Deck 21: Investors and the Investment Process

Question 1

A purely passive strategy

A) uses only index funds.
B) uses weights that change in response to market conditions.
C) uses only risk-free assets
D) is best if there is "noise" in realized returns.
E) is useless if abnormal returns are available.

Answer 1

A

Question 2

Consider the Treynor-Black model.The alpha of an active portfolio is 1%.The expected return on the market index is 16%.The variance of the return on the market portfolio is 4%.The nonsystematic variance of the active portfolio is 1%.The risk-free rate of return is 8%.The beta of the active portfolio is 1.05.The optimal proportion to invest in the active portfolio is _________.

A) 48.7%
B) 50.0%
C) 51.3%
D) 100.0%
E) none of these

Answer 2

C

Question 3

According to the Treynor-Black model,the weight of a security in the active portfolio depends on the ratio of __________ to _________.

A) the degree of mispricing;the nonsystematic risk of the security
B) the degree of mispricing;the systematic risk of the security
C) the market sensitivity of the security;the nonsystematic risk of the security
D) the nonsystematic risk of the security;the systematic risk of the security
E) the total return on the security;the nonsystematic risk of the security

Answer 3

A

Question 4

Consider the Treynor-Black model.The alpha of an active portfolio is 2%.The expected return on the market index is 16%.The variance of return on the market portfolio is 4%.The nonsystematic variance of the active portfolio is 1%.The risk-free rate of return is 8%.The beta of the active portfolio is 1.The optimal proportion to invest in the active portfolio is _________.

A) 0%
B) 25%
C) 50%
D) 100%
E) none of these

Question 5

Variable life insurance

A) combines life insurance with a tax-deferred annuity.
B) provides a minimum death benefit that increases subject to investment performance.
C) can be converted to a stream of income.
D) all of these.
E) none of these

Question 6

The Treynor-Black model assumes that

A) the objective of security analysis is to form an active portfolio of a limited number of mispriced securities.
B) the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock.
C) the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing,the market sensitivity of the security,and its degree of nonsystematic risk.
D) all of these are true.
E) none of these are true.

Question 7

Active portfolio managers try to construct a risky portfolio with _________.

A) a higher Sharpe measure than a passive strategy
B) a lower Sharpe measure than a passive strategy
C) the same Sharpe measure as a passive strategy
D) very few securities
E) none of these

Question 8

Passive portfolio management consists of _________.

A) market timing
B) security analysis
C) indexing
D) market timing and security analysis
E) None of these is true.

Question 9

Consider the Treynor-Black model.The alpha of an active portfolio is 3%.The expected return on the market index is 18%.The standard deviation of the return on the market portfolio is 25%.The nonsystematic standard deviation of the active portfolio is 15%.The risk-free rate of return is 6%.The beta of the active portfolio is 1.2.The optimal proportion to invest in the active portfolio is _________.

A) 50.0%
B) 69.4%
C) 72.3%
D) 80.6%
E) 100.0%

Question 10

One property of a risky portfolio that combines an active portfolio of mispriced securities with a market portfolio is that,when optimized,its squared Sharpe measure increases by the square of the active portfolio's

A) Sharpe ratio.
B) appraisal ratio.
C) alpha.
D) Treynor measure.
E) none of these.

Question 11

A purely passive strategy is defined as

A) one that uses only index funds.
B) one that allocates assets in fixed proportions that do not vary with market conditions.
C) one that is mean-variance efficient.
D) both a and b.
E) all of these.

Question 12

The investment horizon is:

A) the investor's expected age at death.
B) the starting date for establishing investment constraints.
C) based on the investor's risk tolerance.
D) the date at which the portfolio is expected to be fully or partially liquidated.
E) none of these.

Question 13

The critical variable in the determination of the success of the active portfolio is

A) alpha/systematic risk
B) alpha/nonsystematic risk
C) gamma/systematic risk
D) gamma/nonsystematic risk
E) none of these

Question 14

The longest time horizons are likely to be set by

A) banks.
B) property and casualty insurance companies.
C) pension funds
D) a and c
E) b and c

Question 15

Active portfolio management consists of _________.

A) market timing
B) security analysis
C) indexing
D) a and b
E) none of these

Question 16

The Treynor-Black model is a model that shows how an investment manager can use security analysis and statistics to construct _________.

