has options in firm’s stock.

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Although there may be limitations on short sales, they are not prohibited by securities exchanges. There are more potential buyers than sellers of stock so analysts are reluctant to lose these potential customers with a sell recommendation. Also management may hold their firm’s stock and options and put pressure on analysts to not issue sell recommendations.

hinsafdar

Which of the following is characteristic of a long-short trade? A long-short trade has the potential to earn:

A) two alphas and eliminate unsystematic risk.

B) one alpha and eliminate systematic risk.

C) two alphas and eliminate systematic risk.

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Long-short strategies can buy undervalued stocks and short overvalued stocks, earning two alphas. A long-only strategy can only earn the long alpha. Long-short strategies can eliminate expected systematic risk by buying one stock and shorting another in the same industry. The investor however still has unsystematic risk if the short position rises while the long falls.

hinsafdar

Which of the following are advantages of a long-short trade? A long-short trade focuses on:

A) exploiting constraints and can generate a symmetric distribution of active returns.

B) fundamental valuation and can generate an asymmetric distribution of active returns.

C) exploiting constraints and can generate an asymmetric distribution of active returns.

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Long-only strategies are focused on using fundamental analysis to find undervalued stocks. In contrast, long-short strategies focus on exploiting the constraints many investors face. For example, institutions are unable to short a stock. If an investor would like to express a negative view of an index security in a long-only strategy, he is limited to avoidance of the stock. The distribution of potential active weights in a long-only portfolio is asymmetric.

hinsafdar

Which of the following is NOT an advantage of the short extension strategy compared to a long only strategy or a market neutral strategy?

A) A short extension strategy does not utilize swaps or futures.

B) A short extension strategy can short a small cap stock that may have a minimal weight in a market capitalized benchmark.

C) The market return and alpha for the short extension strategy are generated from the same source.

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In a short extension strategy the market return and alpha are generated from the same source – the market return comes from the long position in equities and the alpha comes from shorting those same overpriced/underperforming equities and using the proceeds to invest in undervalued securities. This is a disadvantage because it is more limiting and constraining as compared to the market neutral position which generates alpha by going long and short in under and overpriced securities respectively in the same industry and then using derivatives such as equity index futures to gain market exposure. Thus in the market neutral strategy the alpha and market exposure are gained from different sources.
A disadvantage of a long only strategy is the constraint of only being able to reduce the weight of a poorly performing stock to zero in the portfolio. If the benchmark is market capitalized the effect on the portfolio is minimal for small and mid cap stocks. Conversely, a short extension strategy can short the same under performing small or mid cap stock in a greater proportion and exploit the negative information regarding the stock to a much larger degree than the long only strategy.
A short extension strategy does not rely on the available liquidity of swaps and futures to gain market exposure as the market neutral strategy does.

hinsafdar

Which of the following is least likely to be an advantage of using an ETF instead of a futures contract to equitize a market neutral long-short strategy?

A) ETFs are subject to less regulation.

B) ETFs can be more convenient.

C) ETFs can be more cost effective.

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The review does not specify that ETFs are subject to less regulation than futures. ETFs may be more cost effective and convenient than futures contracts.

hinsafdar

A short extension strategy can be described as:

A) going short in part of the portfolio and purchasing an equal amount of equities resulting in a position that is more than 100% long.

B) shorting part of the portfolio to reduce exposure to over-valued stocks and gaining market exposure through the use of derivatives.

C) a long position in equities with a relaxed constraint on short sales.

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A short extension is characterized by shorting part of the portfolio, for example shorting 20% and taking the proceeds from the short sale and purchasing undervalued securities in the same amount so the net amount of capital invested is 100% (= 100% long − 20% short + 20% long) but the long position is 120% (= 100 from the initial long position + 20 from the proceeds of the short sale). A short extension strategy does not use derivatives but instead only takes long and short positions in equities. A market neutral strategy is characterized by equal amounts of long and short positions to produce an overall beta of 0 whereas a short extension strategy has a beta of greater than 0.

hinsafdar

If an investor wanted to equitize a market neutral long-short strategy with a S&P 500 futures contract, which of the following would be the correct amount of the notional principal of the S&P 500 futures contract?

A) 250 times the value of one contract.

B) The value of the long position.

C) The cash from the short sale.

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If the investor wishes to add systematic risk to a market neutral strategy, the investor would take a long position in an equity futures contract with a notional principal equal to the cash from the short sale.

hinsafdar

Which of the following is the correct benchmark for a market neutral long-short strategy equitized with S&P 500 futures contracts?

A) The S&P 500 index.

B) The risk-free rate.

C) The S&P 500 index plus the risk-free rate.

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If a long-short, market neutral strategy is equitized, the benchmark is the underlying index of the futures contract (in this case the S&P 500).

hinsafdar

Which of the following statements regarding the beta of a short extension strategy versus a market neutral strategy is most accurate?

A) The beta of a short extension strategy is generally designed to be around 1 whereas the beta of a market neutral strategy is 0.

B) The beta of a short extension strategy is generally designed to be around 0 whereas the beta of a market neutral strategy is 1.

C) The beta of both a short extension strategy and a market neutral strategy can vary depending upon the percentage of equity exposure employed in the strategy.

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The beta for a short extension is usually around 1 since it has a much greater percentage of long equity positions than short positions whereas the beta for a market neutral strategy is zero meaning there is no systematic risk. The market neutral strategy goes long and short in stocks in the same industry thus there is only firm specific (unsystematic) risk.