C15 - Portfolio Management (25-30 Qs C15-C17) BC

Question 1

According to CAPM, if the risk-free rate of return is 3%, the expected return to the market is 11%, what is the expected return to a portfolio with a beta of 0?
A) 0.0%
B) 3.0%
C) 5.0%
D) 11.0%

Capital asset pricing model (CAPM)

Answer 1

B - 3%

Expected return on the portfolio (CAPM) = Rf + βp (E(Rm)-Rf)
E(Rp) = 3 + 0(11-3) = 3%

The pieces of the CAPM formula are the risk-free rate (Rrf), investment beta (βa) and the market return (Rm – Rrf). The value of each piece is dynamic, so the CAPM calculation needs to be updated over time. The formula is represented symbolically as: Ra = Rrf + [βa * (Rm – Rrf)], with Ra being the expected return.

β = 0 means no market sensitivity, uncorrelated with the market
β < 1 means Low market sensitivity, less volatile than the market
β = 1 means same as market, neutral
β > 1 means high market sensitivity, more volatile than the market
β < 0 means negative market sensitivity, moves in the opposite direction of the market

Question 2

When there is an increase in the number of assets in a portfolio, total risk is reduced due to the:
A) Increase in unsystematic risk
B) Increase in systemeatic risk
C) Decrease in unsystematic risk
D) Decrease in systematic risk

Answer 2

C - Decrease in unsystematic risk

• Systematic risk refers to the risk inherent to the entire market. Systematic risk, also known as undiversifiable risk, volatility risk, or market risk, affects the overall market, not just a particular stock or industry.
• Unsystematic risk refers to risks that are not shared with a wider market or industry. Unsystematic risks are often specific to an individual company, due to their management, financial obligations, or location. Unlike systematic risks, unsystematic risks can be reduced by diversifying one’s investments.

Question 3

If the expected return on a share is 17.6%, the market expected return is 20% and the risk-free return is 8%, what is the share’s beta?
A) 0
B) 1
C) 0.8
D) 1.2

Answer 3

C - 0.8
Use CAPM formula and rearrange to solve for Beta.

17.6% = 8% + ? (20% - 8%)

Rearrange:
17.6% - 8% = ? (12%)
9.6% = ? (12%)
? = 9.6% / 12%
? = 0.8

CAPM Formula: Ra = Rrf + [βa * (Rm – Rrf)] with:
* risk-free rate (Rrf)
* investment beta (βa)
* market return (Rm – Rrf)
* Ra being the expected return.

CAPM - Capital asset pricing model

Question 4

What is the expected return on a security with a beta of 1.5 if the market risk premium is 6% and the risk-free return is 4%?
A) 6%
B) 7%
C) 9%
D) 13%

Answer 4

D - 13%

CAPM Formula: Ra = Rrf + [βa * (Rm – Rrf)] with:
* (Rrf) risk-free rate
* (Rm) average expected rate of return on the market
* (βa) investment beta
* (Rm – Rrf) market return
* (Ra) being the expected return.

The market risk premium IS “(Rm - Rf)” SO
Expected Return = 0.04 + (1.5 * (0.06)) = 0.13 i.e. 13%

CAPM - Capital asset pricing model

Question 5

What measure of risk is used in the security market line?
A) Standard deviation
B) Beta
C) Default
D) Variance

Answer 5

B - Beta (β)

Beta is a statistical measure that compares the volatility of a particular stock’s price movements to the overall market. In simple terms, it indicates how much the price of a specific security will move in relation to market movements.

• β = 0 means no market sensitivity, uncorrelated with the market
• β < 1 means Low market sensitivity, less volatile than the market
• β = 1 means same as market, neutral
• β > 1 means high market sensitivity, more volatile than the market
• β < 0 means negative market sensitivity, moves in the opposite direction of the market

Question 6

A stock has a beta of 0.8; the risk-free return is 9%, if the market return was 15%, what would the expected return of the stock be?
A) 12%
B) 13.2%
C) 13.8%
D) 14.2%

Answer 6

C - 13.8%

CAPM Formula: Ra = Rrf + [βa * (Rm – Rrf)] with:
* (Rrf) risk-free rate
* (Rm) average expected rate of return on the market
* (βa) investment beta
* (Rm – Rrf) market return
* (Ra) being the expected return.

