CFA 2018 level 3 schweser practice exam CFA 2018 level 3 question bank 32 a

CFA LEVEL-III, PRACTICE QUESTIONS (LOS # 31) Reading 31: (Monitoring and Rebalancing) | Solutions Question - #92369 Your answer: A was correct! Constant proportion strategies (CPPI) outperform when stock market reversals are not expected because as the market increases in value the CPPI investor will invest in a higher proportion of stocks in their portfolio The buy and hold investor will nothing and the proportion of stocks in their portfolio will increase but not as high as the actively managed CPPI portfolio The constant mix investor will have to shift out of stocks as the market increases to maintain a constant proportion of stocks as the market fluctuates If the market trends downward without reversing the CPPI investor will be the first one out of stocks as the market continues its downward slide This question tested from Session 16, Reading 31, LOS j Question - #92659 Your answer: B was correct! Changes in wealth, time horizon, and liquidity requirements all dictate the need to rebalance Taxes, laws, and regulations, as well as unique circumstances, also play into this decision.font> This question tested from Session 16, Reading 31, LOS c Question - #92396 Part 1) Your answer: B was incorrect The correct answer was A) a quote-driven market Order-driven markets not use intermediaries, as traders deal directly with each other Electronic crossing markets are a type of order-driven markets In brokered markets, the broker finds counterparties for each trade In a quote-driven market, market makers generally hold inventories of stocks for sale (Study Session 16, LOS 39.c) This question tested from Session 16, Reading 31 , LOS j Part 2) Your answer: B was incorrect The correct answer was C) Only constant mix A constant-mix rebalancing program would automatically adjust holdings to preset levels If stocks fell, the portfolio would rebalance by deploying cash to purchase stocks If the market fell to zero, the portfolio would theoretically fall to zero A buy and hold strategy would never fall below the value of the cash in the account, and a constant-proportion strategy would never fall below a preset floor value (Study Session 17, LOS 41.h, j) This question tested from Session 16, Reading 31, LOS j Part 3) Your answer: B was incorrect The correct answer was C) He did not get best execution From the information presented, we cannot tell whether Montone got best execution or not We have no other trading data for comparison purposes The other statements are accurate The spreads are small relative to the stock prices, suggesting a liquid market On one of the trades (Grossman Golf), the effective spread was higher than the quoted spread, suggesting that Montone had to purchase liquidity The effective spread for the other two trades was lower than the quoted spread, so Montone provided liquidity on those trades To calculate the effective spread on a purchase transaction, subtract the midpoint of the quoted spread from the execution price and multiply that number by two $8.53 – [($8.52 + $8.45)/2] = $0.045 Doubled, that’s $0.09 (Study Session 16, LOS 39.b) This question tested from Session 16, Reading 31, LOS j Part 4) Your answer: B was incorrect The correct answer was A) constant constant mix proportion Constant mix strategies continually rebalance a portfolio back to a target weight When stocks rise, a constant-mix program sells When stocks fall, the program rises If the market continues jumping up and down regularly, the strategy will result in a rising portfolio value Constant proportion strategies sell when stocks are down and buy when they’re up They outperform during strong upward or downward movements but get whipsawed by volatility in a trendless market A buy-and-hold portfolio’s value would ebb and flow, lagging constant mix in a volatile, trendless market and lagging constant proportion in a trending market (Study Session 17, LOS 41.h, j) This question tested from Session 16, Reading 31, LOS j Part 5) Your answer: B was incorrect The correct answer was C) Constant mix Constant mix assumes relative risk tolerance is constant regardless of the investor’s level of wealth Both constant proportion and buy and hold assume that both relative and absolute risk tolerance is related to wealth (Study Session 17, LOS 41.j) This question tested from Session 16, Reading 31, LOS j Part 6) Your answer: B was correct! To calculate the weighted average effective spread, we start with the effective spread for each transaction Effective spread = × (execution price – midpoint of quoted spread) Security Bid Price Ask Price Trading Price No of Shares Effective Spread Flanders Fudge $45.78 $45.96 $45.90 1,400 $0.06 Grossman Golf $8.45 $8.52 $8.53 600 $0.09 Hedger Health Care $115.67 $115.81 $115.79 150 $0.10 To calculate the weighted average spread, multiply the effective spread by the number of shares for each stock, then sum those numbers and divide by the number of shares, in this case, 2,150 The weighted average spread is $0.0712 (Study Session 16, LOS 39.C) This question tested from Session 16, Reading 31, LOS j Question - #93182 Your answer: B was correct! This is a cost of trading due to rebalancing This question tested from Session 16, Reading 31, LOS b Question - #93074 Your answer: B was correct! Woolaver is incorrect with respect to Responsibility The portfolio manager has a fiduciary duty to construct the portfolio to meet the needs of the client as specified in the investment policy statement Although seeking the maximum return per unit of risk is as admirable goal, the client’s goals with respect to risk tolerance, liquidity, legal