Equity Portfolio

Question 1

What is the concept of passive equity portfolio management?

Answer 1

to hold stocks so the portfolio’s return will track those of a benchmark.

Question 2

How can you construct a passive equity portfolio?

Answer 2

1. ) Full replication
2. ) Sampling
3. ) Quadratic optimization.

Question 3

What is the concept of active equity portfolio management?

Answer 3

to earn a return that is higher than the return of a passive benchmark portfolio.

Question 4

What is the trade-off between a passive and an active portfolio management?

Answer 4

The trade off is between a low cost but less rewarding portfolio and a more expensive but more lucrative portfolio.

Question 5

Why would an investor use an index?

Answer 5

As benchmarks to evaluate the performance of professional money managers: it is a way to check if they are doing better or not than the market.
To create and monitor an index fund
To measure market rates of return in economic studies.
For predicting future market movements by technicians. It allows also traders to have a sense of where certain stocks are moving.

Question 6

What are the 3 ways to build an index?

Answer 6

1. A Price-Weighted Index
2. A Value-Weighted Index
3. An Unweighted Index

Question 7

What is a price-weighted index?

Answer 7

an arithmetic mean of current stock prices (ex: The Dow Jones is a price-weighted average of 30 industrial stock.)

Question 8

What is a value-weighted index?

Answer 8

is using the total market value.

Question 9

What is an un-weighted index?

Answer 9

is an index where all stocks carry the same weight regardless of their price.

Question 10

What is the relationship between a passive portfolio’s tracking error and the number of stocks into the portfolio?

Answer 10

Generally, there is an inverse relationship between a passive portfolio’s tracking error relative to its index and the time and expense necessary to create and maintain the portfolio.

Question 11

What is the concept of full replication when constructing a portfolio?

Answer 11

the manager buys all the securities of the index with the same weights as in the index.

Question 12

What is the sampling technique when constructing a portfolio?

Answer 12

The manager would buy only a limited number of stocks, but that represent the benchmark index.

Question 13

What is the quadratic optimization technique when constructing a portfolio?

Answer 13

Historical information on price changes and correlations between securities are used in computer program to determine which composition would minimize the return deviations from the benchmark.

Question 14

Discuss three strategies active managers can use to add value to their equity portfolio

Answer 14

1. Top down or bottom up approach.
2. Technical strategies: technical analysis of stocks (historical prices).
3. Anomalies and attributes: the idea is to take advantage of some characteristics of companies.

Question 15

What is an asset class rotation strategy?

Answer 15

consists of shifting funds into and out of stocks, bonds and T-bills trying to time the market.

Question 16

What is a sector rotation strategy?

Answer 16

consists of shifting funds among different equity sectors and industries. It is basically the idea of putting more weight on certain sectors or industries in response to the next expected phase of the business cycle.

Question 17

What is a fundamental picking strategy?

Answer 17

strategy consists of choosing equities that can be bought at a discount to what the valuation model indicates. As we have seen, it could be based on model such as discounted cash flow or relative price multiples.

Question 18

What is the difference between value and growth investment?

Answer 18

1. Growth funds focus on companies that managers believe will experience faster than average growth as measured by revenues, earnings, or cash flow.
2. The goal of value funds is to find proverbial diamonds in the rough; that is, companies whose stock prices don’t necessarily reflect their fundamental worth (Buffet approach).