Expected Return = 0.09 + (0.8 * (0.15 - 0.09)) = 0.138 i.e. 13.8%

Question 7

Which of the following is NOT an assumption of the Capital Asset Pricing Model?
A) No taxes
B) All investors agree on the same investment period
C) Investors can borrow or lend at the same risk-free rate
D) Financial markets are monopolistic

Answer 7

D - Financial markets are monopolistic

Question 8

If the beta of portfolio = 0.72 and the covariance of the portfolio with the same return on the market is 273. What is the variance?
A) 379.17
B) 124.56
C) 201
D) 196.56

Answer 8

A - 379.17

Beta = Cov(Portfolio, Market) / Variance Market
Solve for variance 273 / 0.72 = 379.17

Question 9

The standard deviation of a well diversified portfolio is equal to:
A) CAPM Beta
B) the standard deviation of the market
C) the square of the CAPM beta
D) the specific risk of the individual securities invested in the fund

Answer 9

B - the standard deviation of the market

Question 10

The return to a portfolio covaries exactly with the return of the market, if the:
A) Beta of the portfolio is -1
B) expected returns for both are the same
C) return on the market is lower
D) return on the market is higher

Answer 10

B - expected returns for both are the same

β = 1 means same as market, neutral

Question 11

Which of the following are TRUE of systematic risk?
1. It can be controlled by diversification
2. It is the total risk for a fully diversified portfolio
3. It is the risk particular to a particular investment

A) 1 and 3
B) 2 and 3
C) 2 only
D) 1 only

Answer 11

C - 2 (It is the total risk for a fully diversified portfolio) only

Systematic risk refers to the risk inherent to the entire market. Systematic risk, also known as undiversifiable risk, volatility risk, or market risk, affects the overall market, not just a particular stock or industry. It cannot be controlled, but it can be the total risk if a portfolio is fully diversified so that risk for specific investments are balanced out to be neutral overall.

Question 12

If the CAPM beta = 0.8 and the variance of the market is 200, what is the covariance of the portfolio with the market?
A) 250
B) 1600
C) 80
D) 160

Answer 12

D - 160

Beta = Cov(Portfolio, Market)/ Variance Market
0.8 = ? / 200
Rearrange
? = 0.8 x 200 = 160

CAPM - Capital Asset Pricing Model

Question 13

Security X has a beta of 0.7. Security Y has a beta of 1.3. An investor has £100 and wishes to generate returns consistent with a beta of 1 Which of the following weightings should he adopt?

A) X = 80% / Y = 20%
B) X = 70% / Y = 30%
C) X = 30% / Y = 70%
D) X = 50% / Y = 50%

Answer 13

D - 50/50

(50% x 0.7) + (50% x 1.3) = 1

Question 14

What can be associated with a security that has a beta less than one?
A) Yields generally LOWER returns than a security with a beta of more than one
B) Yield generally HIGHER returns than a security with a beta of more than one
C) Systematic risk is greater if the beta is less than one
D) The unsystematic risk is the same in both securities

Answer 14

A - Yields generally LOWER returns than a security with a beta of more than one

A Beta of less than 1 implies a risk lower than the market and hence a lower return

• β = 0 means no market sensitivity, uncorrelated with the market
• β < 1 means Low market sensitivity, less volatile than the market
• β = 1 means same as market, neutral
• β > 1 means high market sensitivity, more volatile than the market
• β < 0 means negative market sensitivity, moves in the opposite direction of the market

Question 15

An active management strategy assumes better results can be obtained by taking on:
A) Idiosyncratic risk
B) Market risk
C) Systematic risk
D) All of the above

Answer 15

A - Idiosyncratic risk

• Idiosyncratic risk is the risk of loss that’s specific to a particular investment, like a stock or sector. It’s also known as unsystematic risk.
• Market risk is the risk that arises from movements in stock prices, interest rates, exchange rates, and commodity prices.
• Systematic risk refers to the risk inherent to the entire market. Systematic risk, also known as undiversifiable risk, volatility risk, or market risk, affects the overall market, not just a particular stock or industry.