considerations, or other factors may not be fully considered under Woolaver’s first statement Responsibility is correct The portfolio manager has a fiduciary duty to monitor the portfolio to be sure it continues to meet the client’s needs This means monitoring the client’s circumstances and capital market conditions, and making changes to the portfolio as necessary This question tested from Session 16, Reading 31, LOS a Question - #92037 Part 1) Your answer: B was incorrect The correct answer was C) convex CPPI has a convex payoff diagram A strategy that generates a convex payoff function is equivalent to buying portfolio insurance (like a protective put) Such strategies are suited for investors whose risk tolerance increases as asset values climb and decreases as asset values fall This question tested from Session 16, Reading 31, LOS j Part 2) Your answer: B was correct! When a market is either trending up or down (with low volatility), a CPPI strategy will outperform other strategies A CPPI strategy will provide increasing exposure to risky assets when asset values are increasing An investor will essentially hold an increasing amount of risky assets when their value is increasing On the other hand, investors following a CPPI strategy will be selling risky assets faster than others as markets decline This question tested from Session 16, Reading 31, LOS j Part 3) Your answer: B was incorrect The correct answer was A) Greater than The implication is that Allen’s firm made some important choices in the trending market This indicates a CPPI allocation strategy, and implies that an “m” greater than was chosen Apparently, Allen’s firm was able to increase exposure to equities quickly enough to take advantage of the upward trending market, and was able to decrease exposures quickly enough to protect its clients as markets trended downward This question tested from Session 16, Reading 31, LOS j Part 4) Your answer: B was incorrect The correct answer was C) buying the asset whose price falls; selling the asset whose price rises Rebalancing under a constant mix strategy requires buying the asset whose price falls and selling the asset whose price rises This produces a concave payoff diagram This question tested from Session 16, Reading 31, LOS j Question - #93107 Your answer: B was incorrect The correct answer was A) flat but oscillating market Constant mix strategies underperform when there are no reversals and outperform when there are updown oscillations This question tested from Session 16, Reading 31, LOS h Question - #91594 Part 1) Your answer: B was correct! Hass is selling Decker’s investments to raise cash, which makes him a liquidity-motivated trader Information-motivated traders must move fast before the value of their information declines Valuemotivated traders look for undervalued securities, and that rationale is not relevant here (Study Session 16, LOS 39.j) This question tested from Session 16, , LOS c Part 2) Your answer: B was incorrect The correct answer was C) is using a tolerance band of more than 3% The optimal corridor widths for the Decker portfolio are debatable But Hass’ strategy is not difficult to defend In a convex strategy, the manager buys stocks when they go up and sells them when they go down Hass is using a concave strategy, selling winners to buy back into losing positions However, we can tell that Hass is using a tolerance band of more than 3% Because he buys into positions down 4% from the target, his tolerance band is no less than 4% But because he did not sell the hedge fund, we can assume his tolerance band is more than 3%, because the hedge fund is up to 3% above the target allocation (Study Session 16, LOS 41.e, g, i) This question tested from Session 16, Reading 31, LOS c Part 3) Your answer: B was incorrect The correct answer was C) Constant proportion In markets trending either upward or downward, a constant-proportion strategy will outperform both constant mix and buy and hold (Study Session 16, LOS 40.h) This question tested from Session 16, Reading 31, LOS c Part 4) Your answer: B was correct! Most 72-year-olds should not have 70% of their money in equities But Decker is not like most investors He is quite wealthy, as we know from the fact that he founded a large business and that he has enough assets to qualify as a hedge-fund investor While money managers must listen to investors’ preferences, there is a limit as to how far fiduciary duty allows them to deviate from traditional investment wisdom, even Decker’s complaints should not drive an ethical manager to a 70% equity weighting While Decker is healthy, at 72 that can change quickly The best justification for a 70% equity position is Decker’s wealth, because he lives on only the stock dividends and obviously has little need for dipping into the principal As such, his wealth increases his risk tolerance Couple that with an attitude that reflects substantial personal tolerance for risk, and you have a candidate for an aggressive-growth portfolio, regardless of his age (Study Session 16, LOS 40.c) This question tested from Session 16, Reading 31, LOS c Part 5) Your answer: B was incorrect The correct answer was A) Constant mix Hass is using a constant-mix strategy with performance bands that prevent him from having to rebalance positions that have not moved that much Calendar rebalancing refers to rebalancing at a set date We know Hass doesn’t that because he just decided on the spur of the moment to rebalance A constant-proportion strategy requires the selling of stocks when they are down and the purchasing of stocks when they are up, which is the opposite of what Hass did (Study Session 16, LOS 