1.2 Portfolio Theroy

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1.2 Portfolio Theroy

Question 1

Assume the expected return on stocks is $18\%$ (represented by Z in the figure), and the expected return on bond is $8\%$ (represented by point Y on the graph).

在这里插入图片描述

The graph shows the portfolio possibilities curve for stocks and bonds. The point on the graph that most likely represents a $90\%$ allocation in stocks and a $10\%$ allocation in bonds is Portfolio:

A. W
B. X
C. Y
D. Z

Answer: A
Since the return to W is the nearest to Z (stocks), it is logical to assume that point W represents an allocation of $90\%$ stocks $10\%$ bonds. The return for W is lower than Z, but it also represents a reduction in risk.

Question 2

Base on the information given in Question 1, the efficient frontier consists of the portfolios between and including:

A. X and W
B. Y and Z
C. X and Z
D. Y and X

Answer: C
The efficient frontier consists of portfolios that have the maximum expected return for any given level of risk (standard deviation or variance).

The efficient frontier starts at the global minimum-variance portfolio and continues above it. Any portfolio below the efficient frontier is dominated by a portfolio on the efficient frontier. This is because efficient portfolios have higher expected returns for the same level of risk.

Question 3

The market portfolio (M) contains the optimal allocation of only risky asset and no risky assets. Let the $S_1$ be the Sharpe ratio of this market portfolio. There exists a risk-free asset. Initially, an investor is fully ( $100\%$ ) invested in M with a portfolio Sharpe ratio of $S_1$ . Subsequently, the investor borrows $30\%$ at the risk-free rate, such that she is $130\%$ invested in the market portfolio (M) where this leverage portfolio has a Sharpe ratio of $S_2$ . After the leverage (i.e., borrowing at the risk-free rate to invest $+30\%$ in M, is the investor still on the efficient frontier and how do the Sharpe ratios?

A. No (no longer efficient), and $S_2 < S_1$ .
B. No, but $S_2 = S_1$ .
C. Yes (still efficient), but $S_2 < S_1$ .
D. Yes and $S_2 = S_1$ .

Answer: D
The ability to borrowing or lend morphs the concave/convex efficient frontier into the linear CML; i.e., the leveraged portfalio is efficient with higher risk and higher return.
All portfolios on the CML have the same Sharpe ratio: the slope of the CML.

Question 4

The efficient frontier is defined by the set of portfolios that, for each volatility level, maximizes the expected return. According to the capital asset pricing model (CAPM), which of the following statements are correct with respect to the efficient frontier?

i. The capital market line is the straight fine connecting the risk-free asset with the zero beta minimum variance portfolio.
ii. The capital market line always has a positive slope and its steepness depends on the market risk premium and the volatility of the market portfolio.
iii. The complete efficient frontier without a risk-free asset can be obtained by combining the minimum variance portfolio and the market portfolio.
iv. The efficient frontier allows different individuals to have different portfolios of risky assets based upon their own risk aversion and forecast for asset returns.
v. The efficient frontier assumes no transaction costs, no taxes, a common investment horizon for all investors, and that the return distribution has no skewness.

A. ii, iii and v
B. i, ii and iii
C. i, iv and v
D. ii, iii and iv

Answer: A
Within modern portfolio theory (MPT), the efficient frontier is a combination of assets that has the best possible expected level of return for its level of risk.

The efficient frontier is the positively sloped portion of the opportunity set that offers the highest expected return for a given risk level. The efficient frontier is at the top of the feasible set of portfolio combinations. ii, iii and v are correct statements.

The capital market line connects the risk-free asset and the market portfolio. The efficient frontier does allow investors to have different risk aversions, but assumes that they all have the same forecast for asset returns.

Question 5

PE2018Q93 / PE2019Q93 / PE2020Q93 / PE2021Q93 / PE2022Q93
The efficient frontier is defined by the set of portfolios that, for each volatility level, maximizes the expected return. According to the CAPM, which of the following statements is correct with respect to the efficient frontier?

A. The capital market line always has a positive slope and its steepness depends on the market risk premium and the volatility of the market portfolio.
B. The capital market line is the straight line connecting the risk-free asset with the zero beta minimum variance portfolio.
C. Investors with the lowest risk aversion will typically hold the portfolio of risky assets that has the lowest standard deviation on the efficient frontier.
D. The efficient frontier allows different individuals to have different portfolios of risky assets based upon their individual forecasts for asset returns.

Answer: A
Learning Objective:

Understand the derivation and components of the CAPM.
Interpret and compare the capital market line and the security market line.

