CHAPTER 15—EQUITY PORTFOLIO MANAGEMENT STRATEGIES
TRUE/FALSE
1. Active equity portfolio management is a long-term buy-and-hold strategy.
2. A benchmark portfolio is defined as a passive portfolio whose average characteristics match the
client’s risk-return objectives.
3. The goal of a passive portfolio is to track the index as closely as possible.
4. An advantage of sampling is that portfolio returns will not track the index as closely as with full
replication.
5. An advantage of quadratic programming is that it relies on historical correlations.
6. Tracking error is defined as the degree to which the portfolio’s returns deviate from those of the actual
index.
7. Completeness funds are portfolios designed to complement active portfolios that do not cover the
entire market.
8. Following an earnings momentum strategy, an investor acquires stocks that have enjoyed
above-market stock price increases.
9. In backtesting, computers are used to examine the composition and returns of portfolios based on
historical data in order to determine if the investment strategy would have worked in the past.
10. Growth stocks consistently outperform value stocks.
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11. Style investing involves constructing portfolios in such a way to capture one or more of the
characteristics of equity securities.
12. It does not make economic sense for portfolio managers to try to “time” between different investment
styles.
13. The three basic techniques for constructing a passive index are: full replication, sampling and linear
programming.
14. With dollar-cost averaging a manager purchases fewer shares when stock prices are low and more
shares when stock prices are high.
15. Style identification allows an investor to select investment managers that allow his overall portfolio to
be properly diversified.
16. Style investing allows control of the total portfolio to be shared between investment managers and
pension fund managers.
17. Growth oriented investors focus on the price component of the Price/Earnings ratio.
18. Sharpe (1991) study reveals that active managers typically outperform passive managers even after
transaction costs and fees.
19. There is a direct relationship between a passive portfolio’s tracking error relative to its index and the
time and expense necessary to create and maintain the portfolio.
20. Exchange-Traded Funds (ETF) are depository receipts that give investors a pro rata claim on the
capital gains and cash flows of securities held by financial institutions.
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MULTIPLE CHOICE
1. Which of the following is not a technique for constructing a passive index portfolio?
a.
Full replication
b.
Sampling
c.
Quadratic programming
d.
Linear programming
e.
None of the above (that is, all are techniques for constructing a passive index portfolio)
2. Which of the following statements concerning active equity portfolio management strategies is true?
a.
The goal of active equity portfolio management is to earn a portfolio return that exceeds
the return of a passive benchmark portfolio (net of transaction costs) on a risk-adjusted
basis.
b.
An actively managed equity portfolio has lower total transaction costs.
c.
An actively managed equity portfolio has lower risk than the passive benchmark.
d.
A key to success for an actively managed equity portfolio is to maximize trading activity.
e.
All of the above.
3. In ____ strategy, certain economic sectors or industries are overweighted relative to the benchmark in
anticipation of the next phase of the business cycle.
a.
Sector rotation
b.
Price momentum
c.
Earnings momentum
d.
Return rotation
e.
None of the above
4. Which of the following is not considered an active management strategy?
a.
Sector rotation
b.
Use of factor models
c.
Quantitative screens
d.
Full replication
e.
Linear programming
5. Which of the following is not considered a mainstream investment style?
a.
Value
b.
Growth
c.
Market-oriented
d.
Benchmark
e.
Small-cap
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6. Which of the following is considered a strategy for timing the market and adding value to actively
managed portfolios?
a.
Time the markets by shifting between different types of securities based on market
forecasts and estimated risk premiums.
b.
Shift funds between the various equity sectors, industries, investment styles, etc., in order
to take advantage of the “hot” concept before the remainder of the market does.
c.
Individual stockpicking in order to buy low and sell high.
d.
Choices a and b only
e.
All of the above
7. Which of the following statements about investment style is false?
a.
Growth stocks generally have smaller capitalizations than value stocks.
b.
Value stocks have P/E and P/B ratios significantly lower than those of growth stocks.
c.
Value stocks dividend yields are much higher than those of growth stocks.
d.
Growth and levels of earnings is higher in growth stocks.
e.
Value stocks have a higher risk premium.
8. Which of the following statements is false?
a.
A manager’s choice to align with an investment style communicates information to clients
about the investor’s focus, area of expertise, and stock evaluation methods.
b.
An investment manager’s style cannot be used as a basis for measuring the manager’s
performance relative to a benchmark.
c.
Style identification allows an investor to select investment managers that allow his overall
portfolio to be properly diversified.
d.
Style investing allows control of the total portfolio to be shared between the investment
managers and a knowledgeable sponsor.
e.
None of the above (all are true statements)
9. Which of the following is not considered an asset allocation strategy?
a.