40.h) This question tested from Session 16, Reading 31, LOS c Part 6) Your answer: B was incorrect The correct answer was A) no violation of Hass’s fiduciary duties Hass has discretionary control of the assets, but they are still the property of Decker If Decker wants to invest in a real-estate venture, Hass can try to talk him out of it, but he has no right to refuse to make the investment After all, it’s not his money If the investment would tilt Decker’s portfolio to the point that the asset allocation is unwise, Hass may have to make a tough choice and stop managing the account But this is not the case Given Decker’s obvious wealth and modest liquidity needs relative to the size of the portfolio, coupled with his expertise in the restaurant and real-estate businesses, the investments are not likely to put him in financial jeopardy Hass’s investment in the real-estate ventures looks unusual, but he is not trading based on insider information, and he did not violate a financial duty to Decker or to his firm, though he may have violated a company-specific trading policy if he is required to clear all investments with Conwell before making them (Study Session 16, LOS 40.a) This question tested from Session 16, Reading 31, LOS c Question - #92357 Your answer: B was incorrect The correct answer was A) Both of these responses are correct In each of these strategies, risk tolerance is zero when the value of assets drops below the floor Under buy and hold, the floor value is the original amount invested in T-bills This question tested from Session 16, Reading 31, LOS j Question 10 - #92824 Your answer: B was incorrect The correct answer was A) Trading provides liquidity to capital markets After costs, it has been shown that few portfolio managers add value through active management Studies have shown that more frequent rebalancing can increase portfolio returns, but only before costs After costs, increasing rebalancing frequency has a detrimental effect on returns This question tested from Session 16, Reading 31, LOS d Question 11 - #92399 Your answer: B was incorrect The correct answer was C) Constant mix Constant mix strategies outperform during stock market reversals This question tested from Session 16, Reading 31, LOS j Question 12 - #92323 Your answer: B was correct! With a constant mix strategy, stocks must be sold as the market rises in order to maintain the ratio of stock to total assets This question tested from Session 16, Reading 31, LOS h Question 13 - #92476 Your answer: B was incorrect The correct answer was A) performs much like a covered call position Constant mix performs best in flat, oscillating markets, much like a covered call strategy Constant mix has weak upside potential in that the strategy reduces exposure to risky assets in an increasing market This question tested from Session 16, Reading 31, LOS i Question 14 - #92613 Your answer: B was correct! Disciplined rebalancing prevents drifting of the asset mix with market variability Evidence suggests that market timing fails to add value This question tested from Session 16, Reading 31, LOS c Question 15 - #92453 Your answer: B was incorrect The correct answer was C) Constant mix In a flat but oscillating market, constant mix outperforms a comparable buy and hold strategy, which, in turn, outperforms a CPPI strategy This question tested from Session 16, Reading 31, LOS h Question 16 - #92875 Your answer: B was incorrect The correct answer was C) Strategies for which the slope of the exposure diagram is greater than one give rise to concave payoff diagrams An exposure diagram for an asset allocation strategy plots the desired stock position (y-axis) against the value of the portfolio (x-axis) Strategies with concave payoff diagrams (y-axis = portfolio value, x-axis = stock market value), such as the constant mix strategy, have exposure diagrams with slopes between zero and one This question tested from Session 16, , LOS i Question 17 - #92741 Your answer: B was incorrect The correct answer was C) $125,000 must be sold The initial portfolio consists of $2.5 million in cash plus $7.5 million in stock The initial stock-tototal value ratio can be expressed as 7.5/(2.5 + 7.5) = 0.75 After the increase in the value of the stock component of the portfolio, the stock-to-total value ratio is 8.0/(2.5 + 8.0) = 0.7619 The amount of stock that must be sold to lower this ratio to 0.75 is determined as follows: (8.0 − X)/(10.5) = 0.75, or X = $125,000 This question tested from Session 16, Reading 31, LOS h Question 18 - #92787 Your answer: B was incorrect The correct answer was A) A "constant mix" asset allocation strategy is also referred to as a "drifting mix." Constant mix is the same thing as disciplined rebalancing This question tested from Session 16, Reading 31, LOS c Question 19 - #92143 Your answer: B was correct! The general form of the factor model is: Ri = b1jR1 + bi2R2 + … + bijRj + εi, where Ri is the return for manager i, bi1, bi2, …, bij are manager i’s exposures to asset classes through j, and R1, R2,…, Rj are the returns on asset classes through j The last term, εi, is the manager’s return in excess of the exposure-weighted return on a portfolio of fully diversified asset class benchmarks Sellier’s portfolio return is: RSellier = 0.35(10.28) + 0.40(9.57) + 0.25(10.05) = 9.9385% The exposure-weighted return on the benchmark portfolios is: Rbenchmark = 0.35(9.78) + 0.40(8.37) + 0.25(10.20) = 9.3210% Thus, Sellier’s alpha (εi) is 9.9385 – 9.3210 = 0.6175% This implies that Sellier’s security selection ability earned her portfolio an extra 0.6175% This question tested from Session 16, Reading 31, LOS j Question 20 - #92512 Your