The capital market line connects the risk-free asset with the market portfolio, which is the efficient portfolio at which the capital market line is tangent to the efficient frontier. The equation of the capital market line is as follows:

$\overline{R_p}=R_f+(\frac{\overline{R_m}-R_f}{\sigma_m})\sigma_p$

where the subscript $p$ denotes an efficient portfolio. Since the shape of the efficient frontier is dictated by the market risk premium, ${R_M}-R_F$ , and the volatility of the market, the slope of the capital market line will also be dependent on these two factors.

B is incorrect. As said in A above, the capital market line connects the risk-free asset with the market portfolio (which by definition has a beta of $1$ ).

C is incorrect. The implication of the CML is that all investors should allocate to two investments: the risk-free asset and the market portfolio. Investors with little tolerance for risk will allocate most of their funds to the risk-free asset.

D is incorrect. One of the crucial assumptions for the derivation of CAPM is that all market participants have the same expectations, and therefore have the same forecast for asset returns. Additionally, as mentioned above, all investors hold the same portfolio of risky assets, which is the market portfolio.

Question 6

PE2019Q98 / PE2020Q98 / PE2021Q98
A risk consultant is advising a pension fund to revise its asset allocation approach to be more consistent with the theory of CAPM. The consultant prepares a list of the assumptions of CAPM to support the advice. Which of the following is an assumption of CAPM?

A. There are transaction costs associated with buying and selling assets.
B. An individual investor can affect the price of a stock by buying or selling stocks.
C. Investors should consider their personal income taxes in making investment decisions.
D. Investors have the same expectations regarding expected returns, the variance of returns, and the correlation structure between all pairs of stocks.

Answer: D
Learning Objective: Describe the assumptions underlying the CAPM.

CAPM assumptions

Access to information for all market participants, meaning that all information is freely available and instantly absorbed.
No transaction cost, taxes, or other frictions
Allocations can be made in an investment of any partial amount (i.e., perfect divisibility).
All participants can borrow and lend at a common risk-free rate
Any individual investor’s allocation decision cannot change the market prices.
Market equilibrium is achieved when all investors hold portfolios consisting of the riskless asset and market portfolio.

Question 7

Which of the following statements about portfolio risk and diversification is least accurate?

A. Not all risk is diversifiable.
B. Unsystematic risk can be substantially reduced by diversification.
C. Systematic risk can be eliminated by holding securities in a well diversified international stock portfolio.
D. None of above.

Answer: C
Systematic risk cannot be eliminated by diversification. Unsystematic risk can be reduced by diversification. Diversification benefits will occur any time security returns have less than perfect positive correlations.

Question 8

PE2018Q94 / PE2019Q94 / PE2020Q94 / PE2022PSQ13 / PE2021Q94 / PE2022Q94
Suppose that the correlation of the return of a portfolio with the return of its benchmark is $0.8$ , the volatility of the return of the portfolio is $5\%$ , and the volatility of the return of the benchmark is $4\%$ . What is the beta of the portfolio with respect to its benchmark?

A. $1.00$
B. $0.80$
C. $0.64$
D. $- 1.00$

Answer: A
Learning Objective: Understand the derivation and components of the CAPM.

The following equation is used to calculate beta:
$\beta=\rho\times\cfrac{\sigma_P}{\sigma_B}=0.8\times\cfrac{0.05}{0.04}=1$

Question 9

A manufacturing company has identified several growth opportunities and is seeking to raise capital in order to expand. The company currently has the following metrics:

Total debt: USD $100$ million
Total equity: USD $100$ million
Debt to equity ratio: $1$
Levered equity beta: $1.75$
Current effective tax rate: $25\%$

Management has submitted a proposal to issue additional debt in the amount of USD $100$ million to pursue these opportunities. This strategy would also result in the company’s effective tax rate decreasing from $25\%$ to $15\%$ . Assuming there are no changes to the company’s unlevered asset beta or the market value of the company’s equity, the resulting levered equity beta would be within which of the following ranges?

A. $0.75$ and $1.75$
B. $1.75$ and $2.50$
C. $2.50$ and $3.25$
D. $3.25$ and $4.00$

Question 10

PE2018Q98
According to the Capital Asset Pricing Model (CAPM), over a single time period, investors seek to maximize their:

A. Wealth and are concerned about the tails of return distributions.
B. Wealth and are not concerned about the tails of return distributions.
C. Expected utility and are concerned about the tails of return distributions.
D. Expected utility and are not concerned about the tails of return distributions.