Integrated asset allocation
b.
Strategic asset allocation
c.
Tactical asset allocation
d.
Insured asset allocation
e.
None of the above (that is, all are asset allocation strategies)
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10. In ____ asset allocation, the investor’s risk tolerance and constraints are assumed to be constant over
time. However, changes in capital market conditions result in changes in the portfolio’s stock-bond
mix.
a.
Integrated
b.
Strategic
c.
Tactical
d.
Insured
e.
None of the above.
11. ____ is a strategy used because the market seems to reward companies that have steady, above average
earnings growth, or whose prices are rising because of market optimism.
a.
Relative strength
b.
Asset momentum
c.
Rotational attribution
d.
All of the above.
e.
None of the above.
12. The asset allocation strategy that separately examines capital market conditions and the investor’s
objectives and constraints is called
a.
Integrated asset allocation.
b.
Tactical asset allocation.
c.
Sector rotation.
d.
Strategic asset allocation.
e.
Insured asset allocation.
13. In equity portfolio management, tracking error occurs when
a.
The managed portfolio outperforms the benchmark portfolio.
b.
The managed portfolio under performs the benchmark portfolio.
c.
The return volatility of the managed portfolio is positively correlated with the return
volatility of the benchmark portfolio.
d.
The return volatility of the managed portfolio is negatively correlated with the return
volatility of the benchmark portfolio.
e.
The return volatility of the managed portfolio is not correlated with the return volatility of
the benchmark portfolio.
14. The following are ways to implement index portfolio investing
a.
Buying shares in index mutual funds
b.
Buying hedge funds.
c.
Buying exchange traded funds
d.
Choices a and b.
e.
Choices a and c.
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15. Exchange traded funds
a.
Are exactly the same as index mutual funds
b.
Can be bought and sold like common stocks
c.
Can be sold short.
d.
Choices a and b.
e.
Choices b and c.
16. A portfolio management strategy that overweights a particular industry, relative to the benchmark
portfolio, based on the next expected phase of the business cycle is called
a.
Tactical asset allocation.
b.
Indexing.
c.
Sector rotation.
d.
Contrarian investing.
e.
Bottom up investing.
17. The following are examples of a fundamental active equity portfolio management strategy.
a.
Contrarian investing.
b.
Earnings momentum investing.
c.
Low P/E and low P/BV investing.
d.
Bottom up investing.
e.
Investing on the basis of calendar effects.
18. A fundamental tenet of the contrarian investment strategy is the notion that
a.
All stock returns are mean reverting.
b.
Certain stocks outperform others during different stages of the business cycle.
c.
Value stock investing is superior to growth stock investing.
d.
Growth stock investing is superior to value stock investing.
e.
None of the above.
19. Value stocks would have the following characteristics
a.
Low price/book, high price/earnings.
b.
Low price/book, low price/earnings.
c.
High EPS growth, high profitability.
d.
Low EPS growth, high profitability.
e.
None of the above.
20. Growth stocks would have the following characteristics
a.
Low price/book, high price/earnings.
b.
Low price/book, low price/earnings.
c.
High EPS growth, high profitability.
d.
Low EPS growth, high profitability.
e.
None of the above.
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21. In returns-based style analysis a coefficient of determination of 95% would suggest that
a.
The portfolio manager outperformed 95% of his peers.
b.
The portfolio manager was outperformed by 95% of his peers.
c.
95% of the portfolio return variability could be attributed to portfolio style.
d.
95% of the portfolio return variability could be attributed to stock selection skills.
e.
5% of the portfolio return variability could be attributed to portfolio style.
22. A Long futures positions in the S&P500 has the effect of ____ portfolio exposure to equities, while
short futures positions in the S&P500 has the effect of ____ portfolio exposure to equities.
a.
Increasing, decreasing.
b.
Decreasing, increasing,
c.
Increasing, increasing.
d.
Decreasing, decreasing.
e.
None of the above.
23. A contrarian investment strategy is based on the belief that
a.
Stock returns are mean reverting.
b.
The best time to buy is when other investors are bullish.
c.
Rising stocks will continue to rise.
d.
Passive management is preferred to active management.
e.
A long/short portfolio will outperform a long only portfolio.
24. Which of the following statements regarding 130/30 strategies is false?
a.
Analyst can make full use of their knowledge of undervalued and overvalued stocks.
b.
Long positions up to 130% of the value of the portfolio cab be made.
c.
Short positions up to 30% of the value of the portfolio can be made.
d.
130/30 strategies are not very popular due to the increased risk of hedging.
e.
The use of short positions creates leverage.
25. Which of the following statements regarding momentum strategies is true?
a.
