Chapter 16 The Portfolio Management Process RQ Flashcards
Identify how diversification is achieved by bond laddering in a portfolio.
A. Inclusion of preferred shares.
B. Inclusion of convertible debentures.
C. Inclusion of bonds with a variety of consecutive terms to maturity.
D. Inclusion of federal, provincial and corporate bonds.
C. Inclusion of bonds with a variety of consecutive terms to maturity.
Bond laddering is the inclusion of bonds with a variety of consecutive terms to maturity. For example, the portfolio might have bonds maturing 4, 6, 8, 10 and 12 years from now. This reduces the interest rate risk of the portfolio as only a portion of the bond portfolio is maturing at any one time. Further, if interest rates increase, parts of the portfolio mature and can be reinvested at higher rates over time.
Which asset allocation strategy involves adjusting the asset mix to systematically re-balance the portfolio back to its long-term target?
A. Dynamic.
B. Active.
C. Passive.
D. Tactical.
A. Dynamic.
Dynamic asset allocation is a portfolio management technique that involves adjusting the asset mix to systematically re-balance the portfolio back to its long-term target or strategic asset mix. Re-balancing may be necessary for a variety of reasons: There is a build-up of idle cash reserves, possibly from dividends or interest income cash flows, that have not been re-invested; or There are movements in the capital markets. These movements can cause abnormal returns, such as the 1987 market crash or the 1998 Asian flu crisis.
Select the cash allocation that a very risk-averse investor would typically have in a diversified portfolio.
A. 0%.
B. 5%.
C. 10%.
D. 25%.
C. 10%.
In general terms, cash usually makes up at least 5% of a diversified portfolio’s asset mix. Investors who are very risk averse may hold as much as 10% in cash. While cash levels may temporarily rise greatly above these amounts during certain market periods or portfolio rebalancings, normal long-term strategic asset allocations for cash are often within the 5%–10% range. A risk-averse investor, someone who is not comfortable taking risks, will likely hold more cash compared to someone who is less risk-averse.
An investment portfolio has a market value of $20,000 on January 1. As a result of $3,000 in capital gains and $2,000 in investment income, the portfolio has a market value of $25,000 on December 31. Calculate the total return on the portfolio.
A. 10%.
B. 15%.
C. 20%.
D. 25%.
D. 25%.
A simple method of computing total return is to divide the portfolio’s total earnings by the amount invested in the portfolio. Total earnings consist of income plus capital gains or losses, or, in other words, the increase (or decrease) in the market value of the portfolio. In this example, ($25,000 - $20,000) / $20,000 x 100 = 25%.
An investment manager with a dynamic asset approach reviews his portfolio following an equity market decline. The portfolio strategic asset allocation is set at 50% equities, 40% fixed income and 10% cash. Currently, the portfolio value is $450,000 equities, $500,000 fixed income and $40,000 cash. Calculate the adjustment that he would make to the asset categories of the portfolio to re-balance the portfolio back to its strategic asset allocation.
A. Increase equities by $50,000, decrease fixed income by $50,000.
B. Increase equities by $25,000, decrease fixed income by $25,000.
C. Increase equities by $45,000, decrease fixed income by $104,000, increase cash by $59,000.
D. Increase equities by $30,000, decrease fixed income by $20,000, decrease cash by $10,000.
C. Increase equities by $45,000, decrease fixed income by $104,000, increase cash by $59,000.
The overall portfolio value is $450,000 + $500,000 + $40,000 = $990,000. 50% of $990,000 = $495,000; 40% = $396,000; and 10% = $99,000. Therefore, the equities would be increased by $495,000 - $450,000 = $45,000; fixed income decreased by $500,000 - $396,000 = $104,000; and cash increased by $99,000 - $40,000 = $59,000.
Select the Sharpe ratio that demonstrates outperformance in comparison with Sharpe ratio of 5 for the applicable benchmark.
A. -4.
B. 0.
C. 2.
D. 6.
D. 6.
If a manager is being measured against a benchmark, the portfolio’s Sharpe ratio can be compared to the Sharpe ratio of the applicable benchmark. The larger the Sharpe ratio, the better the portfolio performed. A money manager with a Sharpe ratio greater than the Sharpe ratio of the benchmark outperformed the benchmark. A portfolio’s Sharpe ratio that is smaller than the benchmark’s signals underperformance. A negative Sharpe ratio means the portfolio had a return less than the risk-free return.
A tactical asset allocation manager has a strategic asset allocation of 10% cash, 30% fixed income and 60% equity. Select the asset mix the manager might utilize if she anticipates a decline in the equity markets.
A. 5% cash, 20% fixed income and 75% equity.
B. 5% cash, 10% fixed income and 85% equity.
C. 10% cash, 30% fixed income and 60% equity.
D. 10% cash, 45% fixed income and 45% equity.
D. 10% cash, 45% fixed income and 45% equity.
A tactical asset allocation manager is able to deviate from the strategic asset allocation where there are opportunities to capitalize on investment opportunities in one asset class. After the opportunity, the manager will revert back to the long-term strategic allocation mix. This enables the manager to exercise any market timing skills he or she may have, while investing for the expected return indicated by the strategic mix. In this example, the manager would temporarily underweight equities until such time as equity markets are again perceived as attractive for investment.