Answer: D
Learning Objective: Describe the assumptions underlying the CAPM.

CAPM assumes investors seek to maximize the expected utility of their wealth at the end of the period, and that when choosing their portfolios, investors only consider the first two moments of return distribution: the expected return and the variance. Hence, investors are not concerned
with the tails of the return distribution.

Question 11

Patricia Franklin makes buy and sell stock recommendations using the capital asset pricing model. Franklin has derived the following information for the broad market and for the stock of the CostSave Company (CS):

Expected market risk premium $8\%$
Risk-free rate $5\%$
Historical beta for CostSave $1.50$

Franklin believes that historical betas do not provide good forecasts of future beta, and therefore uses the following formula to forecast beta:

$\text{Forecasted\;beta} = 0.80 + 0.20\times{\text{Historical\;beta}}$

After conducting a thorough examination of market trends and the CS financial statements, Franklin predicts that the CS return will equal $10\%$ . Franklin should derive the following required return for CS along with the following valuation decision (undervalued or overvalued):

	Valuation	CAPM required return
A.	overvalued	$8.3\%$
B.	overvalued	$13.8\%$
C.	undervalued	$8.3\%$
D.	undervalued	$13.8\%$

Answer: B
The CAPM equation is: $E(R_i)=R_p +\beta_i[E(R_M)-R_F]$

Franklin forecasts the beta for CostSave as follows: $0.20\times1.50 = 1.10$

The CAPM required return for CostSave is: $1.1\times0.08 = 13. 8\%$
Note that the market premium, $E(R_M) - R_F$ , is provided in the question ( $8\%$ ).

Franklin should decide that the stock is overvalued because she forecasts that the CostSave return will equal only $10\%$ , whereas the required return (minimum acceptable return) is $13.8\%$ .

Question 12

PE2018Q48 / PE2019Q48 / PE2020Q48 / PE2021Q48 / PE2022Q48
An investment advisor is analyzing the range of potential expected returns of a new fund designed to replicate the directional moves of the Straits Times Index (STI) but with twice the volatility of the index. STI has an expected annual return of $8.4\%$ and a volatility of $16.0\%$ , and the risk free rate is $2.0\%$ per year. Assuming the correlation between the fund’s returns and that of the index is $1$ , what is the expected return of the fund using the CAPM?

A. $14.8\%$
B. $19.0\%$
C. $22.1\%$
D. $24.6\%$

Answer: A
Learning Objective: Apply the CAPM in calculating the expected return on an asset.

If the CAPM holds, then $R_i= R_f+\beta_i(R_m-R_f)$ .

Beta ( $β_i$ ), which determines how much the return of the fund fluctuates in relation to the index return is expressed as follows:

$\beta_i=\cfrac{Cov(R_i,R_m)}{\sigma_m^2}=\cfrac{\rho\times\sigma_i}{\sigma_m}$

Where $i$ and $m$ denote the new fund and the index, respectively, and $R_i$ is the expected return on the fund, $R_m$ is the expected return on the index, $R_f$ is the risk-free rate, $\sigma_i$ is the volatility of the fund, $\sigma_m$ is the volatility of the index.

If the new fund has twice the volatility of the index, then $\sigma_i=2\sigma_m$ , and given that $\rho= 1$ , the beta of the new fund then becomes: $\beta_i=\cfrac{1\times2\sigma_m}{\sigma_m}=2$

Therefore, using CAPM, $R_i = R_f+\beta_i\times(R_m-R_f) = 14.8\%$

Question 13

PE2018Q23 / PE2019Q23 / PE2020Q23/ PE2021Q23 / PE2022PSQ3 / PE2022Q23
Suppose the S&P 500 Index has an expected annual return of $7.2\%$ and volatility of $8.2\%$ . Suppose the Andromeda Fund has an expected annual return of $6.8\%$ and volatility of $7.0\%$ and is benchmarked against the S&P 500 Index. According to the CAPM, if the risk-free rate is $2.2\%$ per year, what is the beta of the Andromeda Fund?

A. $0.92$
B. $0.95$
C. $1.13$
D. $1.23$

Answer: A
Learning Objective:

Apply the CAPM in calculating the expected return on an asset.
Interpret beta and calculate the beta of a single asset or portfolio.