Price momentum is a fundamental strategy.
b.
Earnings momentum is a technical strategy.
c.
Price momentum and earnings momentum strategies will often result in identical portfolio
strategies and holdings.
d.
The earnings momentum investor will most likely acquire stocks for companies that have
positive earnings surprises.
e.
All of the above statements are true
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26. An investor focusing on a growth strategy does all of the following except:
a.
Focuses on the earnings per share (EPS) component on the P/E ratio
b.
Seek out investments with higher expected growth in earnings.
c.
Implicitly assume that the P/E ratio will grow over the near term.
d.
Focuses on the current and future economic “story” of a company.
e.
All of the above statements are true.
27. If you have a portfolio with a market value of $100 million and a beta (measured against the S&P 500)
of 1.5, then if the market rises by 10%, what value would you expect your portfolio to have?
a.
$100 million
b.
$110 million
c.
$150 million
d.
$165 million
e.
$1.65 billion
28. If the annual geometric mean for the equity risk premium is 8.4%, what percentage of the equity risk
premium is consumed by trading costs of 1.2%?
a.
7.20%
b.
9.60%
c.
9.70%
d.
10.08%
e.
14.29%
29. The table below provides returns on a portfolio along with returns for the corresponding benchmark
index for the past eight quarters. The table also provides the difference between portfolio returns and
the benchmark index, the average of these differences over the past eight quarters and the standard
deviation of these differences.
Period
Portfolio
Index
Difference
1
0.05
0.027
0.023
2
−0.036
−0.046
0.010
3
0.022
0.019
0.003
4
0.012
0.022
−0.010
5
−0.003
−0.001
−0.002
6
−0.023
−0.03
0.007
7
0.089
0.081
0.008
8
−0.008
0.006
−0.014
Average
0.003
SD
0.011789
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The annualized tracking error for this period is
a.
2.36%
b.
4.08%
c.
2.89%
d.
3.33%
e.
1.18%
Exhibit 15-1
USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT QUESTION(S)
A portfolio manager is trying to establish a strategic asset allocation for two different clients, Bob
Bowman and Tom Luck. Bob Bowman has a risk tolerance factor of 22 and Tom Luck has a risk
tolerance factor of 6. The characteristics of the three model portfolios under consideration are provided
in the table below.
Asset Mix
Portfolio
Stock
Bond
Expected
Return
Variance
A
0.75
0.25
0.12
0.45
B
0.4
0.6
0.08
0.16
C
0.3
0.7
0.05
0.06
30. Refer to Exhibit 15-1. The expected utilities of Portfolios A, B and C for Bob Bowman are
a.
Portfolio A = 9.95, Portfolio B = 7.27, Portfolio C = 4.73
b.
Portfolio A = 4.5, Portfolio B = 5.33, Portfolio C = 4.0
c.
Portfolio A = 7.95, Portfolio B = 5.33, Portfolio C = 4.73
d.
Portfolio A = 3.5, Portfolio B = 7.27, Portfolio C = 4.73
e.
Portfolio A = 5.33, Portfolio B = 7.27, Portfolio C = 4.73
Bowman
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31. Refer to Exhibit 15-1. The expected utilities of Portfolios A, B and C for Tom Luck are
a.
Portfolio A = 9.95, Portfolio B = 7.27, Portfolio C = 4.73
b.
Portfolio A = 4.5, Portfolio B = 5.33, Portfolio C = 4.0
c.
Portfolio A = 7.95, Portfolio B = 5.33, Portfolio C = 4.73
d.
Portfolio A = 3.5, Portfolio B = 7.27, Portfolio C = 4.73
e.
Portfolio A = 5.33, Portfolio B = 7.27, Portfolio C = 6.75
32. Refer to Exhibit 15-1. The recommended portfolio for Bob Bowman is
a.
Portfolio A because it has expected utility of 9.95
b.
Portfolio A because it has expected utility of 4.5
c.
Portfolio B because it has expected utility of 5.33
d.
Portfolio B because it has expected utility of 7.27
e.
Portfolio C because it has expected utility of 6.75
33. Refer to Exhibit 15-1. The recommended portfolio for Tom Luck is
a.
Portfolio A because it has expected utility of 9.95
b.
Portfolio A because it has expected utility of 4.5
c.
Portfolio B because it has expected utility of 5.33
d.
Portfolio B because it has expected utility of 7.27
e.
Portfolio C because it has expected utility of 6.75
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34. An active portfolio manager sold $90 million of stocks in a year. If the portfolio had an average value
of $110 million in assets under management, what is the portfolio turnover ratio?
a.
22.2%
b.
81.8%
c.
90.0%
d.
110.0%
e.
122.2%