Portfolio (1)

 Which of the following is least likely true for a separately managed account
(SMA) compared with a mutual fund?
A. Assets are directly owned by the individual.
B. The minimum investment required to open a SMA is lower than that of
a mutual fund.
C. Transactions can be tailored to the specific tax needs of the investor.

1-30
Portfolio (1)
 Solution: B
B is correct. The minimum investment required to open a separately
managed account is usually much higher than that to open a mutual fund.
A is incorrect because SMA assets are directly owned by the individual. The
investor has control over which assets are bought and sold as well as the
timing of the transactions.
C is incorrect because SMA transactions can be tailored to the specific tax
needs of the investor.

2-30
Portfolio (2)
 Risk management is a process that can most likely be best described as:
A. minimizing risks while attempting to maximize returns.
B. forecasting the level of risk that can meet a defined required return.
C. defining a level of risk to be taken with the goal of maximizing the
portfolio’s value.

3-30
Portfolio (2)
 Solution: C
C is correct. Risk management is the process by which an organization or
individual defines the level of risk to be taken, measures the level of risk
being taken, and adjusts the latter toward the former, with the goal of
maximizing the company’s or portfolio’s value or the individual’s overall
satisfaction or utility.
A is incorrect. Risk management is actively understanding how to best
balance the achievement of goals with an acceptable chance of failure.
B is incorrect. Risk management is not about predicting risks.

4-30
Portfolio (3)
 The following table represents the history of an investment in a company:
Dividends Paid
Time Activity Price per Share
per Share
Beginning of Year 1 Purchase 20 shares €320  
End of Year 1 Purchase 10 shares €336 €5.00
End of Year 2 €350 €6.00
End of Year 3 Sell 30 shares €330 €0.00

All dividends received at the end of the period, and the investor does not reinvest the dividends
that he received. Assuming no taxes on dividends, the time-weighted rate of return will most
likely:
A. smaller than money-weighted rate of return.
B. greater than money-weighted rate of return.
C. same as money-weighted rate of return.
5-30
Portfolio (3)
 Solution: B.
  Year 1 Year 2 Year 3
Beginning Value 20 × €320 = €6,400 30 × €336 = €10,080 30 × €350 = €10,500

Ending Value 20 × €336 = €6,720 30 × €350 = €10,500 30 × €330 = €9,900

Dividend 20 × €5.00 = €100 30 × €6.00 = €180 30 × €0.00 = €0
Received

HPRYear 1 = (€6,720 – €6,400 + €100)/€6,400 = 6.56%

HPRYear 2 = (€10,500 – €10,080 + €180)/€10,080 =5.95%

HPRYear 3 = (€9,900 – €10,500)/€10,500 = – 5.71%

.
6-30
 Portfolio (3)
 Solution continued:
Then, calculate MWRR:
CFo= -6,400;
C01=-10*336+5*20=-3,260, F01=1;
C02=6*30=180, F02=1;
C03=330*30=9900, F03=1.
IRR (CPT)=MWRR=1.62%

TWRR (2.1%) > MWRR (1.62%)

7-30
Portfolio (4)
 A 35-year-old financial analyst expects to retire at the age of 65 and is
interested in investing to fund her retirement. She describes herself as being
financially astute with average risk tolerance. Which asset class is least likely
to be suitable for a majority allocation in her portfolio to meet her
retirement needs?
A. Long-term bonds
B. US Treasury bills
C. Exchange-listed equities

8-30
Portfolio (4)
 Solution: B.
B is correct. The investor has a 30-year time horizon and average risk tolerance, so
she is able to accept the additional risk associated with exchange-listed equities
and long-term bonds compared with US Treasury bills.
A is incorrect because the investor has a 30-year time horizon and average risk
tolerance, so she is able to accept the additional risk associated with long-term
bonds compared with US Treasury bills.
C is incorrect because the investor has a 30-year time horizon and average risk
tolerance, so she is able to accept the additional risk associated with exchange-
listed equities compared with US Treasury bills.
9-30
Portfolio (5)
 The relative strength index for a stock stands at 75. This reading is best
described as an indication that the stock is
A. neutral.
B. oversold.
C. overbought.

10-30
Portfolio (5)
 Solution: C.

C is correct. The relative strength index (RSI) is a momentum oscillator and provides

information on whether or not an asset is overbought or oversold. An RSI greater than 70

indicates that a stock is overbought; an RSI lower than 30 suggests that a stock is oversold.

A is incorrect. The relative strength index is a momentum oscillator and provides

information on whether or not an asset is overbought or oversold. An RSI greater than 70

indicates that a stock is overbought; an RSI lower than 30 suggests that a stock is oversold.

B is incorrect. The relative strength index is a momentum oscillator and provides

information on whether or not an asset is overbought or oversold. An RSI greater than 70

indicates that a stock is overbought; an RSI lower than 30 suggests that a stock is oversold.

11-30
Portfolio (6)
 For a portfolio consisting of two assets with a correlation coefficient of +1.0,
it is most likely that portfolio risk is:
A. equal to the weighted average of the risk of the two assets in the
portfolio.
B. less than the weighted average of the risk of the two assets in the
portfolio.
C. greater than the weighted average of the risk of the two assets in the
portfolio.

12-30
Portfolio (6)
 Solution: A.
A is correct. With a correlation coefficient of +1.0, no diversification benefits
are obtained and the portfolio risk is equal to the weighted average of the
risk of the two assets in the portfolio.
B is incorrect. Portfolio risk is less than the weighted average of the risk of
the two assets in the portfolio only when the correlation coefficient is
smaller than one.
C is incorrect. Portfolio risk can never be greater than the weighted average
of the risk of the two assets in the portfolio.

