C15 - Portfolio Management (25-30 Qs C15-C17) BC Flashcards
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)
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
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
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.
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
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
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%
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
What measure of risk is used in the security market line?
A) Standard deviation
B) Beta
C) Default
D) Variance
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
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%
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%
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
D - Financial markets are monopolistic
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
A - 379.17
Beta = Cov(Portfolio, Market) / Variance Market
Solve for variance 273 / 0.72 = 379.17
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
B - the standard deviation of the market
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
B - expected returns for both are the same
β = 1 means same as market, neutral
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
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.
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
D - 160
Beta = Cov(Portfolio, Market)/ Variance Market
0.8 = ? / 200
Rearrange
? = 0.8 x 200 = 160
CAPM - Capital Asset Pricing Model
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%
D - 50/50
(50% x 0.7) + (50% x 1.3) = 1
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
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
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
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.
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%
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%
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
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
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
A - 0.82
(0.7 x 0.7) + (0.3 x 1.1) = 0.82
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
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.
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%
B - 7%
Market risk premium = market return - Risk-free rate
SO 12% - 5% = 7%
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
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.
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
B - 1.25
Beta = Covariance / Market Variance SO
Beta = 5 / 2^2 = 1.25
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
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
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%
D - 8%
Market risk premium = Market Return - Risk-free rate SO:
11% - 3% = 8%
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%
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
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%
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
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
A - Obtain an optimal risk-return trade-off
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
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.
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
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.
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
D - Relatively low tracking erorr
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
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.
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
D - All of them
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
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
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
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.
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
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).
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
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
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
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
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
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.
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
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.
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
A - 2.65%
Using the Holding Period Return (HRP) = (97-94.50)/94.50 = 0.0265 i.e. 2.65%
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
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.
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
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.
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
C - Tracking
Tracking is a passive managament strategy where fund manager tries to match the retuns of the portfolio to the chosen index
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
A - 7.4 years
Bond Portfolio Duration = (0.3 x 6 years) + (0.7 x 8 years) = 7.4 years
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
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
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
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
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
D - Dedicated portfolio
A dedicated portfolio is an investment portfolio where the cash flows are designed to match the anticipated liabilities.
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
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.
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
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
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%
B - 2.6%
(98-95.5)/95.5 = 2.6%
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
B - Short dated high coupon bonds
Short dates are LESS exposed to interest rate movements an d high coupons provide some insulation.
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
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.
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
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.
Riding the yield curve requires the yield curve to be:
A) Falling
B) Humped
C) Flat
D) Upward-sloping
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.
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
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.
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
A - None of them
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%
C - 2.70%
(3 months price - 6 month price)/6 month price
(£95 - £92.50)/£92.50 = 0.027 i.e. 2.7%
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
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.
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
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.
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%
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%
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
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.
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
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%
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
C - Semi-Strong form
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
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).
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
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).