Since the correlation or covariance between the Andromeda Fund and the S&P 500 Index is not known, CAPM must be used to back out the beta:

$E(R_i)= R_f+\beta_i\times[E(R_m)-R_f]$

where,
$E(R_i)$ is the expected annual return of the fund,
$\beta_i$ is the beta of the fund with the market index (the S&P 500 Index),
$R_f$ is the risk-free rate per year,
$E(R_m)$ is the expected annual return of the market (in this case, the S&P 500 index).

Hence, $\beta_i =\cfrac{6.8\%-2.2\%}{7.2\%-2.2\%}=0.92$

Question 14

You are interested in constructing a portfolio benchmarked to the S&P 500 with a standard deviation of returns less than or equal to $10\%$ per year. Assume the CAPM holds. If the risk-free rate is $2\%$ per year and the expected return on the S&P 500 is $8\%$ per year with a standard deviation of $25\%$ per year, what is the highest expected return you could achieve on your portfolio?

A. $4.4\%$ per year
B. $5.2\%$ per year
C. 6.0% per year
D. 6.8% per year

Question 15

An analyst is considering an investment in stock DKR and has gathered the following information:

Expected return of DKR is $8.00\%$
Risk-free rate is $2.50\%$
Standard deviation of DKR returns is $14.75\%$
Standard deviation of market returns is $13.50\%$
Correlation of DKR return and market returns $0.76$

The analyst believes DKR is fairly valued according to the CAPM. Based on this information, what is the expected return of the market portfolio?

A. $9.12\%$
B. $10.43\%$
C. $12.19\%$
D. $15.12\%$

Question 16

Assuming a positive market risk premium and holding all other things equal, which of the following statements about the CAPM is correct?

A. The expected return on a security decreases when its correlation with the market return decreases.
B. For a security with a beta greater than $1.0$ , an increase in the risk-free rate will increase its expected return.
C. A stock with a beta of $2.0$ will always have a higher standard deviation than a stock with a beta of $0.5$ .
D. The expected return on a security will increase when the standard deviation of the market return increases.

Question 17

The valuation team at a bank is asked to value a small business that will operate under a 3-year lease and then liquidate at the end of the 3-year period. An analyst has made the following year-end cash flow projections for the business:

Year	1	2	3
Net Cash Flow(SGD)	1,400,000	1,800,000	800,000

After carefully analyzing other similar businesses, the analyst has assigned a beta of $1.67$ to the business, if the risk-free rate is $2.25\%$ per year and the market risk premium is $4.70\%$ per year, what is the best estimate for the current value of the business?

A. SGD $3, 160, 000$
B. SGD $3, 356, 000$
C. SGD $3, 480, 000$
D. SGD $3, 537, 000$

Question 18

There are both absolute risk (measured without reference to a benchmark) and relative risk (measured against a benchmark) measures of market risk. Which of the following is an absolute measure of market risk?

A. Tracking error
B. Volatility of total returns
C. Correlation with a benchmark portfolio
D. Deviations from a benchmark index

Answer: B
Market risk is the risk of losses from movements in market prices.
Absolute risk measures these changes in terms of the volatility of total returns.
Tracking error is a relative measure of market risk defined as the deviation from a benchmark index.
Correlation refers to a benchmark.
Deviation from the benchmark index is a consideration in measuring relative risk.

Question 19

Assume that you are only concerned with systematic risk. Which of the following would be the best measure to use to rank order funds with different betas based on their risk-return relationship with the market portfolio?

A. Treynor ratio
B. Sharpe ratio
C. Jensen’s alpha
D. Sortino ratio

Answer: A
Systematic risk of a portfolio is that risk which is inherent in the market and thus cannot be diversified away. In this situation you should seek a measure which ranks funds based on systematic risk only, which is reflected in the beta as defined: $\beta = \cfrac{\rho_{p,m}\times\sigma_p}{\sigma_m}$ , where is the correlation coefficient between the portfolio and the market, represents the standard deviation of the portfolio and represents the standard deviation of the market.

In a well-diversified portfolio (where one is normally only concerned with systematic risk), it can be assumed that the correlation coefficient is close to $1$ , therefore beta can be approximated to an even simpler equation: $\beta =\cfrac{\sigma_p}{\sigma_m}$

In either case, beta explains the volatility of the portfolio compared to the volatility of the market, which captures only systematic risk.

The Treynor ratio is the correct ratio to use in this case.

Question 20

Donaldson Capital Management, a regional money management firm, manages nearly $ $400$ million allocated among three investment managers. All portfolios have the same objective, which is to produce superior risk-adjusted returns (by beating the market) for their clients. You have been hired as a consultant to measure the performance of the portfolio managers. You have collected the following information based on the last ten years of returns.

