Solutions for Chapter 15: Questions and Problems
CHAPTER 15
EQUITY PORTFOLIO MANAGEMENT STRATEGIES
Answers to Questions
1. Passive portfolio management strategies have grown in popularity because investors are
2. Numerous studies have shown that the majority of portfolio managers have been unable
to match the risk-return performance of stock or bond indexes. Following an indexing
portfolio strategy, the portfolio manager builds a portfolio that matches the performance
3. There are a number of active management strategies discussed in the book including
sector rotation, the use of factor models, quantitative screens, and linear programming
methods.
Following a sector rotation strategy, the manager over-weights certain economic sectors,
industries or other stock attributes in anticipation of an upcoming economic period or the
Solutions for Chapter 15: Questions and Problems
4. Three basic techniques exist for constructing a passive portfolio: (1) full replication of an
index, in which all securities in the index are purchased proportionally to their weight in
5. Managers attempt to add value to their portfolio by: (1) timing their investments in the
6. The job of an active portfolio manager is not easy. In order to succeed, the manager
should maintain his/her investment philosophy, “don’t panic.” Since the transaction costs
7. The four asset allocation strategies are: (1) integrated asset allocation strategy, which
separately examines capital market conditions and the investor’s objectives and
constraints to establish a portfolio mix; (2) strategic asset allocation strategy, which
8. A price momentum strategy is based on the assumption that a stock’s recent price
behaviour will continue to hold. Thus an investor would buy a stock whose price has
recently been rising, and sell (or short) a stock whose price has been falling.
Solutions for Chapter 15: Questions and Problems
9. There are tradeoffs between using the full replication and the sampling method. Fully
10. The portfolio manager could emphasize or overweight, relative to the benchmark,
investments in natural resource stocks. The portfolio manager could also purchase options
Jun
-0.8
-0.5
-0.30
0.2
-0.20
Aug
1.5
1.6
-0.10
Nov
2.4
2
0.40
Solutions for Chapter 15: Questions and Problems
– 125 –
CHAPTER 15
Answers to Problems
1. Using a spreadsheet and its functions we obtain the following values:
R2 : 0.98
alpha or intercept term: 0.08
Portfolio S&P 500 [Ri – E(Ri)] x
2(a). Portfolio turnover is the dollar value of securities sold in a year divided by the average
value of the assets:
Fund W: 37.2/289.4 = .1285 or 12.85%
Portfolio
Return
S&P
Return
Difference
in Returns
Jan
5.0
5.2
R2
0.9834
-0.20
Feb
-2.3
-3
0.70
Mar
-1.8
-1.6
Intercept
0.0822
-0.20
Apr
2.2
1.9
Slope
0.9571
0.30
Solutions for Chapter 15: Questions and Problems
– 126 –
(c) The tax cost ratio is compute as [1 – (1 + TAR)/(1+PTR)] × 100 where TAR represents
tax-adjusted return and PTR is the pre-tax return. Our calculations are as follows:
(d) The tax cost ratio represents the percentage of an investor’s assets that are lost to taxes
3(a). EUpk = ERp – (p2/RTk)
Portfolios Ms. A Mr. B
1 8 – (5/8) = 7.38 8 – (5/27) = 7.81
3(b). The optimal portfolio is the one with the highest expected utility. Thus, portfolio 3
represents the optimal strategic allocation for Ms. A, while Portfolio 4 is the optimal
allocation for Mr. B. Since Mr. B has a higher risk tolerance, he is able to pursue more
volatile portfolios with higher expected returns.
3(c). For Ms. A: Portfolio 1 = Portfolio 2
8 – (5/RT) = 9 – (10/RT)
RT = 5
In other words, a risk tolerance factor of 5 would leave Ms. A indifferent between having
4
0.80%
2.90%
-0.50%
1.30%
3.40%
5
-7.90%
-5.90%
-3.90%
-4.00%
-2.00%
6
23.20%
26.30%
21.70%
1.50%
4.60%
7
-10.40%
-11.20%
-13.20%
2.80%
2.00%
8
5.60%
5.50%
5.30%
0.30%
0.20%
9
2.30%
4.20%
2.40%
-0.10%
1.80%
10
19.00%
18.80%
19.70%
-0.70%
-0.90%
Solutions for Chapter 15: Questions and Problems
– 127 –
Period
Manager
A
Manager
B
Index
A minus
Index
B minus
Index
1
12.80%
13.90%
11.80%
1.00%
2.10%
2
-2.10%
-4.20%
-2.20%
0.10%
-2.00%
3
15.60%
13.50%
18.90%
-3.30%
-5.40%
Average
5.89%
6.38%
6.00%
-0.11%
0.38%
Std Dev
11.41%
11.77%
11.66%
2.11%
3.00%
Paired t-
0.872825
0.697977
t-statistic
-0.16469
0.400714
statistic
t-test
t-test,
0.983224
0.942993
difference
0.872825
0.697977
same var
from zero