Chapter 6 Flashcards

1
Q

[1056995] You are holding a meeting with your client, during which you are explaining to her the benefits of diversifying into different asset types and classes. With regard to diversification benefits, which of the following statements is least likely to be true?
AIf the investments are company shares, there is little benefit in diversifying between British and international equity markets BAs property has gained in popularity, it has become recognised as a core asset class in its own right CAssets with a low or negative correlation tend to be attractive to investors since when one asset is performing badly, the other asset is rising in value DThere is a predictably strong positive correlation between investor returns from equities, and investor returns from government bonds

A

The correct answer is: D - There is a predictably strong positive correlation between investor returns from equities, and investor returns from government bonds
Explanation
Globalisation has reduced diversification benefits from holding a mixture of both UK and international shares in a portfolio, since returns from different equity markets tend to be strongly positively correlated to one another. By contrast, returns from shares and government bonds tend to move in opposite directions in times of equity market stress, there is often a ‘flight to quality’ effect as investors sell shares and move into bonds instead.

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2
Q

[1070009] How does a smart beta fund differ from a traditional passive fund?
AA percentage of the portfolio is actively managed, and the rest is passively held BThe fund over weights and under weights constituents of the index CThe fund enhances return by charging fees for stock lending DThe fund creates its own benchmark based on active research, and then matches that benchmark

A

The correct answer is: D - The fund creates its own benchmark based on active research, and then matches that benchmark
Explanation
The creation of the benchmark is an active strategy, and the tracking of the benchmark is the passive strategy.

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3
Q

[1056993] Which of the following statements is the BEST description of the way in which diversification and risk reduction are related?
ADiversification and risk reduction is achieved by combining assets whose returns are not perfectly negatively correlated with one another BDiversification and risk reduction is achieved by combining assets whose returns are not perfectly positively correlated with one another CDiversification and risk reduction is achieved by combining assets whose returns are not correlated at all with one another DDiversification and risk reduction are not related to the idea of correlation between assets

A

The correct answer is: B - Diversification and risk reduction is achieved by combining assets whose returns are not perfectly positively correlated with one another
Explanation
Diversification and risk reduction is achieved by combining assets, whose returns have not moved in perfect step, or are not perfectly positively correlated with one another.

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4
Q

[1024417] Eckhardt is heavily invested in UK equity and now wishes to extend his investment portfolio to include overseas equity. What new risk is he exposing himself to?
ALiquidity BCapital CCurrency DIncome

A

The correct answer is: C - Currency
Explanation
Eckhardt was already exposing himself to liquidity, capital and income risks, but by investing overseas he will be using other currencies and exposing himself to the risk of movements in foreign exchange rates.

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5
Q

[1049226] Malcolm is talking about the reduction in yield figure. He makes the following comments:
Comment 1: RIY considers annual management charges Comment 2: RIY does not include any initial charges
Which is true?
ABoth BComment 1 only CComment 2 only DNeither

A

The correct answer is: B - Comment 1 only
Explanation
Both the initial charge and the annual management charge are included in the reduction in yield figure.

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6
Q

[1070011] Which of the following is TRUE regarding synthetic risk and reward indicators (SRRI)?
IUCITS IV requires a SRRI score to be part of the KIID for all UCITS funds
IISRRI scores range from 1 to 7, with 1 representing the most risky fund, and 7 representing the least risky fund
IIISRRI is based on the historic volatility of the NAV of the fund over a 10 year period
IVHistoric volatility of more than 25% corresponds to a SRRI score of 7
AI,II only BII,III only CI,II,IV only DI,IV only

A

The correct answer is: D - I,IV only
Explanation
A SRRI score of 1 indicates the lowest risk level, and a score of 7 indicates the highest risk level.
SRRI is based on historic volatility over a 5 year period.

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7
Q

[1049225] A true bottom up active fund is characterised by which risk?
ATracking error BConcentration risk CBeta risk DLiquidity risk

A

The correct answer is: A - Tracking error
Explanation
Tracking error characterises a true bottom up active fund’s strategy.

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8
Q

[1049224] Which of the following is not a stage in top down active management?
ACurrency selection BAsset allocation CSector allocation DStock selection

A

The correct answer is: A - Currency selection
Explanation
The three stages in top down active management are: asset allocation, sector allocation and stock selection.

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9
Q

[1049972] An analyst is using known probabilities to forecast future outcomes. It is most likely that they are using a … approach.
AStochastic BStatistical CDeterministic DBrownian

A

The correct answer is: C - Deterministic
Explanation
Deterministic approaches uses known parameters and probabilities. Stochastic approaches allow for unknown, random variables.

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10
Q

[1017497] Which of the following is not used in fundamental analysis?
APrice patterns BDividend cover CManagement information DCash flows

A

The correct answer is: A - Price patterns
Explanation
Price patterns are associated with technical analysis.
Fundamental analysis is more likely to take advantage of the other measures.

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11
Q

[1070010] Which of the following is TRUE regarding performance by active fund managers and active share?
AA link exists between outperformance and low active share BA link exists between outperformance and high active share CNo link exists between outperformance and high active share DNo link exists between underperformance and high active

A

The correct answer is: B - A link exists between outperformance and high active share
Explanation
Active share looks to compare the stock weights of the manager to that of the benchmark. It is seen as an improvement on traditional tracking error analysis, and will more easily reveal if the manager is just a “closet-tracker”.

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12
Q

[1035749] Which of the following is the LEAST important when discussing an investment of 20K, which may be needed soon for an illness?
APenalties BTaxation CCapital loss DLiquidity

A

The correct answer is: B - Taxation
Explanation
The question is asking about very short-term investments: i.e. where the funds may be needed very soon. It is, therefore, important to avoid investments that have penalties for withdrawing at short notice or that could incur capital losses. It is also important to have adequate liquidity. Taxation of the returns is a secondary consideration, as the investment is not likely to be held for very long.

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13
Q

[1049220] Which of the following is an assumption of Modern Portfolio Theory?
AInvestors are loss averse BInvestors are risk averse CInvestors are risk takers DInvestors are risk avoiders

A

The correct answer is: B - Investors are risk averse
Explanation
MPT assumes investors are risk averse meaning they need to be compensated with return for taking on risk.

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14
Q

[1049181] Which of the following is not a passive bond strategy?
ACash matching BLadder portfolio CImmunisation DEnhanced indexing

A

The correct answer is: D - Enhanced indexing
Explanation
Enhanced indexing is a semi-active strategy.

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