Portfolio Manager	Mean Annualized Rate of Return	Beta	Standard Deviation of Return
a	0.18	1.35	0.24
b	0.21	1.95	0.25
c	0.24	2.10	0.22

During the same time period the average annual rate of return on the market portfolio was $13\%$ with a standard deviation of $19\%$ . In order to assess the portfolio performance of the above managers, you should use:

A. The Treynor measure of performance
B. The Sharpe measure of performance
C. The Jensen measure of performance
D. The Sortino measure of performance

Answer: B
The Treynor measure is most appropriate for comparing well-diversified portfolios. That is the Treynor measure is the best to compare the excess returns per unit of systematic risk earned by portfolio managers, provided all portfolios are well-diversified.

All three portfolios managed by Donaldson Capital Management are clearly less diversified than the market portfolio. Standard deviation of returns for each of the three portfolios is higher than the standard deviation of the market portfolio, reflecting a low level of diversification.

Jensen’s alpha is the most appropriate measure for comparing portfolios that have the same beta. The Sharpe measure can be applied to all portfolios because it uses total risk and it is more widely used than the other two measures. Also, the Sharpe ratio evaluates the portfolio performance based on realized returns and diversification. A less-diversified portfolio will have higher total risk and vice versa.

Question 21

A high net worth investor is monitoring the performance of an index tracking fund in which she has invested. The performance figures of the fund and the benchmark portfolio are summarized in the table below:

Year	Benchmark Return	Fund Return
2005	9.00%	1.00%
2006	7.00%	3.00%
2007	7.00%	5.00%
2008	5.00%	4.00%
2009	2.00%	1.50%

What is the tracking error volatility of the fund over this period?

A. $0.09\%$
B. $1.10\%$
C. $3.05\%$
D. $4.09\%$

Answer: C
Relative risk measures risk relative to a benchmark index, and measures it in terms of tracking error or deviation from the index.

We need to calculate the standard deviation (square root of the variance) of the series:[ $0.08$ , $0.04$ , $0.02$ , $0.01$ , $0.005$ )

Perform the calculation by computing the difference of each data point from the mean, square the result of each, take the average of those values, and then take the square root. This is equal to $3.04\%$ .

Question 22

PE2018Q99 / PE2019Q99 / PE2020Q99 / PE2021Q99 / PE2022Q99
An analyst is analyzing the historical performance of two commodity funds tracking the Reuters/Jefferies-CRB Index (CRB) as benchmark. The analyst collated the data on the monthly returns and decided to use the information ratio ( $\text{IR}$ ) to assess which fund achieved higher returns more efficiently and presented his findings.

	Fund I	Fund II	Benchmark returns
Average monthly returns	$1.488\%$	$1.468\%$	$1.415\%$
Average excess return	$0.073\%$	$0.053\%$	$0.000\%$
Standard deviation of returns	$0.294\%$	$0.237\%$	$0.238\%$
Tracking error	$0.344\%$	$0.341\%$	$0.000\%$

What is the information ratio for each fund and what conclusion can be drawn?

A. $\text{IR}$ for Fund I is $0.212$ , IR for Fund II is $0.155$ ; Fund I performed better as it has a higher $\text{IR}$ .
B. $\text{IR}$ for Fund I is $0.212$ , $\text{IR}$ for Fund II is $0.155$ ; Fund II performed better as it has a lower $\text{IR}$ .
C. $\text{IR}$ for Fund I is $0.248$ , $\text{IR}$ for Fund II is $0.224$ ; Fund I performed better as it has a higher $\text{IR}$ .
D. $\text{IR}$ for Fund I is $0.248$ , $\text{IR}$ for Fund II is $0.224$ ; Fund II performed better as it has a lower $\text{IR}$ .

Answer: A
Learning Objective: Calculate, compare, and interpret the following performance measures: the Sharpe performance index, the Treynor performance index, the Jensen performance index, the tracking error, information ratio, and Sortino ratio.

The information ratio may be calculated by either a comparison of the residual return to residual risk, or the excess return to tracking error. The higher the $\text{IR}$ , the better informed the manager is at picking assets to invest in. Since neither residual return nor risk is given, only the latter is an option.

$\text{IR} = \cfrac{E(R_p-R_b)}{\text{Tracking Error}}$

For Fund I: $\text{IR} = 0.00073/0.00344 = 0.212$

For Fund II: $\text{IR} = 0.00053/0.00341 = 0.155$

Question 23

PE2018Q97
Portfolio A has an expected return of $8\%$ , volatility of $20\%$ , and beta of $0.4$ . Assume that the market has an expected return of $10\%$ and volatility of $25\%$ . Also assume a risk-free rate of $5\%$ .What is Jensen’s alpha for portfolio A?