answer: B was correct! Tax costs are the key costs associated with rebalancing a portfolio and are often underestimated Investors focus on brokerage commissions and forget trading costs such as market impact, trade execution inefficiencies and opportunity costs This question tested from Session 16, Reading 31, LOS d Question 21 - #92234 Your answer: B was correct! In a constant mix strategy an investor will hold stocks at all wealth levels A constant mix strategy requires the purchase of stocks as they fall and the selling of stocks as they rise, capitalizing on market reversals A constant mix strategy will generally underperform a comparable buy-and-hold strategy when there are no market reversals This question tested from Session 16, Reading 31, LOS j Question 22 - #92020 Your answer: B was incorrect The correct answer was A) Constant proportion portfolio insurance (CPPI) CPPI is the term used by Perold and Sharpe It is referred to as insured asset allocation and momentum based by Maginn and Tuttle CPPI is a momentum based strategy that aggressively increases exposure to risky assets in a rising market This question tested from Session 16, Reading 31, LOS h Question 23 - #93063 Your answer: B was correct! CPPI represents the purchase of portfolio insurance Constant mix performs best in flat, oscillating markets This question tested from Session 16, Reading 31, LOS i Question 24 - #92160 Your answer: B was incorrect The correct answer was C) sell stocks as prices fall and buy stocks as prices rise The constant mix strategy has a concave payoff diagram Because convex strategies sell stocks as prices fall and buy as prices rise, they perform poorly in flat, oscillating markets—selling on weakness only to see the market rebound, and buying on strength only to see the market fall This question tested from Session 16, Reading 31, LOS j Question 25 - #93084 Your answer: B was correct! The initial construction of an investor’s portfolio is based upon the client’s circumstances and longterm capital market expectations at the time of construction The reason why a fiduciary must monitor the portfolio is because both of these broad categories are subject to change Changes in the investor’s circumstances (risk tolerance, liquidity, establishment of a trust, or other factors) or changes in economic conditions or capital market expectations may necessitate changes to the client’s portfolio which should be carried out by the portfolio manager This question tested from Session 16, Reading 31, LOS a Question 26 - #92558 Your answer: B was incorrect The correct answer was A) Impact of trades on security prices Impact of trades on security prices represents a cost of rebalancing Changing time horizon may necessitate changes in asset mix New securities may allow asset allocation shifts with lower transaction costs or create more efficient portfolios This question tested from Session 16, Reading 31, LOS b Question 27 - #92311 Your answer: B was incorrect The correct answer was A) Malley is incorrect; Upshaw is correct Malley’s statement is incorrect Rebalancing the portfolio so that target weights are maintained (constant mix strategy) requires more or less constant trading and is likely to force the manager to provide liquidity which could result in poorly timed trades but generally supplying liquidity results in lower trading costs Note that requiring liquidity is selling when others in the market are also selling or buying when others are buying (resulting in higher bid-ask spreads) while providing liquidity is selling when others are buying or buying when others are selling, which may minimize trading costs Upshaw’s statement is correct – both rebalancing to maintain target portfolio weights or creating tolerance bands would require constant monitoring of the portfolio, although the tolerance band method is likely to result in less frequent trading This question tested from Session 16, Reading 31, LOS h Question 28 - #93283 Your answer: B was incorrect The correct answer was C) The constant mix portfolio will be worth $20.83 more than the buy-and-hold portfolio Buy and hold portfolio: After the 10% decrease in the market, the value of the stock in the buy-andhold portfolio is 0.9 x $7,500 = $6,750 Combined with the cash value of $2,500, the total value of the portfolio is $2,500 + $6,750 = $9,250 When the market returns to 1,000, an increase of 11.11% (100/900), the stock value is 1.111($6,750) = $7,500, and the total portfolio value returns to $10,000 = $2,500 + $7,500 Constant mix portfolio: After the 10% decrease in the market, the portfolio consists of $2,500 in cash and 0.9 x $7,500 = $6,750 in stock, for a total value of $9,250 This represents a stock/total asset ratio of 6,750/9,250 = 0.7297 To maintain the desired 0.75 stock/total asset mix, additional stock must be purchased The amount of stock that must be repurchased is determined as follows: ($6,750 + X)/$9,250 = 0.75, or X = $187.50 After the purchase of $187.50 in additional stock, the portfolio consists of stock valued at $6,937.50 = $6,750 + $187.50 and cash in the amount of $2,500 – $187.50 = $2,312.50 Following the 11.11% increase in the stock market, the constant mix portfolio value is equal to: $2,312.50 + 1.1111($6,937.50) = $10,020.83 Thus, the ending value of the constant mix portfolio is $20.83 greater than that of the buy-and-hold portfolio This demonstrates that a constant mix strategy outperforms a buy-and-hold strategy in a flat, oscillating market This question tested from Session 16, Reading 31, LOS h Question 29 - #92935 Your answer: B was correct! When an asset class is volatile and/or the rest of the assets are volatile, the