13-30
Portfolio (7)
 If Investor A has a lower risk aversion coefficient than Investor B, on the
capital allocation line, will Investor B’s optimal portfolio most likely have a
higher expected return?
A. Yes.
B. No, because Investor B has a higher risk tolerance.
C. No, because Investor B has a lower risk tolerance.

14-30
Portfolio (7)
 Solution: C.
C is correct. Investor B has a higher risk aversion coefficient, thus a lower
risk tolerance and a lower expected return on the capital allocation line.
A is incorrect. Investor A has a higher expected return on the capital
allocation line.
B is incorrect. Investor B has lower risk tolerance.

15-30
Portfolio (8)
 If a company has a one-day 5% Value at Risk of $1 million, this means:
A. 5% of the time the firm is expected to lose at least $1 million in one
day.
B. 95% of the time the firm is expected to lose at least $1 million in one
day.
C. 5% of the time the firm is expected to lose no more than $1 million in
one day.

16-30
Portfolio (8)
 Solution: A
The VaR measure indicates the probability of a loss of at least a certain level
in a time period.

17-30
Portfolio (9)
 An investment policy statement’s risk objective states that over a 12-month
period, with a probability of 95%, the client’s portfolio must not lose more
than 5% of its value. This statement is most likely a(n):
A. total risk objective.
B. relative risk objective.
C. absolute risk objective.

18-30
Portfolio (9)
 Solution: C
C is correct. The statement is an absolute risk objective because it expresses a
maximum
loss in value with an associated probability of loss.
A is incorrect because this is an absolute (not total) risk objective because it
expresses
a maximum loss in value with an associated probability of loss.
B is incorrect because this is an absolute (not relative) risk objective because it
expresses
a maximum loss in value with an associated probability of loss.
19-30
Portfolio (10)
 The point of tangency between the capital allocation line (CAL) and the
efficient frontier of risky assets most likely identifies the:
A. optimal risky portfolio.
B. optimal investor portfolio.
C. global minimum-variance portfolio.

20-30
Portfolio (10)
 Solution: A.
A is correct. The optimal risky portfolio lies at the point of tangency
between the capital allocation line and the efficient frontier of risky assets.
B is incorrect. The optimal investor portfolio lies at the point of tangency
between the investor’s indifference curve and the capital allocation line.
C is incorrect. The global minimum-variance portfolio is the left-most point
on the minimum-variance frontier.

21-30
Portfolio (11)
 Which of the following statements best describes a potential concern for
clients using robo-advisers? Robo-advisers:
A. must be established as registered investment advisers.
B. do not seem to incorporate the full range of investment information
into their recommendations.
C. are likely to be held to a similar code of conduct as other investment
professionals in the given region.

22-30
Portfolio (11)
 Solution: B
B is correct. Initial research has shown that robo-advisers do not seem to
incorporate the full range of investment information into their recommendations,
meaning that important points may be missing in investment decisions.
A is incorrect. It is an advantage to clients that robo-advisers must be registered
as investment advisers, because they are subject to guidance from the securities
regulator of their country.
C is incorrect. It is an advantage to clients that robo-advisers must be held to a
similar code of conduct as other investment professionals in the given region.

23-30
Portfolio (12)
 An investment has a 50% probability of returning 12% and a 50% probability

of returning 6%. An investor prefers this uncertain investment over a

guaranteed return of 10%. This preference most likely indicates that the

investor is risk:
A. seeking.
B. averse.
C. neutral.

24-30
Portfolio (12)
 Solution: A.
A is correct. The expected value of the uncertain investment is 9%, which
is less than the guaranteed return of 10%. Only a risk-seeking person
would be willing to accept this investment.
B is incorrect. A risk-averse person would prefer the guaranteed outcome
of 10%.
C is incorrect. A risk-neutral person would prefer the guaranteed outcome
of 10%.

25-30
Portfolio (13)
 Following its decision to divest its non-core assets, analysts expect HCL Corp’s
standard deviation of returns to rise to 30% and its correlation with the market
portfolio to remain unchanged at 0.8. The risk-free rate and the market risk
premium are expected to remain unchanged at 6% and 8%, respectively. The
market portfolio’s standard deviation of returns, however, is expected to
decrease to 15%. The firm’s expected return after the restructure is closest to:
A. 9.2%.
B. 17.6%.
C. 18.8%.

26-30
Portfolio (13)
 Solution: C.
C is correct. We first compute the firm’s beta using
The Beta is
The expected return is computed using
E(Ri) = Rf + [E(Rm) – Rf] x βi

So, E(Ri) = 0.06 + (0.08)x1.6 = 18.8%.

A is incorrect because the beta is incorrectly calculated as [(0.8 × 0.15)/0.30] = 0.4, resulting in
an expected return of 0.06 + (0.08)0.4 = 9.2%.
B is incorrect because the expected return is incorrectly calculated as 0.08 + (0.06)1.6 = 17.6%.

27-30
Portfolio (14)
 When a security that was in an upward trend falls 1% below its trendline, a
technical analyst will most likely determine that:
A. a downward trend is beginning.
B. the upward trend is ending.
C. the trendline needs an adjustment.

28-30
Portfolio (14)
 Solution: C.
C is correct. When a security’s price drops through the trendline by a significant amount
(at least 5% to 10%), this decline signals that the uptrend has ended and further decline
may follow. Minor breakthroughs simply call for the trendline to be moderately adjusted
over time. A security falling 1% below its trendline is considered a minor breakthrough.
A is incorrect. The amount the price falls below the trendline would need to be at least
5% before it would be considered a signal that the uptrend is ending and may signal a
further decline in price.
B is incorrect. The amount the price falls below the trendline would need to be at least
5% before it would be considered a signal that the uptrend is ending.

29-30