Question 16

If the total risk of a fund equals 576 (in variance terms), and specific risk is 14% What is systematic risk?
A) 380
B) 100
C) 19.49%
D) 10%

Answer 16

C - 19.49%

Total risk = Specific Risk + Systematic risk (in variance terms)
576 = 14^2 + Systematic risk^2
576 - 196 = Systematic risk^2
Systematic risk^2 = 380
Systematic risk in standard deviation terms = Square root of 380 = 19.49%

Question 17

Share Z has a beta of 0.75. Share A has a beta of 1.25. An investor has £100 and wishes to generate returns consistent with a beta of 1
How much of the £100 should go into each share?
A) Z: £90 / A: £10
B) Z: £10 / A: £90
C) Z: £75 / A: £25
D) Z: £50 / A: £50

Answer 17

D - Z: £50 / A: £50
We need a weighted average beta of 1. SO:
(0.5 x 0.75) + (0.5 x 1.25) = 1

Question 18

A portfolio is madeup of two shares X and Y, with betas of 0.7 and 1.1 respectively 70% of your money is invested in X, and the rest in Y, what is the beta of your portfolio?
A) 0.82
B) 0.78
C) 0.95
D) 1.26

Answer 18

A - 0.82

(0.7 x 0.7) + (0.3 x 1.1) = 0.82

Question 19

Using the following details about two portfolios, which of the following statements is TRUE?
Portfolio A: Correlation coefficient with the market +0.94
Portfolio B: Correlation coefficient with the market +0.62

A) Portfolios A and B are well diversified
B) Portfolkio A and B are poorly diversified
C) Portfolio A is well diversified, portfolio B is relatively diversified
D) Portfolio B is well diversified, portfolio A is relatively poorl diversified

Answer 19

C - Portfolio A is well diversified, portfolio B is relatively diversified

If a portfolio is well diversified, you would expect a strong correlation to the market. The closer to +1, the stronger the correlation and therefore the better diversified.

Question 20

Using the Capital Asset Pricing Model, what is the market risk premium given the following:
Beta of Share A: 0.75
Risk free rate of return: 5%
Expected return on the market: 12%

A) 5.25%
B) 7%
C) 10.25%
D) 9%

Answer 20

B - 7%

Market risk premium = market return - Risk-free rate
SO 12% - 5% = 7%

Question 21

Which of the following is the CORRECT equation for the beta of share J?
A) The covariance of share J and the market divided by the variance of the market
B) The covariance of share J and the market divided by the variance of share J
C) The covariance of share J and market divided by the standard deviation of the market
D) The covariance of share J and the market divided by the standard deviation of share J

Answer 21

A - The covariance of share J and the market divided by the variance of the market

Covariance is a statistical measurement that shows how the returns of two assets move in relation to each other. It’s used in investment management to help investors understand how assets perform relative to each other, and to diversify their portfolios.

Question 22

If the covariance between a share and the market is 5 and the standard deviation of the market equals 2, what is the share’s beta?
A) 1.10
B) 1.25
C) 2.25
D) 2.50

Answer 22

B - 1.25

Beta = Covariance / Market Variance SO
Beta = 5 / 2^2 = 1.25

Question 23

A portfolio is made up of two shares M and N with betas of 0.2 and 1.2 respectively 50% of your money is invested in M, the rest in N, what is the beta of your portfolio?
A) 0.6
B) 0.7
C) 0.8
D) 1.0

Answer 23

B - 0.7

Portfolio Beta = (allocation M x Beta M) + (Allocation N x Beta N) SO
(0.5 x 0.2) + (0.5 x 1.2) = 0.7

Question 24

If the market return is 11% and the risk-free rate is 3%, whar is the market-risk premium?
A) 14%
B) 11%
C) 3%
D) 8%

Answer 24

D - 8%

Market risk premium = Market Return - Risk-free rate SO:
11% - 3% = 8%

Question 25

If the market risk premium is 11% and the risk-free rate is 3%, what is the market return? A) 14% B) 11% C) 3% D) 8%

Answer 25

**A - 14%** Market Return IS both the risk free rate AND the market risk premium SO 11% + 3% = 14% *Tip - If it has "risk" in the title (market risk premium) it is the component, if it doesn't (Market Return) then it is the full sum*