tolerance corridor should be small to give the portfolio manager the ability to detect any violation in the allocation in the asset class and react quickly enough to avoid an even worse violation However, in this example the low trading volume and high bid-ask spread implies a large corridor When an asset class is illiquid and transactions costs are high, the corridor should be wider to try to avoid frequent trading This question tested from Session 16, Reading 31, LOS f Question 30 - #92368 Your answer: B was incorrect The correct answer was C) Portfolio C The key to this question is the rebalancing discipline employed Portfolio C is rebalanced to the precise target weights if the allocation strays from those weights, which would result in virtually constant analysis and trading, and thus higher trading costs Both of the others have certain thresholds or defined dates for rebalancing, which gives the portfolio more flexibility as to changes in allocation before any trades would take place This question tested from Session 16, Reading 31, LOS g Question 31 - #92268 Part 1) Your answer: B was incorrect The correct answer was C) Johnson Kent Portfolio C has the most invested in equity and alternative investments such as the hedge fund and the least invested in bonds thus it is most suited to someone who can tolerate more risk such as Kent who is only 26 years old Since Lerner is the oldest at 70 years old and still owns the copper mine he would not benefit from the private equity or real estate investments in portfolio B Also, private equity could have a long lock up period which would not be appropriate for an older person Since portfolio B has a higher concentration of long term bonds than portfolio A, portfolio B is more interest rate sensitive making it less appropriate than portfolio A for Lerner Johnson on the other hand is younger than Lerner and can therefore tolerate the longer lock up period of the private equity in portfolio B and greater interest rate sensitivity of the higher concentration of long term bonds in portfolio B (Study Session 16, LOS 40.j) This question tested from Session 16, Reading 31, LOS h Part 2) Your answer: B was correct! To calculate the targeted stock holding, multiply the stock multiplier by (total assets – portfolio floor) Total assets = $93,000 Portfolio floor = $70,000 Stock multiplier = The new stock holdings = × ($93,000 - $70,000) = $46,000 Current stock holdings are $57,350, so we must sell $11,350 in stocks to hit the target, which means that the bond holdings will rise by $11,350 (Study Session 16, LOS 40.h) This question tested from Session 16, Reading 31, LOS h Part 3) Your answer: B was correct! Traders who make moves for the purchase of reallocating assets or dealing with liquidity issues are called passive or liquidity-oriented traders Liquidity-oriented traders are more concerned with time than price, because they are willing to pay for liquidity when they need it Wallace is price-sensitive rather than time-sensitive, which classifies him as a passive trader (Study Session 16, LOS 39.j) This question tested from Session 16, , LOS h Part 4) Your answer: B was incorrect The correct answer was A) liquidity The portfolio does contain a fair amount of income-producing bonds, and the diversification of the portfolio could suggest some interest in limiting volatility and the effect of market downturns But the presence of real estate and private equity in the portfolio suggest the owner is not concerned about liquidity (Study Session 16, LOS 40.c, f) This question tested from Session 16, Reading 31, LOS h Part 5) Your answer: B was incorrect The correct answer was A) buy and hold A constant-mix strategy outperforms in a flat but oscillating market but underperforms in a trending market A constant-proportion strategy outperforms in a trending market but underperforms in a flat but oscillating market Buy and hold limits downside by keeping funds in cash or bonds, while it performs well in an upward-trending market and is roughly flat in an oscillating market If Nack doesn’t have any insight on where the market is going and wants to limit loss of principal, buy and hold is the best option of those offered, especially considering that her analysts are projecting either a flat or upward market, but not a downward market (Study Session 16, LOS 40.h) This question tested from Session 16, Reading 31, LOS h Part 6) Your answer: B was correct! At the time of the second rebalancing, the portfolio’s stock weighting is 68.11% Constant-mix rebalancing assumes the purchase or sale of stock sufficient to return the portfolio to its original weighting, in this case 65% 68.11% − 65% = 3.11% (Study Session 16, LOS 40.h, j) This question tested from Session 16, Reading 31, LOS h Question 32 - #92051 Part 1) Your answer: B was incorrect The correct answer was C) The tangential intersection between an investor's indifference curve and the efficient frontier An optimal portfolio is any set of assets that maximizes an investor’s utility, which is dictated by his indifference curve, with those assets yielding the highest returns at given risk levels, which are dictated by the efficient frontier The tangential intersection of indifference curves with the efficient frontier dictates an investor’s optimal portfolio This question tested from Session 16, Reading 31, LOS j Part 2) Your answer: B was incorrect The correct answer was A) Constant proportion portfolio insurance strategy When a market is either trending up or down with few oscillations, a constant proportion portfolio insurance (CPPI) strategy will outperform other strategies A CPPI strategy will provide increasing exposure