Chapter 18

Question 1

Passive Management

Answer 1

Holding a well-diversified portfolio without attempting to search out security mispricing

Question 2

Cash

Answer 2

Shorthand for virtually risk-free money market securities.

Question 3

Active Management

Answer 3

Attempts to achieve returns higher than commensurate with risk by forecasting broad markets and/or by identifying mispriced securities.

Question 4

Comparison Universe

Answer 4

The set of portfolio managers with similar investment styles that is used to assess relative performance.

Question 5

Alpha Capture

Answer 5

Construction of a positive-alpha portfolio with all systematic risk hedged away.

Question 6

Alpha Transfer or Alpha Transport

Answer 6

Establishing alpha while using index products both to hedge market exposure and to establish exposure to desired sectors.

Question 7

What are the 3 Steps to Portfolio Evaluation?

Answer 7

• Portfolio return
• Selection of a benchmark
• Selection of comparison method

Question 8

Types of Portfolio Return (3)

Answer 8

• Arithmetic average rate of return
• Time weighted rate of return
  
  • Geometric rate of return
  • Managers’ performance (buy and hold)
• Value weighted rate of return
  
  • Internal rate of return
  • Investors’ actual performance

Question 9

Step 2: Selection of Benchmark. Examples

Answer 9

• S&P 500; DJIA – General market index
• NYSE composite; Wilshire 5000- Market
• Russell 2000 –Small cap
• Russell 2000 Growth –Small cap growth
• Russell 2000 Value – Small cap value
• Barclays Capital Aggregate Bond Index
• MSCI EAFE – International developed

Question 10

What are the different Comparison Methods? (4)

Answer 10

• Sharpe ratio
• Treynor ratio
• Information ratio
• Jensen’s alpha; multifactor alpha

Question 11

Sharpe Ratio

Answer 11

Reward-to-volatility ratio; ratio of portfolio excess return to standard deviation.

• Used when choosing among competing portfolios that will not be mixed.
• Used for entire portfolio or wealth

Question 12

Treynor Ratio

Answer 12

Ratio of portfolio excess return to beta.

• Used to evaluate portfolio that is part of larger portfolio with different managers.
• Diversified Portfolios

Question 13

Information Ratio

Answer 13

Ratio of alpha to standard deviation of diversifiable risk.

- Actively Managed Investments

Question 14

Jensen Measure

Answer 14

Alpha of an investment

- Diversified Portfolios

Question 15

Futures Contract

Answer 15

• they specify the purchase or sale of some underlying security at some future date
• carries the obligation to go through with the agreed-upon transaction

Question 16

Bull Market

Answer 16

group of securities in which prices are rising or are expected to rise

Question 17

Bear Market

Answer 17

prices are falling and widespread pessimism causes the negative sentiment to be self-sustaining.

Question 18

Nine-Step Investment Process

Answer 18

1. Develop an understanding of the client’s goals
2. Identify a target rate of return
3. Agree on the time horizon
4. Determine the client’s tolerance and capacity for risk
5. Define the asset classes
6. Determine an appropriate asset allocation
7. Create the IPS
8. Select the Investments themselves
9. Monitor and adjust as needed

Question 19

Strategic Asset Allocation

Answer 19

core: low fee, low tax cost; capture beta

Question 20

Tactical Asset Allocation

Answer 20

• satellite: active management, sector; capture alpha

- behavioral consideration