A. $0.5\%$
B. $1.0\%$
C. $10\%$
D. $15\%$

Answer: B
Learning Objective: Calculate, compare, and evaluate the Treynor measure, the Sharpe measure, and Jensen’s alpha.

The Jensen measure of a portfolio, or Jensen’s alpha, is computed as follows:

$\alpha_p = E(R_p)-R_F-\beta\times[E(R_M)-R_F]=1.0\%$

Question 24

PE2018Q25 / PE2019Q25 / PE2020Q25 / PE2021Q25 / PE2022PSQ1 / PE2022Q25
An analyst is evaluating the performance of a portfolio of Mexican equities that is benchmarked to the IPC Index. The analyst collects the information about the portfolio and the benchmark index shown below:

Expected return on the portfolio: $8.7\%$
Volatility of returns on the portfolio: $12.0\%$
Expected return on the IPC Index: $4.0\%$
Volatility of returns on the IPC Index: $8.7\%$
Risk-free rate of return: $2.0\%$
Beta of portfolio relative to IPC Index: $1.4\%$

What is the Sharpe ratio for this portfolio?

A. $0.036$
B. $0.047$
C. $0.389$
D. $0.558$

Answer: C
Learning Objective: Calculate, compare, and interpret the following performance measures: the Sharpe performance index, the Treynor performance index, the Jensen performance index, the tracking error, information ratio, the Sortino ratio.

The Sharpe ratio for the portfolio is
$\frac{\text{Expected return of portfolio}\;-\;\text{Risk free rate}}{\text{Volatility of returns of portfolio}}=\frac{8.7\% - 2.0\%}{12.0\%} = 0.5583$

Question 25

A portfolio has an average return over the last year of $13.2\%$ . Its benchmark has provided an average return over the same period of $12.3\%$ . The portfolio’s standard deviation is $15.3\%$ , its beta is $1.15$ , its tracking error volatility is $6.5\%$ and its semi-standard deviation is $9.4\%$ . Lastly, the risk-free rate is $4.5\%$ . Calculate the portfolio’s information Ratio ( $\text{IR}$ ).

A. $0.569$
B. $0.076$
C. $0.139$
D. $0.096$

Answer: C
$\text{IR} = E(R_p-R_b)/\text{Tracking Error}=0.139$

Question 26

Market portfolio’s sharp ratio is $40\%$ , the correlation between the market portfolio and the stock is $0.7$ , the stock’s sharp ratio is:

A. $12\%$
B. $28\%$
C. $32\%$
D. $30\%$

Answer: B
$E(R_i)-R_f = \beta_i\times[E(R_m)-R_f]$

$\frac{E(R_i)-R_f }{\sigma_i}=\frac{\beta_i\times[E(R_m)-R_f]}{ \sigma_i}=\frac{\beta_i\times\sigma_m}{\sigma_i}\times\frac{[E(R_m)-R_f]}{ \sigma_m}=\rho\times\frac{[E(R_m)-R_f]}{ \sigma_m}=28\%$

Question 27

A risk manager is evaluating a portfolio of equities with an annual volatility of $12.1\%$ per year that is benchmarked to the Straits Times Index. If the risk-free rate is $2.5\%$ per year, based on the regression results given in the chart below, what is the Jensen’s alpha of the portfolio?
在这里插入图片描述
A. $0.4936\%$
B. $0.5387\%$
C. $1.2069\%$
D. $3.7069\%$

Answer: D
$\text{Excess Return on Portfolio}=0.4936\times\text{Excess Return on Market}+3.7069$

$E(R_P)-R_F = 0.4936[E(R_M)-R_F]+3.7069$

Jensen’s $\alpha=E(R_p)-\lbrace R_F+\beta \times[E(R_M)-R_F]\rbrace= E(R_P)-R_F-\beta\times[E(R_M)-R_F]= 3.7069\%$

The Jensen’s alpha is equal to the y-intercept, or the excess return of the portfolio when the excess market return is zero. Therefore it is $3.7069\%$ .

Question 28

You are evaluating the historical performance of four equity funds benchmarked to the BSE SENSEX Index, as shown in the table below:

	Average Annual Return	Average Excess Return	Standard Deviation of Returns	Tracking Error
Fund A	15.45%	2.95%	15.00%	4.20%
Fund B	14.10%	1.60%	12.00%	1.50%
Fund C	20.50%	8.00%	22.00%	8.70%
Fund D	16.75%	4.25%	18.10%	5.10%

Which fund has the highest information ratio?

