Portfolio Management: An Overview (Reading 42)

Exercise Problems:

1.      Which of the following types of institutions is most likely to have a long investment time horizon and a higher level of risk tolerance?

A. A bank

B. An endowment

C. An insurance company

B is correct. Endowments have a long investment time horizon and a high level of risk tolerance.

2.      The execution step of the portfolio management process includes:

A. finalizing the asset allocation.

B. monitoring the portfolio performance.

C. preparing the investment policy statement.

A is correct. Asset allocation occurs in the execution step.

3.      A key difference between a wrap account and a mutual fund is that wrap accounts:

A. have a lower required minimum investment.

B. can not be tailored to the tax needs of a client.

C. have assets that are owned directly by the individual.

C is correct. The key difference between a wrap account and a mutual fund is that in a wrap account the assets are owned directly by the individual.

4.      In general, which of the following institutions will most likely have a high need for liquidity and a short investment time horizon?

A. Banks

B. Endowments

C. Defined benefit pension plans

Ans: A;

A is correct. Banks have a short term horizon and high liquidity needs. 

5.      Which of the following is most likely a part of the feedback step in the portfolio management process?

A. Portfolio construction

B. Performance measurement

C. Developing the investment policy statement

B is correct. Performance measurement along with portfolio monitoring and rebalancing is part of the feedback loop.

6.      An analyst gathered the following information about two common stocks:

·  Variance of returns for the Libby Company = 15.5

·  Variance of returns for the Metromedia Company = 22.3

·       Covariance between returns of Libby Company and Metromedia Company = 8.65

The correlation coefficient between returns for the two common stocks is closest to:

A. 0.025.

B. 0.388.

C. 0.465.

C is correct. The correlation coefficient =  . 

Standard deviation of Libby = = 3.937

Standard deviation of Metromedia = = 4.722

Correlation between Libby and Metromedia = 8.65/(3.937*4.722)= 0.465

7.      Which of the following is not an assumption of the Markowitz model? Investors:

A. have homogeneous expectations.

B. maximize one-period expected utility.

C. base decisions solely on expected return and risk.

A is correct. This is not an assumption of the Markowitz model, it is an assumption of the Capital Asset Pricing Model (CAPM).

C is not the correct choice. An accelerated sinking fund provision rather than just a sinking fund provision provides flexibility for the bond issuer.