Lesson 4: Portfolio Evaluation Flashcards
Dinah’s portfolio consists of a 50 percent equity index fund and a 50 percent fixed-income index fund. More details are shown below:
Fund
Shares
Net Asset Value
Total Value
Equity Index
2,000
$25.00
$50,000
Fixed-income Index
1,250
$40.00
$50,000
A year later, the price of the equity fund changes to $20.00 and the price of the fixed-income fund changes to $50.00. All of the following statements correctly describe how these price changes affected the portfolio EXCEPT:
A) The portfolio likely has a riskier asset allocation.
B) The expected return of the portfolio has likely decreased.
C) The portfolio’s style is drifting away from balance and more toward fixed-income securities.
D) To rebalance her portfolio, Dinah must sell shares of the fixed-income index and buy shares of the equity index.
The allocation after the changes in prices is as follows:
Fund
Shares
Net Asset Value
Total Value
New Allocation
Equity Index
2,000
$20.00
$40,000
39.02%
Fixed-Income Index
1,250
$50.00
$62,500
60.98%
Dinah’s portfolio is now weighted more toward fixed-income securities. This means her portfolio is likely less risky than it was before and is also likely to have a lower return. To rebalance back to a 50/50 allocation, Dinah must sell off shares of the fixed-income index and buy shares of the equity index.
A fund generated a return of 10 percent. Meanwhile, the market returned 11 percent and the risk-free return was 3 percent. If the fund’s beta is 0.9, then Jensen’s alpha for the fund is closest to which of the following?
A) -2.6
B) -0.2
C) +6.2
D) +7.8
The correct answer is (B).
a = rp - [rf + (rm - rf) x β]
a = 10 - [3 + (11 - 3) x 0.9]
a = 10 - [3 + (8 x 0.9)]
a = 10 - [3 + 7.2]
a = 10 – 10.2 = -0.2
The Paul Fund earns 14 percent during the year while the risk-free rate is 3 percent. The Paul Fund has a beta of 1.10 and a standard deviation of 18 percent. The Treynor ratio is closest to
A) 0.61.
B) 0.78.
C) 1.00
D) 10.00.
The correct answer is (D).
Treynor = (Portfolio Return Risk–Free Return Rate) ÷ Beta
Treynor = (14 − 3) ÷ 1.10 = 10.00
The Miracle Whip Fund (MWF) generated a return of 14.2 percent. Meanwhile, the market returned 10.75 percent and the risk-free return was 3.2 percent. If MWF’s beta is 1.3, then Jensen’s alpha for the fund is closest to which of the following?
A) -2.0
B) +1.96
C) +1.2
D) +5.2
The correct answer is (C).
ap = rp − [rf + (rm − rf) × βp]
a = 14.2 − [3.2 + (10.75 - 3.2) × 1.3]
a = 14.2 − [3.2 + (7.55 × 1.3)]
a = 14.2 − [3.2 + 9.815]
a = 14.2 − 13.015 = 1.2
The Yoko Fund earns 11.2 percent during the year while the risk-free rate is 3.1 percent. The Yoko Fund has a beta of 1.20 and a standard deviation of 17.5 percent. The Treynor ratio is closest to
A) 0.463.
B) 0.640.
C) 6.750.
D) 9.333.
The correct answer is (C).
Treynor = (Portfolio Return Risk–Free Return Rate) ÷ Beta
Treynor = (11.2 − 3.1) ÷ 1.20 = 6.750
Peaches, Inc., expects to generate $50 million in operating cash flows during the next year. It estimates its long-term dividend growth rate to be 3 percent, and it has 50 million shares outstanding. What is the intrinsic value of Peaches, Inc., if your required rate of return is 10 percent?
A) $5.88
B) $10.00
C) $14.29
D) $33.33
The correct answer is (C).
Intrinsic value = Total market value ÷ Outstanding Shares.
Total market value = Operating Cash Flow ÷ (Required Rate of Return – Dividend Growth Rate)
Total market value = $50,000,000 ÷ (0.10 − 0.03) = $50,000,000 ÷ 0.07 = $714,285,714
Intrinsic value = $714,285,714 ÷ 50,000,000 = $14.29
Ollie, who is a financial advisor, manages an equity portfolio for the Green Arrow University endowment fund, which has an 8.1 percent return objective. Ollie makes a strategic allocation recommendation that produces a return of 7.8 percent in an economy that has experienced a 2.7 percent rate of inflation. Ollie also creates his own benchmark for the fund, which includes multiple indexes that have similar risk profiles of the securities in the fund. The benchmark return during the period is 7.5 percent. Is the endowment fund satisfied with Ollie’s performance?
A) Yes, because the fund outperformed inflation.
B) Yes, because the fund outperformed the return objective.
C) Yes, because the fund outperformed the benchmark return.
D) No, because the fund underperformed the objective.
The correct answer is (C).
While the fund did not return more than the return objective, it still performed better than the benchmark return.
A mutual fund with a beta of 0.90 and a standard deviation of 11% earns an 8% return during a year in which the risk-free rate is 3 percent. Meanwhile, the market portfolio returned 9% with a standard deviation of 10%. The mutual fund’s Sharpe ratio is closest to
A) -0.4000.
B) 0.4545.
C) 0.7273.
D) 5.5556.
The correct answer is (B).
Sharpe = (Portfolio Return Risk - Risk-Free Return Rate) ÷ Standard Deviation
Sharpe = (8 - 3) ÷ 11 = 0.4545
How does the constant-weighting strategy differ from other asset allocation strategies?
A) The constant-weighting strategy requires a fund manager to regularly return to the strategic asset allocation.
B) Only under the constant-weighting strategy is the asset allocation unable to change over time.
C) Under the constant-weighting strategy, fund managers are constantly looking for ways to change the asset weights to beat the market.
D) The constant-weighting strategy is especially focused on fixed-income securities.
The correct answer is (A).
Under the constant-weighting strategy, the fund manager will set up a pre-determined rule for when to return to the strategic asset allocation. Generally, the rule is that the fund cannot have an asset allocation too different from the strategic asset allocation. For example, a manager who wants a 70/30 stock/bond allocation will rebalance if the portfolio allocation rises to 75/25 or falls to 65/35. Another common rule is to rebalance back to the strategic asset allocation on a fixed schedule such as at the beginning of every quarter.
The John Fund earns 10 percent during the year while the risk-free rate is 3 percent. The John Fund has a beta of 1.10 and a standard deviation of 15 percent. Meanwhile, the market portfolio returned 8 percent with a standard deviation of 10 percent. The Sharpe ratio is closest to
A) 0.1333.
B) 0.4667.
C) 1.8182.
D) 6.3636.
The correct answer is (B).
Sharpe = (Portfolio Return Risk–Risk-Free Return Rate) ÷ Standard Deviation
Sharpe = (10 − 3) ÷ 15 = 0.4667