Question 26

If the risk-free rate of return is 3% and the expected return to the market is 11, what is the expected return to the portfolio that has a beta of 0? A) 11% B) 8.0% C) 3.0% D) 0.0%

Answer 26

**C - 3.0%** If the portfolio has a beta of zero, it has NO risk. Therefore the required return = the risk free return. * β = 0 means no market sensitivity, uncorrelated with the market * β < 1 means Low market sensitivity, less volatile than the market * β = 1 means same as market, neutral * β > 1 means high market sensitivity, more volatile than the market * β < 0 means negative market sensitivity, moves in the opposite direction of the market

Question 27

Portfolio diversification aims to: A) Obtain an optimal risk-return trade-off B) Reduce risk at all times C) Reduce returns at all times D) Obtain the greates return regardles of risk

Answer 27

**A - Obtain an optimal risk-return trade-off**

Question 28

Which of the following are the primary factors in determining whether an index tracking fund has met its targets? 1. Total capital gains 2. Tracking error 3. Total dividend income A) All of them B) 1 only C) 2 only D) 3 only

Answer 28

**C - 2 (Tracking Error) only** Tracking error is the standard deviation of the divergence between the portfolio and market returns. A tracking fund is meant to following a specified index as close as possible so tracking error is the primary factor to consider.

Question 29

An active fund manager assumes that better results can be obtained by taking on which of the following risks: A) Systematic B) Tracking C) Beta D) Specific/idiosyncratic

Answer 29

**D - Specific/idiosyncratic** * **Idiosyncratic** risk is the risk of loss that's specific to a particular investment, like a stock or sector. It's also known as unsystematic risk. * **Tracking Error** is the standard deviation of the divergence between the portfolio and market returns. * **Beta** is a statistical measurement that shows how volatile an investment's price is compared to the overall stock market. * **Systematic risk** refers to the risk inherent to the entire market. Systematic risk, also known as undiversifiable risk, volatility risk, or market risk, affects the overall market, not just a particular stock or industry.

Question 30

Which of the following is generally an attribute of index funds: A) Larger number of securities than the index B) Relatively high managment changes C) Relatively high transaction costs D) Relatively low tracking error

Answer 30

**D - Relatively low tracking erorr**

Question 31

Which of the following is the BEST definition of efficient diversification? A) Selecting stocks from the same sector B) Selecting stocks that have uncorrelated returns C) Selecting stocks that have correlted returns D) Selecting stocks at random

Answer 31

**B - Selecting stocks that have uncorrelated returns** To be fully diverse you want a portfolio full of uncorrelated returns, so that the overall portfolio is balanced against risk.

Question 32

Which of the following are key issues in active fund management? 1. Market timing 2. Stock selection 3. Identifiying mis-priced securities A) 1 only B) 1 and 2 C) 1 and 3 D) All of the above

Answer 32

**D - All of them**

Question 33

Which of the following explains the relationship between risk and return for any 'rational' investor? A) No relationship B) Inverse relationship C) A positive relationship D) Indirect relationship

Answer 33

**C - A positive relationship** As risk increases, rational investor would want more return to compensate this. Hence, a positive relationship where by two factors increase/decrease together. *Inverse relationship would be where one factor increases, the other decreases like when interest rates increase, the number of properties puchased decreased*

Question 34

An example of a passive investment strategy is: A) The trustees do NOT usually evaluate the performance of the fund manager B) The trustees take NO part in the management of the fund at any stage C) The fund manager is trying to identify and acquire undervalued stocks D) The fund manager is seeking to track a benchmark index having determined the preferred level of risk of the client

Answer 34

**D - The fund manager is seeking to track a benchmark index having determined the preferred level of risk of the client** Passively managed funds are usualyy tracker or index funds. The fund manager is NOT trying to choose cheap stocks, but instead looking to mimic the performance of a particular index.

Question 35

Which of the following statements apply to cash matching strategy in a bond portfolio? 1. The strategy would lead to the formation of a dedicated portfolio# 2. The is no re-investment risk involved 3. There is no interest rate involved A) 1 and 2 B) 1 and 3 C) 2 and 3 D) All of the above

Answer 35

**D - All of the above** A cash flow matching strategy makes use of cash flows from principal and coupon payments on various bonds that are chosen so that the total cash flows exactly match the liability amounts. Reinvestment Risk is the potential risk where future proceeds, such as the coupon payments or debt principal, will need to be reinvested at a lower interest rate compared to the original yield (i.e. on a debt security).