to risky assets when asset values are increasing An investor will essentially hold an increasing amount of risky assets when their value is increasing On the other hand, in markets with a declining trend, investors following a CPPI strategy will be selling risky assets faster than others when markets are declining This question tested from Session 16, Reading 31, LOS j Part 3) Your answer: B was incorrect The correct answer was A) Greater than The implication is that Allen’s firm made some important choices in a trending market This indicates a constant proportion portfolio insurance (CPPI) allocation strategy, which requires that an “m” greater than be chosen Apparently, Allen’s firm was able to increase exposure to equities quickly enough to take advantage of a trending market and probably was able to decrease exposures quickly enough before markets may have trended downward This question tested from Session 16, Reading 31, LOS j Question 33 - #92254 Your answer: B was incorrect The correct answer was C) For constant proportion portfolio insurance (CPPI) strategies, the payoff curve is concave For CPPI strategies, the payoff curve is convex The other statements are true This question tested from Session 16, Reading 31, LOS i Question 34 - #92258 Your answer: B was incorrect The correct answer was C) Constant mix sells stocks as they fall and buys stocks as they rise A constant mix asset allocation strategy buys stocks as they fall and sells stocks as they rise Both of the other statements given are true This question tested from Session 16, Reading 31, LOS i Question 35 - #92306 Your answer: B was incorrect The correct answer was A) Calendar Percentage-of-Portfolio The two primary methods of rebalancing are calendar rebalancing and percentage-of-portfolio rebalancing – Monte Carlo is not a rebalancing method With calendar rebalancing, the portfolio is rebalancing on a predetermined date Since calendar rebalancing provides discipline without the need for constant monitoring, calendar rebalancing would be appropriate for Wilkins Percentage-ofportfolio rebalancing is triggered by changes in value rather than calendar dates Since Ortiz is most concerned about asset classes straying from a target allocation, Ortiz could use percentage of portfolio rebalancing to set a target corridor for each asset class and rebalance the portfolio when the portfolio’s asset allocation moves outside of the corridor This question tested from Session 16, Reading 31, LOS e Question 36 - #92079 Your answer: B was incorrect The correct answer was C) buy stocks as they fall in price Concave strategies buy stocks as they fall in price and not have much downside protection Constant mix strategies, not CPPI, are examples of concave strategies This question tested from Session 16, , LOS j Question 37 - #92915 Your answer: B was incorrect The correct answer was A) Riley’s statement is incorrect; Gray’s statement is incorrect Both Riley’s statement and Gray’s statement are incorrect Based on the criteria they have stated – they should be setting tight tolerance corridors for rebalancing purposes Riley said that her client has a low risk tolerance With a low risk tolerance, tolerance corridors should be smaller in order to detect corridor violations and take action to avoid an even worse violation If the portfolio is allowed to drift, riskier assets in the portfolio will tend to take over With volatile asset classes, Gray’s client should also have small tolerance corridors When an asset class is volatile and/or the rest of the assets are volatile, the tolerance corridor should be small to give the portfolio manager the ability to detect any violation in the allocation and react quickly to avoid an even worse violation This question tested from Session 16, Reading 31, LOS f Question 38 - #92745 Your answer: B was incorrect The correct answer was A) Negatively correlated asset classes need rebalancing more frequently than positively correlated asset classes Because the denominator and the numerator (the value of the individual asset class divided by the total value of the portfolio) both change in the same direction when asset classes (and securities) are positively correlated, the portfolio manager needs to rebalance less frequently However, negatively correlated assets require more rebalancing In this case the numerator and the denominator might change in opposite directions This question tested from Session 16, Reading 31, LOS d Question 39 - #91595 Your answer: B was incorrect The correct answer was C) Market timing strategies will tend to outperform constant mix strategies Market timing strategies have been shown to perform poorly relative to constant mix strategies The other statements are true This question tested from Session 16, Reading 31, LOS d Question 40 - #92954 Your answer: B was incorrect The correct answer was A) As stock prices rise, the stock to total assets ratio increases, so stocks should be purchased To maintain the constant mix, when stock prices rise, stocks must be sold This question tested from Session 16, Reading 31, LOS h Question 41 - #93031 Your answer: B was correct! Since the portfolio manager is in a position of trust, he has the fiduciary duty to construct the needs of the client as specified in the IPS and the duty to monitor the portfolio to be sure it continues to meet the client needs The monitoring process includes monitoring a client’s objectives and constraints as well as changes in market conditions Therefore, Item is a fiduciary duty not related to monitoring, while Items 1, 3, and address fiduciary duties related to monitoring Item is not necessarily true since a skilled manager