7. Active Risk & Return

Question 1

Active investing

Answer 1

Investing to beat the benchmark

Question 2

CAPM assumes…

Answer 2

expected returns are proportional to beta and expected residual returns are zero

Question 3

Probability of active investing based on CAPM =

Answer 3

0 –> no residual return (alpha)

Question 4

If everyone has the same information, then everyones return will be

Answer 4

equal

Question 5

Job of an active fund manager is to

Answer 5

outperform the benchmark portfolio (in NZ = NZX50, small sized portfolio = Russel 2000)R

Question 6

Russel 2000

Answer 6

smallest 2000 stocks in russel 3000 portfolio (russel3000 = largest 3000 companies in US)

Question 7

Objective of an active fund is to

Answer 7

beat the benchmark

Question 8

Objective of a passive fund is to

Answer 8

replicate the fund

Question 9

Fundamental Funds focus on (2)

Answer 9

long position in undervalued stocks

Question 10

Quantitative Funds focus on (2)

Answer 10

long and short positions in both over and undervalued stocks

Question 11

______ funds underperformed _____ funds during COVID-19

Answer 11

Quantitative, fundamentals

Question 12

What is value investing?

Answer 12

Based on the fundamentals, suggests choosing stocks that appear to be undervalued

Question 13

Who is the father of value investing?

Answer 13

Benjamin Graham

Question 14

Grinlod-Kahn quantitative approach

Answer 14

ranks stocks on continuum

Question 15

Exceptional Return

Answer 15

residual return (alpha) + benchmark timing

Question 16

buy ___ alpha stocks

Answer 16

positive

Question 17

sell ___ alpha stocks

Answer 17

negative

Question 18

Active investment can be dividend into two components:

Answer 18

stock selection and benchmark timing

Question 19

What is benchmark timing?

Answer 19

Using skilled forecast of returns to the benchmark to time aggressive and defensive investing moves (aggressive = > + 1 beta, defensive = < + 1 beta)

Question 20

What is stock selection?

Answer 20

Using skilled forecast of individual stock returns to outperform the benchmark

Question 21

Information ratio =

Answer 21

alpha/omega = active return/active risk

Question 22

Sharpe Ratio

Answer 22

Mean (Return - Rf)/Std Dev (return - rf)

Question 23

How to annualise sharpe ratio?

Answer 23

x by square root of trading days

Question 24

Skilled forecasts are possible if the market

Answer 24

is not fully efficient

Question 25

Active investing involves ____ frontier

Answer 25

ex-ante - maximising utility type function based on investors risk aversion rather than minimising risk (markowitz)

Question 26

How to generate skilled forecast? (3)

Answer 26

1. Identify characteristics of stocks that are associated with beating benchmark
2. Collect measures of those characteristics and standardise them
3. Run a back test to see whether these characteristics outperformed the benchmark or not

Question 27

When should you overinvest in DY?

Answer 27

high

Question 28

When should you overinvest in P/E?

Answer 28

low

Question 29

Tactical asset allocation could be the…

Answer 29

short-term choice of alpha exposure in which active managers shift the holdings of stock in a portfolio to take advantage of certain market events

Question 30

strategic asset allocation could be the

Answer 30

long-term choice of beta risk made by high-level decision makers = active investing

Question 31

Investors prefer…

Answer 31

higher returns and less risk

Question 32

utility is a

Answer 32

positive function of expected return and negative function of risk

Question 33

risk aversion

Answer 33

lamda

Question 34

variance squared

Answer 34

standard deviation

Question 35

risk premium

Answer 35

Rp - Rf

Question 36

K

Answer 36

skilled forecast

Question 37

μ

Answer 37

naive/consensus forecast

Question 38

KP =

Answer 38

Eskilled (RP)-RF

Question 39

μP =

Answer 39

Econcensus(RP)-RF

Question 40

Concensus forecast

Answer 40

cannot outperform benchmark (CAPM + benchmark)

Question 41

Investors care more about _____ than _______

Answer 41

active risk than benchmark risks

Question 42

Risk aversion to _____ is much higher than to ______

Answer 42

active risk, benchmark risk