Question 36

Which of the following is TRUE of a cash matching strategy: 1. No bonds have to be sold before maturity 2. Yield curve shifts have adverse effects 3. Cash flows ino the fund match casahflows out of the fund A) 1 and 3 B) 1 and 2 C) 2 and 3 D) 3 only

Answer 36

**A - 1 (No bonds have to be sold before maturity) and 3 (Cash flows ino the fund match casahflows out of the fund) only** Yield curves shifts impact will depend on the direction of the shift

Question 37

Which of the following is BEST suited for matching the liabilities of a life assurance fund which pays annual annuities? A) UK Equities B) US TBills C) UK T Bills D) GIlts

Answer 37

**D - Gilts** They have set yearly payouts (coupons) and are generally longer term which will match the long horizon for life assurance funds. Treasury Bills are short-term inverstments

Question 38

What BEST describes a bullet portfolio? A) A portfolio which matches the duration of bonds with similar duration of the liabilities B) A portfolio which matches the duration of bonds with much smaller and much larger durations of the liabilities C) A portolio which matches the cash flows of bonds with much saller cash flows of the liabilities D) A portfolio which matches cashflows of bones with similiar cash flows of the liabilities

Answer 38

**A portfolio which matches the duration of bonds with similar duration of the liabilities** A bullet bond portfolio, commonly referred to as a bullet portfolio, is made up of a range of bullet bonds, from short-term to long-term bullet bonds. A bullet bond is a non-callable bond wherein the total principal amount or its total value is paid in a lump sum on the bond’s maturity date.

Question 39

What is a Barbell portfolio? A) A portfolio in which invested bonds have a similar DURATION to those of the target liabilities B) A portfoloio in which invested bonds havde similar CASH FLOWS to those of the target liabilities C) A portfolio in which invested bonds have much larger and much smaller DURATIONS than those of the target liabilities D) A portfolio in which investment bonds have much larger and much smaller CASH FLOWS than those of the target liabilities

Answer 39

**C - A portfolio in which invested bonds have much larger and much smaller DURATIONS than those of the target liabilities** The barbell is an investment strategy applicable primarily to a fixed income portfolio. Following a barbell method, half the portfolio contains long-term bonds and the other half holds short-term bonds. The “barbell” gets its name because the investment strategy looks like a barbell with bonds heavily weighted at both ends of the maturity timeline. The graph will show a large number of short-term holdings and long-term maturities, but little or nothing in intermediate holdings.

Question 40

*A 6 month T Bill is priced at £94.50 and the 3 month T bill is £97.00* What is the return if an investor buyus a 6 month bill and holds it for 3 months riding the yield curve (assume no shifts)? A) 2.65% B) 3.56% C) 1.65% D) Cannot calculate

Answer 40

**A - 2.65%** Using the Holding Period Return (HRP) = (97-94.50)/94.50 = 0.0265 i.e. 2.65%

Question 41

Which of the following is/are TRUE of discretionary investments management? 1. Seeking client approval before buying and selling 2. Initiating transactions 3. Monitoring transactions to settlements A) 1 and 2 B) 1 and 3 C) 2 and 3 D) 3 only

Answer 41

**C - 2 (Initiating transactions) and 3 (Monitoring transactions to settlements) only are true** Discretionary investment management is a form of investing in which a client's buy and sell decisions are made by a portfolio manager, and doesn't need the client's approval to do this.

Question 42

What conditions MUST be present for duration-based immunisation? 1. Flat yield curve 2. Parallel shifts in the yield curve 3. Risk-free asset A) All of the above B) 2 and 3 only C) 1 and 2 only D) 1 and 3 only

Answer 42

**C - 1 (Flat yield curve) and 2 (Risk-free asset) only** Duration-based immunisation is a financial strategy that aims to reduce interest rate risk by matching the duration of a portfolio with the duration of its liabilities. This strategy is also known as duration matching.