could use tactical asset allocation to reduce risk and/or increase returns This question tested from Session 16, Reading 31, LOS a Question 42 - #92749 Your answer: B was incorrect The correct answer was C) Not rebalance her portfolio at this time Given the fact that Jill is in good health, is covered by the health plan and also has a healthy retirement portfolio, she should leave her allocation intact because since the retirement plan is not inflation indexed, she may need the growth potential of equities in the future This question tested from Session 16, Reading 31, LOS c Question 43 - #92497 Your answer: B was incorrect The correct answer was C) Interest expense Brokerage fees, spreads, trader timing costs, and opportunity costs are component costs of trading This question tested from Session 16, Reading 31, LOS d Question 44 - #91596 Your answer: B was correct! The liquidity needs of sending his children to school should take precedence over his retirement needs, which are already well funded This question tested from Session 16, Reading 31, LOS c Question 45 - #92290 Part 1) Your answer: B was correct! Considering the Jones are very close to retirement, the current equity portion of the portfolio should be reduced At 65%, it could be debated that equities are properly represented, but, considering the equity tendencies of high yield bonds, this pushes the allocation to 95% With no cash, liquidity will need to be increased to fund their living expenses This question tested from Session 16, Reading 31, LOS b Part 2) Your answer: B was incorrect The correct answer was A) Corporate bonds Considering the Jones are very close to retirement, the current equity portion of the portfolio should be reduced At 65%, it could be debated that equities are properly represented But, considering the equity tendencies of high yield bonds, this pushes the allocation to 95% With no cash, liquidity will need to be increased to fund their living expenses This question tested from Session 16, Reading 31, LOS b Part 3) Your answer: B was incorrect The correct answer was A) Portfolio D At 70%, it can be argued that the corporate bond allocation is too high However, based on the other alternatives, it is the best available Income from the bonds can be used for living expenses while the 5% cash allocation can provide for emergency expenses The equity component can facilitate the need to outpace inflation Portfolio A is underweighted in equities, portfolio B has too much invested in bonds, portfolio C is overweighted in equities at 60% if high yield bonds are viewed more as an equity than a bond Portfolio C is also underweighted in bonds at only 30% in corporate bonds with T-bills equaling the cash component This question tested from Session 16, Reading 31, LOS b Part 4) Your answer: A was incorrect The correct answer was C) Portfolio A With 35% cash, the expected return will be substantially lower than the other investment choices This question tested from Session 16, Reading 31, LOS b Question 46 - #92471 Your answer: A was incorrect The correct answer was B) Constant proportion portfolio insurance (CPPI) In a trending market, CPPI outperforms a comparable buy and hold, which, in turn, outperforms a constant mix strategy This question tested from Session 16, Reading 31, LOS h Question 47 - #92383 Your answer: B was incorrect The correct answer was C) will result in higher trading costs The key issue here is trading costs Rebalancing a portfolio to consistently maintain an asset class’s target portfolio weight requires more or less constant trading and the inability for the manager to time the trades Both of these factors mean that rebalancing to a target portfolio weight results in higher trading costs Note that the higher trading costs could increase the tracking error of the portfolio versus one that has allowable trading bands Also, even though trading costs would be reduced by having an allowable range for each asset class, the manager would still need to constantly monitor the portfolio to see if the asset classes are still within the allowable bands, so there is no discernable difference in the amount of monitoring on the part of the portfolio manager This question tested from Session 16, Reading 31, LOS g Question 48 - #92942 Your answer: B was incorrect The correct answer was C) agree with Croniser’s statement, but disagree with Hopkins’ statement Yazbeck should agree with Croniser’s statement A high degree of correlation between asset classes means that the assets will tend to move together For example, if interest rates rise, the prices of U.S Government and corporate bonds are likely to fall by similar amounts and thus are likely to stay within acceptable ranges High correlations between asset classes mean that they are likely to stay in range together even if corridors are small Conversely, assets that have zero or negative correlation will tend to move opposite one another, and thus are more likely to exceed corridor limits Yazbeck should disagree with Hopkins’ statement The more liquid an asset class is, the lower the transaction costs for trading that asset Since transaction costs are minimal for government bonds, a small corridor would not much to increase aggregate trading costs In contrast, an illiquid asset class (i.e private equity) would have high trading costs and should have a wider corridor to compensate This question tested from Session 16, Reading 31, LOS f Question 49 - #92014 Your answer: B was incorrect The correct answer was A) Constant mix assumes relative risk tolerance is directly related to wealth CPPI, not constant mix, assumes risk tolerance is directly related to wealth A constant