An investment policy statement contains the objective “the portfolio will achieve a modest level of income and aggressive long-term growth.” Select the appropriate asset allocation for this objective.
A. 5% cash; 5% fixed income; 90% equity.
B. 5% cash; 15% fixed income; 80% equity.
C. 10% cash; 5% fixed income; 85% equity.
D. 15% cash; 15% fixed income; 70% equity.
B. 5% cash; 15% fixed income; 80% equity.
An investment policy statement provides guidelines for investment. In this instance, the client’s needs for modest level of income and aggressive long-term growth would be best achieved, of the listed choices, by a mix of 5% cash, 15% fixed income, and 80% equity. The 5% cash allows for a degree of liquidity and some diversification, without overweighting the portfolio, while the 15% fixed income should provide a low level of income plus diversification, while the 80% equity would be suitable for an individual seeking aggressive long-term growth.
ABC Inc. is described by its analyst as being a high-risk equity based on its low capitalization, very limited earnings record, no dividends and short operating history. Determine the risk category ABC belongs to.
A. Venture.
B. Growth.
C. Speculative.
D. Conservative.
A. Venture.
A “venture” equity investment is characterized by as high risk due to low capitalization; limited earnings record; no dividends; and short operating history; and high volatility.
Determine the investor who would be most likely to have a primary investment objective of growth.
A. Mikhail, aged 42, planning for a new business venture in 3 months.
B. Gitaz, aged 31, a senior executive with a Canadian bank planning on early retirement.
C. Greg (age 28) and Marc (age 29), saving for their first home purchase.
D. Simon, aged 82, retired with a substantial pension and investment portfolio.
B. Gitaz, aged 31, a senior executive with a Canadian bank planning on early retirement.
Growth of capital, also referred to as capital gains, refers to the profit made when securities are sold for more than they cost to buy. Gitaz, as a well-paid executive saving for early retirement would need to have a growth objective to achieve her goal, whereas Mikhail, with a short time horizon, Greg and Marc saving for a home purchase and Simon, in a secure retirement, would be more likely to be focused on safety of principal.
Select the investor who would have unique circumstances as a constraint on their investment strategy.
A. Takuma, who is in the highest marginal tax bracket.
B. Helio, who is an insider of a publicly traded company.
C. Graeme, who will not invest in tobacco stocks.
D. Sebastian, who has an uncertain time horizon for his investments.
C. Graeme, who will not invest in tobacco stocks.
There can be unique circumstances specific to each client that must be considered when creating the investment policy. An example of unique circumstances is the desire for ethically and socially responsible investing. For example, some clients may instruct that no alcohol or tobacco stocks be purchased because of their personal convictions. While considerations such as tax brackets, legal status, etc., must be considered, these are not unusual circumstances for creation of an IPS.
ABC Investments, an active investment management firm, is selling their short-term bonds and buying mid- to long-term bonds and avoiding increasing the proportion of their portfolios invested in equities. Determine the phase of the equity cycle the investment manager is preparing for.
A. Equity cycle peak.
B. Stock market trough.
C. Contraction.
D. Recovery and expansion.
C. Contraction.
In the contraction phase, an active management firm will lengthen term of bond holdings by selling short-term bonds and buying mid- to long-term bonds and avoid or reduce stock exposure.
A client portfolio has a January 1 market value of $200,000. On December 31, the client contributed an additional $21,000 to the portfolio and ended the year with a portfolio value of $225,000. Calculate the total return on the portfolio that comes from return on investments and not from new contributions.
A. 1.8%.
B. 2.0%.
C. 11.11%.
D. 12.5%.
B. 2.0%.
Total return measures the growth of a portfolio. The formula used is: Total Return = Increase in Market Value/Beginning Market Value x 100. If the client contributes funds, then a portion of the growth is due to the contribution, not to return on investment. If we deduct the $21,000 of contribution from year end market value, we have a market value that reflects only investment growth: $225,000 - $21,000 = $204,000. This $4,000 increase in market value divided by the beginning of year market value will give us the total return based on investment growth of $4,000 / $200,000 x 100 = 2%
Calculate the Sharpe Ratio for XYZ Investment Fund, which had an average fund return of 10%, a standard deviation of 4% and an average risk-free return for the period of 1.5%. Round the answer to 2 decimal places.
A. 0.55%.
B. 2.13%.
C. 2.50%.
D. 7.33%.
B. 2.13%.
The Sharpe Ratio Calculation would be calculated as: (10% - 1.5%)/4% = 2.125, with 10% representing the average fund return, 4% the standard deviation, and 1.5% the average risk-free return.
An analyst’s report states that stock prices are expected to decrease by 2% with expected dividend yields of 3%. Calculate the expected total pre-tax return for equities.
A. -2%.
B. 1%.
C. 3%.
D. 5%.
B. 1%.
Expected total returns for an asset group are calculated by adding the expected annual income to the expected capital gain or loss for an asset group. In this example, the analyst is predicting a capital loss for stocks of 2%, and a dividend yield of 3%, which would indicate an expected total return for the asset group of -2% + 3% = 1%