Question 43

Which of the following is NOT a method of selecting securities in an actively managed portfolio? A) Fundamental analysis B) Identify potential takeover candidates C) Tracking D) Picking winners

Answer 43

**C - Tracking** Tracking is a passive managament strategy where fund manager tries to match the retuns of the portfolio to the chosen index

Question 44

What is the duration of a bond portfolio if 30% by value has a duration of 6 years and 70% by value a duration of 8 years? A) 7.4 years B) 6.6years C) 7 years D) 6 years

Answer 44

**A - 7.4 years** Bond Portfolio Duration = (0.3 x 6 years) + (0.7 x 8 years) = 7.4 years

Question 45

An investment is set up to meet a future liability, the risk that the income from the bonds is invested at an interest rate lower than the interest rate at the start of the fund is called: A) Market risk B) Re-investment risk C) Interest rate risk D) Duration

Answer 45

**B - Re-investment risk** Interest rate risk is the risk that an investment's value will change due to interest rate fluctuations, while reinvestment risk is the risk that reinvested funds will earn a lower yield. Both are financial risks that can affect fixed income investments like bonds. **Interest rate risk** * The risk that an investment's value will change due to interest rate fluctuations * For example, a bond's price may fall if interest rates increase * Affects the value of bonds more than stocks **Reinvestment risk** * The risk that reinvested funds will earn a lower yield * For example, an investor may not be able to reinvest interest at the same rate as the original investment * Can apply to any investment that has cash flows or matures during the investor's investment horizon

Question 46

Which of the following is TRUE with regard to immunisation: 1. Matches cash flows 2. Matched durations 3. Assumes a flat yield curve 4. Protects portfolio against changes in interest rates A) 1 only B) 2 and 4 C) 2, 3 and 4 D) All of the above

Answer 46

**C - 2 (matched durations), 3 (assume flat yield curve) and 4 (protects against interest rate changes)** Immunisation investment is a strategy that matches the duration of assets and liabilities to reduce the impact of interest rate changes. It's also known as multi-period immunisation

Question 47

A portfolio of bonds where the casah received from the coupons and principal at each period exactly matches each cash flow is called: A: Matched portfolio B) Bullet portfolio C) Barbell portfolio D) Dedicated portfolio

Answer 47

**D - Dedicated portfolio** A dedicated portfolio is an investment portfolio where the cash flows are designed to match the anticipated liabilities.

Question 48

What is a passive fund? A) Where the fund manager takes advantage of mis-priced assets B) Where there is no fund manager C) Where the fund manager times his purchases to buy at low prices D) Where the fund manager mimics a financial market index

Answer 48

**D - Where the fund manager mimics a financial market index** A and C are active management, and B is wrong as a fund manager is always needed.

Question 49

An insurance company has a liability, which falls due in 20 years; it wishes to meet this liability with a portfolio of 5 fixed coupon bonds held equally with: A) Durations of 20, 21, 24, 25 and 30 years B) Durations of 28, 12, 20, 8 and 32 years C) Durations of 19, 17, 27, 27 and 12 years D) 20 years each to maturity

Answer 49

**B - Durations of 28, 12, 20, 8 and 32 years** Equal weighting in 5 bonds means 20% in each SO: (28 x 0.2) + (12 x 0.2) + (20 x 0.2) + (8 x 0.2) + (32 x 0.2) = 20 (years) *THIS QUESTION IS STUPID AS D IS ALSO RIGHT...(20 X 0.2) X 5 = 20*

Question 50

*There ar two treasury bills with maturities of 3 and 6 months, the par values of both are £100, and the current prices ar £98 and £95.5 respectively. An investor has liability to meet in 3 months* What is the % return of the buying the 6 months bill and selling it in 3 months to fund the liability? A) 2.5% B) 2.6% C) 4.7% D) 2.1%

Answer 50

**B - 2.6%** (98-95.5)/95.5 = 2.6%

Question 51

A bond portfolio manager expects interest rates to increase, he should tilt his portfolio towards: A) Low or zero coupon bonds B) Short dated high coupon bonds C) Long dated D) Corporate bonds from government bonds

Answer 51

**B - Short dated high coupon bonds** Short dates are LESS exposed to interest rate movements an d high coupons provide some insulation.