A. Fund A
B. Fund B
C. Fund C
D. Fund D

Question 29

Two portfolios that have the same expected return are benchmarked to the same market index. In comparing these two portfolios, which of the following statements about performance measures is correct?

A. The portfolio with the higher beta will have the higher Treynor ratio.
B. Jensen’s alpha is particularly well suited for comparing portfolios with different levels of risk.
C. The portfolio with the higher volatility will have the higher Sharpe ratio but the lower Treynor ratio.
D. There is an exact linear relationship between the Treynor ratio and Jensen’s alpha for each portfolio.

Question 30

The following table lists the annual risk-free rate, the return on an equity fund ,and the return on the market portfolio for the past three years:

Year	Risk-Free Rate(%)	Equity Rund Return(%)	Market Portfolio Return(%)
1	1.50	5.50	4.00
2	2.75	6.50	9.50
3	4.25	3.50	5.00

Using a linear regression, the beta relating the excess returns of the equity fund to the excess returns of the market portfolio is estimated to be $0.60$ .What is the best estimate of Jensen’s alpha of this equity fund over this 3-year period?

A. $-3.07\%$
B. $-1.00\%$
C. $0.33\%$
D. $4.34\%$

Question 31

Which of the following is least likely to be one of the inputs to a multifactor model?

A. The mean-variance efficient market portfolio
B. Factor betas
C. Deviation of factor values from their expected values
D. Firm-specific returns

Answer: A
The mean-variance efficient market portfolio is essential to the capital asset pricing model, but is not required in multi-factor models.

Question 32

Suppose an analyst examines expected return for the Broad Band Company (BBC) base on a 2-factor model. Initially, the expected return for BBC equals $10\%$ . The analyst identifies GDP and 10-year interest rates as the two factors for the factor model. Assume the following data is used:

GDP growth consensus forecast $6\%$
Interest rate consensus forecast $3\%$
GDP factor beta for BBC $= 1.5$
Interest rate factor beta for BBC $= - 1.00$

Suppose GDP ends up growing $5\%$ and the 10-year interest rate ends up equaling $4\%$ . Also assume that during the period, the Broad Band Company unexpectedly experiences shortage of key inputs, causing its revenues to be less than originally expected. Consequently, the firm specific return is $-2\%$ during the period. Using the 2-factor model with the revised data, which of the following expected returns for BBC is correct?

A. $1.5\%$
B. $3.5\%$
C. $5.5\%$
D. $6.5\%$

Answer: C
$R_{\text{BBC}} = E(R_{\text{BBC}})+\beta_{\text{BBC}, \text{GDP}}F_{GDP}+\beta_{\text{BBC}, \text{IR}}F_{\text{IR}}+e_{\text{BBC}}$

$R_{\text{BBC}}=0.10+1.5\times-0.01-1\times0.01-0.02 = 0.055 =5.5\%$

Question 33

PE2018Q100 / PE2019Q100 / PE2020Q100 / PE2021Q100 / PE2022Q100
An analyst is estimating the sensitivity of the return of stock A to different macroeconomic factors. He prepares the following estimates for the factor betas:

$\beta_{\text{Industrial Production}}=1.3$ , $\beta_{\text{Interest Rate}}=-0.75$

Under baseline expectations, with industrial production growth of $3\%$ and an interest rate of $1.5\%$ , the expected return for Stock A is estimated to be $5\%$ .

The economic research department is forecasting an acceleration of economic activity for the following year, with GDP forecast to grow $4.2\%$ and interest rates increasing $25$ basis points to $1.75\%$ .

What return of Stock A can be expected for next year according to this forecast?

A. $4.8\%$
B. $6.4\%$
C. $6.8\%$
D. $7.8\%$

Answer: B
Learning Objective: Calculate the expected return of an asset using a single-factor and a multi-factor model.

The expected return for Stock A equals the expected return for the stock under the baseline scenario, plus the impact of “shocks”, or excess returns of, both factors. Since the baseline scenario incorporates 3% industrial production growth and a 1.5% interest rate, the “shocks” are 1.2% for the GDP factor and 0.25% for the interest rate factor.