mix strategy assumes that relative risk tolerance is constant regardless of wealth levels but that absolute risk tolerance is positively related to wealth For the constant mix investor as wealth increases they are exposed to a greater dollar amount of equities thus absolute risk tolerance has increased but the percent invested in equities has remained the same hence their relative risk tolerance has not changed This question tested from Session 16, Reading 31, LOS h Question 50 - #92243 Your answer: B was incorrect The correct answer was C) Severino is correct; Chalmers is correct Both Severino and Chalmers make correct statements With calendar rebalancing, the rebalancing process is related to the passage of time rather than the value of the portfolio In theory, a portfolio that is rebalanced using the calendar rebalancing method could stray considerably from the target asset allocation before the rebalancing date, but move closer to target on the rebalancing date, resulting in minor trades in the portfolio In the case of percentage-of-portfolio rebalancing, a tolerance band is set for each asset class in the portfolio, and the portfolio is rebalanced when it moves outside of the tolerance band Under the percentage-of-portfolio method, if the asset classes never stray outside of the tolerance levels, the portfolio will never have to be rebalanced This question tested from Session 16, Reading 31, LOS e Question 51 - #93037 Your answer: B was correct! Constant proportion is a convex strategy This question tested from Session 16, Reading 31, LOS h Question 52 - #92692 Your answer: B was incorrect The correct answer was C) A buy and hold strategy may not satisfy the current asset allocation needs of a client Buy and hold strategies “drift” over time Because of this, initial asset allocation decisions may not be evident in the resulting portfolio Disciplined rebalancing performs better than buy and hold strategies in a flat but oscillating market This question tested from Session 16, Reading 31, LOS d Question 53 - #92430 Your answer: B was incorrect The correct answer was C) Buy and hold This is the definition of a buy and hold strategy Constant mix strategies take a contrarian view of investing in order to maintain a constant asset allocation regardless of wealth levels CPPI is a momentum-based strategy that aggressively increases exposure to risky assets in a rising market This question tested from Session 16, Reading 31, LOS j Question 54 - #92267 Your answer: B was incorrect The correct answer was A) Insured asset allocation is similar to a constant mix-type asset allocation strategy An insured asset allocation is similar to a constant proportion portfolio insurance strategy This question tested from Session 16, Reading 31, LOS i Question 55 - #92244 Your answer: B was incorrect The correct answer was A) Constant mix The constant mix strategy takes a contrarian view of investing in order to maintain a constant asset allocation regardless of wealth levels Buy and hold strategies passively assume that risk tolerance is directly related to wealth levels The CPPI is a momentum-based strategy that aggressively increases exposure to risky assets in a rising market This question tested from Session 16, Reading 31, LOS j Question 56 - #93274 Your answer: B was incorrect The correct answer was A) Momentum-based rebalancing strategies outperform disciplined rebalancing strategies Disciplined rebalancing (e.g., maintaining a 60% stock / 40% bond mix) is superior to a momentumbased rebalancing strategy when the market is not following a sustained trend This question tested from Session 16, Reading 31, LOS h Question 57 - #92704 Your answer: B was incorrect The correct answer was A) outperforms buy and hold when stock market reversals occur Constant mix is a concave strategy This question tested from Session 16, Reading 31, LOS h Question 58 - #92991 Your answer: B was incorrect The correct answer was C) Percentage-ofCalendar rebalancing Unknown portfolio The primary benefit to calendar rebalancing is that it provides the discipline of rebalancing without the constant need to monitor the portfolio The result is that calendar rebalancing is the less time intensive rebalancing method Trading expense related to rebalancing is a result of where asset thresholds are set under the percentage-of-portfolio method, and also the volatility of the portfolio For a portfolio with low volatility and wide thresholds, calendar rebalancing would result in more frequent trading, while a volatile portfolio with tight thresholds would lead to more frequent trades under the percentage-ofportfolio method Therefore, the best method if trading expenses were the primary criteria is unknown The primary benefit of percentage-of-portfolio rebalancing is that it minimizes the degree to which asset classes can violate their allocation corridors, resulting in the most consistent asset allocation With calendar rebalancing, the portfolio allocation could vary widely in between rebalancing dates This question tested from Session 16, Reading 31, LOS e  ... Reading 31 , LOS i Question 35 - #9 230 6 Your answer: B was incorrect The correct answer was A) Calendar Percentage-of-Portfolio The two primary methods of rebalancing are calendar rebalancing and... Your answer: B was incorrect The correct answer was A) Insured asset allocation is similar to a constant mix-type asset allocation strategy An insured asset allocation is similar to a constant... market This indicates a CPPI allocation strategy, and implies that an “m” greater than was chosen Apparently, Allen’s firm was able to increase exposure to equities quickly enough to take advantage