Question 52

Which of the following strategies can immunise a fund? 1. Matching cashflows 2. Matching durations 3. Matching maturities A) 1 only B) 1 and 2 C) 2 only D) All of the above

Answer 52

**C - 2 (Matching durations) only** Duration-based immunisation is a financial strategy that aims to reduce interest rate risk by matching the duration of a portfolio with the duration of its liabilities. This strategy is also known as duration matching.

Question 53

Which of the following best describes a barbell portfolio? A) A portfolio with an equal proportion of the portfolio in a set of bonds B) A portfolio whose casah inflows exactly match the cash outflow of the fund C) A bond portfolio where the weighted average maturity of the individual bonds equals the maturity of the liability to be met D) The durations of the bonds' chosen are far apart compared to the duration of the liability to be met

Answer 53

**D - The durations of the bonds' chosen are far apart compared to the duration of the liability to be met** The barbell is an investment strategy applicable primarily to a fixed income portfolio. Following a barbell method, half the portfolio contains long-term bonds and the other half holds short-term bonds. The “barbell” gets its name because the investment strategy looks like a barbell with bonds heavily weighted at both ends of the maturity timeline. The graph will show a large number of short-term holdings and long-term maturities, but little or nothing in intermediate holdings.

Question 54

Riding the yield curve requires the yield curve to be: A) Falling B) Humped C) Flat D) Upward-sloping

Answer 54

**D - Upward-sloping** Riding the yield curve is a trading strategy that involves buying a long-term bond and selling it before it matures so as to profit from the declining yield that occurs over the life of a bond. Investors hope to achieve capital gains by employing this strategy.

Question 55

Which of the following bonds would constitute a barbell portoflio (the liability to be immunised is in 10 years): 1. Bond with duration equal to 1 year 2. Bond with duration equal to 19 years 3. Bond with duration equal to 9 years 4. Bond with duration equal to 11 years A) 2 and 4 B) 1, 2 and 4 C) 1 and 2 D) 1 and 3

Answer 55

**C - 1 (1 year) and 2 (19 years)** A barbell strategy is a strategy where a bond portfolio holds bonds with durations much smaller and much larger than the target. *The “barbell” gets its name because the investment strategy looks like a barbell with bonds heavily weighted at both ends of the maturity timeline. The graph will show a large number of short-term holdings and long-term maturities, but little or nothing in intermediate holdings.*

Question 56

Which of the following statements apply to a cash matching strategy in a bond portfolio? 1. There is re-investment risk involved 2. There is interest rate risk involved 3. The strategy would NOT lead to the formaion of a "dedicated" portfolio A) None of them B) 1 only C) 1 and 2 D) 2 and 3

Answer 56

**A - None of them**

Question 57

*A 6 month treasury bill is priced at £92.50 and the 3 month T-bill is £95.00* Assuming the invest rides the yield curve (with no shifts), what is the return if an investor buys a 6-month bill and holds it for 3 months? A) 2.63% B) -2.63% C) 2.70% D) -2.70%

Answer 57

**C - 2.70%** (3 months price - 6 month price)/6 month price (£95 - £92.50)/£92.50 = 0.027 i.e. 2.7%

Question 58

Increasing the number of assets in a portfolio reduces the total risk due to an: A) Increase in unsystematic risk B) Decrease in unsystematic risk C) Increase in systematic risk D) Decrease in systematic risk

Answer 58

**B - Decrease in unsystematic risk** * **Systematic risk** refers to the risk inherent to the entire market. Systematic risk, also known as undiversifiable risk, volatility risk, or market risk, affects the overall market, not just a particular stock or industry. * **Unsystematic risk** refers to risks that are not shared with a wider market or industry. Unsystematic risks are often specific to an individual company, due to their management, financial obligations, or location. Unlike systematic risks, unsystematic risks can be reduced by diversifying one's investments.

