Portfolio Management

Question 1

The major assumptions of APT (arbitrage pricing theory) are (3)

Answer 1

The major assumptions of APT (arbitrage pricing theory) are as follows: asset returns are described by a factor model; there are many assets, so asset-specific risk can be eliminated (not factor risk); assets are priced such that there are no arbitrage opportunities

Question 2

Fundamental Factor Models

Answer 2

Fundamental Factor Models – factors are attributes of stocks or companies

Question 3

Statistical Factor Models

Answer 3

Statistical Factor Models – statistical methods are applied to a set of historical returns

Question 4

Arbitrage Opportunity (portfolio/model)

Answer 4

Arbitrage Opportunity: compare given expected returns to model expected returns, long or short the portfolio with the inequality, then buy or sell (opposite of arbitrage portfolio) and combination of the equality portfolios using weights to match the arbitrage portfolio qualities

Question 5

Value Added

Answer 5

Value Added – related to active weights in the portfolio, defined as differences between the various asset weights in the managed portfolio and their weights in the benchmark portfolio

Question 6

Information Ratio

Answer 6

Information Ratio: IR=(R_P-R_B)/(STD(R_P-R_B))=R_A/(STD(R_A))=(Active Return)/(Active Risk)

Question 7

Expected Active Return

Answer 7

Expected Active Return: E(R_A )=(TC)(IC)√BR σ_A where IR=IC√BR where TC – transfer coefficient, IC – information coefficient, BR – breadth (# independent decisions per year), σA – active risk, IR – information ratio

Question 8

The average level of real short-term interest rates is positively related to

Answer 8

The average level of real short-term interest rates is positively related to the trend of growth of the underlying economy and also to the volatility of economic growth in the economy

Question 9

When the output gap is positive (negative), …

Answer 9

When the output gap is positive (negative), the policy rate should also be above (below) the neutral rate

Question 10

Investors will demand an

Answer 10

Investors will demand an equity risk premium because the consumption hedging properties of equities are poor

Question 11

Break-even inflation rate is

Answer 11

Break-even inflation rate is the difference between the yield on a zero-coupon risk-free nominal bond and on a zero-coupon risk-free real bond of the same maturity; the difference (premiums) reflects: inflation expectations (θ) and risk premium for uncertainty (π)