A) a market portfolio
B) a passive portfolio
C) an active portfolio
D) an index portfolio
E) a balanced portfolio

Question 17

The Treynor-Black model

A) considers both macroeconomic and microeconomic risks.
B) considers security selection only.
C) is relatively easy to implement.
D) a and c.
E) b and c.

Question 18

In the Treynor-Black model,the weight of each security in the portfolio should be proportional to its _________.

A) alpha/beta
B) alpha/beta/residual variance
C) beta/residual variance
D) alpha/residual variance
E) none of these

Question 19

The security selection form of active portfolio management relies on __________ forecasting and the market timing form of active portfolio management relies on __________ forecasting.

A) macroeconomic,macroeconomic
B) macroeconomic,microeconomic
C) microeconomic,macroeconomic
D) microeconomic,microeconomic
E) perfect,imperfect

Question 20

The Treynor-Black model does not assume that

A) the objective of security analysis is to form an active portfolio of a limited number of mispriced securities.
B) the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock.
C) the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing,the market sensitivity of the security,and its degree of nonsystematic risk.
D) indexing is always optimal.
E) the objective of security analysis is to form an active portfolio of a limited number of mispriced securities;the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock;and the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing,the market sensitivity of the security,and its degree of nonsystematic risk.

Question 21

Hedging is a technique used by investors to:

A) Reduce the risk and simultaneously increase the rate of return of a portfolio of assets.
B) Reduce the risk without affecting the rate of return of portfolio assets.
C) Reduce the risk by stabilizing the value of the portfolio of assets.
D) All of these.
E) None of these.

Question 22

To hedge a portfolio of medium to large cap stocks,an investor would use:

A) Futures contracts written on each stock in the portfolio.
B) Futures contracts written on Treasury securities.
C) Futures contracts written on British pounds.
D) Futures contracts written on the TSX 60.
E) None of these.

Question 23

To determine the optimal risky portfolio in the Treynor-Black Model,macroeconomic forecasts are used for the _________ and composite forecasts are used for the _________.

A) passive index portfolio;active portfolio
B) active portfolio;passive index portfolio
C) expected return;standard deviation
D) expected return;beta coefficient
E) alpha coefficient;beta coefficient

Question 24

A corporate treasurer expects to receive $1 million in the near future.He wishes to invest the amount in 90-day maturity T-bills.To protect the investment from a decline in the short-term rates,the investor would most likely:

A) Buy futures contracts written on T-bonds.
B) Sell futures contracts written on T-bills.
C) Buy futures contracts written on T-bills.
D) Sell futures contracts written on Eurodollars.
E) None of these.

Question 25

Perfect timing ability is equivalent to having __________ on the market portfolio.

A) a call option
B) a futures contract
C) a put option
D) a commodities contract
E) None of these is true.

Question 26

A portfolio manager holds a $10 million bond portfolio with a modified duration of 7 years.What is the price value of a basis point (PVBP)?

A) $700,000
B) $70,000
C) $7,000
D) $700
E) none of these

Question 27

Hedging

A) provides a link between the CAPM and the multifactor APT.
B) is very risky as options are involved.
C) allows one to limit the risk of the portfolio.
D) a and b.
E) a and c.

Question 28

Stock index futures contracts are tools used by equity investors to reduce:

A) Interest rate risk.
B) Systematic risk.
C) Exchange rate risk.
D) All of these.
E) None of these.

Question 29

You hold a $10 million bond portfolio with a modified duration of 8 years.How would you,using T-bond futures,hedge this portfolio? Assume that the bond to be delivered has a modified duration of 9 years and that the futures price is currently $92 for $100 par value.

A) Sell approximately 97 contracts
B) Buy approximately 97 contracts
C) Sell approximately 90 contracts
D) Buy approximately 90 contracts
E) None of these

Question 30

The beta of an active portfolio is 1.45.The standard deviation of the returns on the market index is 22%.The nonsystematic variance of the active portfolio is 3%.The standard deviation of the returns on the active portfolio is _________.

A) 36.30%
B) 5.84%
C) 19.60%
D) 24.17%
E) 26.0%

Question 31

Suppose that a corporation needs to raise capital by issuing commercial paper with a maturity of 90 days three months from now.What would the firm most likely do as a protection against an unanticipated increase in short-term rates?