Therefore the expected return for the new scenario = Baseline scenario expected return + $\beta_{\text{Industrial Production}}\times$ Industrial Production shock + $\beta_{\text{Interest Rate}} \times$ Interest Rate shock

$=5\%+(1.3\times1.2\%)+ (-0.75\times0.25\%) =6.37\%$

Question 34

Which of the following statements is least likely a requirement for an arbitrage opportunity? The arbitrage situation leads to a:

A. Risk-free opportunity
B. Zero net investment opportunity
C. Profitable opportunity
D. Return in excess of the risk-free rate opportunity

Answer: D
An arbitrage situation exists if a risk-free, zero net investment can be created that produces a positive profit. The arbitrage return need not exceed the risk-free rate.

Question 35

Which of the following assumptions is not made when forming a single-factor security market line?

A. Security returns are described by a factor model.
B. A mean-variance efficient market portfolio exists.
C. Weli-diversified portfolio can be formed.
D. No arbitrage opportunities exist.

Answer: B
The derivation of the single-factor security market line does not rely on the assumption that a mean-variance efficient market portfolio exists. This is in contrast with the capital asset pricing model, which relies on the existence of the mean-variance efficient market portfolio.

Question 36

Suppose Portfolio P has factor beta of $0.40$ and $0.50$ on two risk factors (risk factors $1$ and $2$ , respectively). Assume a portfolio manager wishes to hedge away all of the exposure to the two risk factors, yet does not want to sell the portfolio. Which of the following strategies is expected to achieve the desired result?

A. Short sell a hedge portfolio that allocates $40\%$ to the first factor portfolio, $50\%$ to the second factor portfolio, and $10$ to the risk-free asset.
B. Short sell a hedge portfolio that allocates $90\%$ to the market portfolio and $10\%$ to the risk-free asset.
C. Buy a hedge portfolio that allocates $40\%$ to the first factor portfolio, $50\%$ to the second factor portfolio, and $10\%$ to the risk-free asset.
D. Buy a hedge portfolio that allocates $90\%$ to the market portfolio and $10\%$ to the risk-free asset.

Answer: A
A factor portfolio is a well-diversified portfolio that has a factor beta equal to one for a single risk factor, and factor betas equal to zero on the remaining factors. By shorting the hedge portfolio, the investor will offset the factor risks of the original portfolio. In this case, the 0.40 and 0.50 exposures to the two risk factors are offset by the short position in the hedge portfolio that also has 0.40 and 0.50 exposures to the two risk factors.

Question 37

PE2019Q97 / PE2020Q97 / PE2021Q97 / PE2022Q97
An investment performance analyst is calculating some performance measures on portfolio LCM. Portfolio LCM has an expected return of $9\%$ , volatility of $21\%$ , and a beta of $0.3$ . If the risk-free rate is $3\%$ , what is the Treynor measure of portfolio LCM?

A. $0.08$
B. $0.15$
C. $0.20$
D. $0.40$

The Treynor measure can be calculated using the following equation:

$T_p=\cfrac{E(R_p)-R_F}{\beta_p}=\cfrac{9\%-3\%}{0.3}=0.2$

Question 38

PE2022PSQ19
The investment committee of a large pension fund is evaluating a range of investment options using the mean-variance framework. The committee assumes that the fund can borrow and lend at the risk-free rate and wants to invest only in portfolios that are represented by points on the efficient frontier.

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If there are only two investable risky assets, A and B, and the market is in equilibrium, which of the following statements would be correct about the committee’s target portfolio according to the mean-variance framework?

A. If the committee’s aversion to risk changes, the proportion of asset A to asset B held in the fund’s target portfolio will change.
B. The proportion of asset A to asset B held in the target portfolio will be constant and in proportion to the assets’ respective share of all investable assets.
C. The proportion of asset A to asset B held in the target portfolio will be constant and in proportion to the assets’ relative risk contributions to the total market risk.
D. The proportion of asset A to asset B held in the target portfolio will be constant and a function of the assets’ respective expected returns.

Answer: B
Learning Objective: Describe the mean-variance framework and the efficient frontier.

B is correct. Within the mean-variance framework, the point M is the market portfolio-
consisting of all investments in the market with the proportional amount of any investment in the portfolio being the same as the proportion of all available investments that it represents. If an asset is under(over)-represented by this criterion, the market price will fall(rise) until the criterion is satisfied.

A is incorrect. If the market is in equilibrium, all investors should choose to invest in the same portfolio of risky assets, represented by point M. They should then reflect their risk appetite by borrowing or lending at the risk-free rate.

C and D are incorrect. The proportion of A and B reflects the proportion of the assets’ share of all available investments.