Question 59

*An investor has a portfolio of FTSE100 index shares and now wishes to become more ethical by excluding tobacco products from their portfolio* What are the implications? A) The investor will have to sell all his shares and take out a deposit B) There are no implications. The investor can continue to invest in the FTSE100 C) The investor will need to switch into AIM shares D) The investor will need to narrow the range of the FTSE100 share he invests in

Answer 59

**D - The investor will need to narrow the range of the FTSE100 share he invests in** The FTSE100 will need to be negatively screened for tobacco companies, and these companies taken away from the portfolio. This may reduce the diversity of the portfolio, but would make it more ethically sound. *The Alternative Investment Market (AIM) serves as a sub-segment of the London Stock Exchange (LSE) and has been specifically tailored to help smaller, riskier, or high-growth companies secure significant capital from the public market, often between £1m and £50m.*

Question 60

*Six month T Bill priced at £96.30, three month T-bill priced at £99.05* What is the extra return in buying the siz month bill and selling it after three months, rather than buying the three month bill and holding it to maturity. Assume no change in the yield curve. A) 2% B) 1.9% C) 1.5% D) 2.5%

Answer 60

**B - 1.9%** Return from buying a 3 months T Bill and letting it mature: (£100-£99.05)/£99.05 = 0.0009591 x 100 = 0.9591% Return from buying a 6 month T Bill and selling it after 3 months as a 3 month T Bill: (£99.05-£96.30)/£96.30 = 0.02856 x 100 = 2.8556% Excess Return: 2.8556% - 0.9591% = 1.8965% Say 1.9%

Question 61

The type of risk that can be driven towards zero as a fund invests in more and more securities is known as: A) Systemic B) Systematic C) Specific D) Serial

Answer 61

**C - Specific** Specific risk (aka unsystemative or diversifiable risk) is related to the individual asset. This can be diversified away as a fund increases the number of securities it holds. On the other hand, systematic risk (or market risk) cannot be easily diversified away apart from chosing less risk/returns which may reduce it somewhat but not completely.

Question 62

*Melanie calculates the variance of the UK stock market as being equal to 120% over the last year, and the covariance of excess return on the market and the excess return on stocks X, Y and Z as being 60%, 80%, and 150% respectively over the same period. She knows that the risk-free rate of the next year will be 4%, and expects the return on the market will be 8% next year* If melanie believes the capital asset pricing model (CAPM) and calculates the security market line (SML), what return would she expect to receive from stocks X, Y and Z respectively over the next year? A) 0.50%, 0.67%, and 1.25% respectively B) 5.50%, 7.00%, and 8.50% respectively C) 6.50%, 6.75%, and 7.75% respectively D) 6.00%, 6.67%, and 9.00% respectively

Answer 62

**D - 6.00%, 6.67%, and 9.00% respectively** **SML(CAPM) = Rf + β(Rm - Rf)** In order to get the expected returns of X, Y, Z, you need to first calculate their β which is not given in the question. **β = Covariance(Rp, Rm) / Variance(Rm)** SO: **Stock X:** β = 60% / 120% = 0.5 SML = 4 + [0.5 (8 - 4) ] = 6.00% **Stock Y:** β = 80% / 120% = 0.667 SML = 4 + [0.067 (8 - 4) ] = 6.67% **Stock Z:** β = 150% / 120% = 1.25 SML = 4 + [1.25 (8 - 4) ] = 9.00%

Question 63

Which ONE of the following is NOT a type of efficient market? A) Weak form B) Semi-weak form C) Semi-strong form D) Strong form

Answer 63

**C - Semi-Strong form**

Question 64

*An agent has savings accounts paying a low rate of interest at the same time as maintaining credit card debts charging a high rate of interest* This is an example of which of the following behavioural biases? A) Mental accounting bias B) Regret avoidance C) Representative bias D) Conservatism

Answer 64

**A - Mental accounting bias** The optimal approach for the agent would be to use the saving accounts to pay off the credit cards. Viewing these as separate entities is called framing (or mental accounting bias).

Question 65

Considering the following statements below. Which one is TRUE? A) Environmental, social, and governance (ESG) is generally considered to be ethics agnostic B) Socially responsible investing (SRI) does NOT involve ethical choices C) SRI never involves negative screening of investments D) The Stewardship Code is produced annually by HM Treasury

Answer 65

**A - Environmental, social, and governance (ESG) is generally considered to be ethics agnostic** ESG investing looks at environmentally or socially impactful investments, but doesn't necessarily exclude 'sin-stock' such as tobacco, gambling, and drugs. SRI will have negative screening to remove sin-stock as per the ethical preferences of the investor The Stewardship Code is produced by the Financial Reporting Committee (FRC).