A) Buy futures contracts written on T-bills.
B) Sell futures contracts written on T-bills.
C) Buy futures contracts written on corporate bonds.
D) Sell futures contracts written on T-bonds.
E) None of these.

Question 32

Approximately how many TSX 60 futures contracts are needed to hedge a portfolio constructed of 4500 shares of each of the three stocks,X,Y and Z against a 20 point movement in the TSX?

A) 5
B) 3
C) 4
D) 2
E) none of these

Question 33

You hold a portfolio of stocks and you are concerned about a decline in the market value of the portfolio.You might hedge with:

A) A short position in stock index futures.
B) A long position in stock index futures.
C) A long position in call options.
D) A short position in put options.
E) None of these.

Question 34

A position in stocks and options that is hedged with respect to fluctuations in the price of the underlying asset is said to be

A) stable.
B) delta neutral.
C) volatility neutral.
D) riskless.
E) none of these.

Question 35

Hedging against future interest rate changes

A) is very simple as futures contracts on many different fixed income investments are available.
B) provides for less risk than an unhedged position,even if cross-hedging is used.
C) is complex as yield spreads fluctuate over time.
D) a and b.
E) b and c.

Question 36

Delta

A) is the slope of the option-pricing curve.
B) tells how many shares of underlying stock one must hold to offset the exposure from an option position.
C) is meaningful in terms of U.S.southern geography and in the naming of social organizations,but has no financial connotation.
D) a and b.
E) none of these.

Question 37

A decrease in the TSX 60 index futures to 400 would lead to a __________ on each long TSX 60 futures contract.

A) loss of $2500
B) profit of $2500
C) loss of $5000
D) profit of $5000
E) neither loss nor profit

Question 38

Kane,Marcus,and Trippi (1999)show that the annualized fee that investors should be willing to pay for active management,over and above the fee charged by a passive index fund,depends on
I)the investor's coefficient of risk aversion
II)the value of at-the-money call option on the market portfolio
III)the value of out-of-the-money call option on the market portfolio
IV)the precision of the security analyst
V)the distribution of the squared information ratio of in the universe of securities

A) I,II,IV
B) I,III,V
C) II,IV,V
D) I,IV,V
E) II,III,V

Question 39

A decrease in the cash TSX 60 index to 390 would represent a decrease of __________ in the value of the portfolio composed of 4500 shares of each of the three stocks.

A) $15,187
B) $11,228
C) $10,800
D) $10,125
E) none of these

Question 40

A portfolio of corporate bonds is best hedged with:

A) Futures contracts written on corporate bonds.
B) Futures contracts written on Canada bonds
C) Futures contracts written on Treasury bills.
D) Futures contracts written on the TSX 60.
E) None of these.

Question 41

The contribution of selection within markets to Wiseguys total excess return was

A) 1%
B) 3%
C) 4%
D) 5%
E) none of these

Question 42

The contribution of asset allocation across markets to the total excess return was

A) 1%
B) 3%
C) 4%
D) 5%
E) none of these

Question 43

Discuss the relationship between hedging demands,the capital asset pricing model,and arbitrage pricing theory.

Question 44

Cross-hedging

A) accounts for most hedging activity.
B) uses a hedge vehicle that is based on a different asset than the one to be hedged.
C) can eliminate a large fraction of the total risk of an unprotected portfolio.
D) both b and c.
E) all of these.

Question 45

A fund places 40% of its money in an active portfolio and 60% in a market index.If the return on the market index is 16% and the return on the active portfolio is 18%,the return on the entire fund is _________.

A) 16.4%
B) 16.8%
C) 17.2%
D) 17.6%
E) none of these

Question 46

The total excess return on the Wiseguys managed portfolio was _________.

A) 1%
B) 3%
C) 4%
D) 5%
E) none of these

Question 47

Describe how one might hedge against systematic risk.

Question 48

You have a record of an analyst's past forecasts of alpha.Describe how you would use this information within the context of the Treynor-Black model to determine the forecasting ability of the analyst.

Question 49

Discuss the Treynor-Black model.

Question 50

Discuss the problem associated with hedging interest rate risk.What is cross-hedging? Is cross-hedging of any value? Explain.