Chapter 17

Question 1

Strategic Asset Allocation

Answer 1

refers to the benchmark asset mix designed to achieve the clients long term goals and objectives

Question 2

Rebalancing

Answer 2

necessary when the client’s asset mix becomes too far from the SAA benchmark

Question 3

Tactical Asset Allocation

Answer 3

altering the SAA to take advantage of short term fluctuations in the relative performance of asset classes

Question 4

Bottom Up Approach

Answer 4

investment approach that focuses on analyzing individual stocks and de-emphasizes the significance of macroeconomic and market cycles

Question 5

Passive Investment Strategies

Answer 5

indexing and buy-and-hold

Question 6

Portfolio Expected Return

Answer 6

Weighted average of the expected returns on the individual securities in the portfolio

Question 7

Standard Deviation

Answer 7

a measure of the extent to which the return on an investment varies from the expected return, the more it differs the greater the volatility and therefore the greater the standard deviation

Question 8

correlation coefficient

Answer 8

measures the strength of the relationship, or in other words it is a measure of the degree to which the securities’ returns deviate from their expected returns at a given time (between +1 and -1)

Question 9

Mean Variance Optimization relies on 4 assumptions:

Answer 9

• all investors are risk averse (when given the choice between two investments with same return they’ll choose the less risky one)
• Investors have access to information on expected returns, standard deviations, and correlation of all assets
• Investors build their portfolios using only the expected returns, standard deviations, and correlation of assets
• There are no transaction costs or taxes

Question 10

When does Markowitz consider a portfolio efficient?

Answer 10

If it provided the highest expected return for a given level of risk

Question 11

minimum variance frontier

Answer 11

Graph of the lowest possible portfolio variance that is attainable for a given portfolio expected return

Question 12

efficient frontier

Answer 12

the upper part of the minimum variance frontier that offer the highest expected return for a defined level of risk for a given level of expected return (Markowitz theory)

Question 13

Capital Asset Pricing Model (CAPM)

Answer 13

Expected Return on Any Asset = Rf + Assets Beta X [expected return on market portfolio - Rf]

Question 14

Beta

Answer 14

measure of the sensitivity of an assets return to the return on the market portfolio, it is a measure of systematic risk

Question 15

Systematic Risk

Answer 15

The degree to which the value of an asset goes up or down relative to market moves (measured by beta)

Question 16

Unsystematic Risk

Answer 16

unrelated to fluctuations in the market portfolio and unique to each asset (measured by r-squared)

Question 17

Beta Measurements

Answer 17

• If beta =1, systematic risk is the same as the markets
• Beta >1, systematic risk is greater than the markets and therefore a greater expected return
• Beta <1, systematic risk is less than markets so expected return is less than the market
• Beta =0, risk free asset

Question 18

R-squared Measurements

Answer 18

• Value of 0 means that the return on the security or portfolio and the return of the market index are unrelated
• A value of 1 means that the return on the security or portfolio is perfectly correlated

Question 19

Portfolio Opportunity Set

Answer 19

Curved line that represents the risk-return tradeoff between stocks and bonds given their expected returns, standard deviation, and correlation