Download MFIN5600 Practice questions Chapter 1 1. Characterize each of the

MFIN5600 Practice questions
Chapter 1
1. Characterize each of the investment objectives given below as one of the following: an absolute risk
objective, a relative risk objective, an absolute return objective, or a relative return objective.
a) Achieve a rate of return of 8% a year.
b) Limit the standard deviation of portfolio returns to 20% a year or less.
c) Achieve returns in the top quartile of the portfolio’s peer universe (the set of portfolios with
similar investment objectives and characteristics).
d) Maintain a 10% or smaller probability that the portfolio’s return falls below the threshold level
of 5% per annum over a one-year time horizon.
e) Achieve a tracking risk of no more than 4% per annum with respect to the portfolio’s
benchmark.
2. Maple College Endowment fund
Case Facts
Type of investor
Purpose
Asset base
Stated return desire
Other return factors
Tax concerns
Institutional; endowment
Provide annual scholarships currently totalling $39.5 million
$1 billion
6%, calculated as spending rate of 4% plus previously expected college
tuition inflation of 2%
Revised expectation of college tuition inflation is 3%
Tax exempt
i. Choose the word at the right that best describes the client’s:
a)
b)
c)
d)
e)
Risk Tolerance
Liquidity Requirement
Time Horizon
Overall Time Horizon
Tax concerns
Below Average
Significant
Single Stage
Short to Intermediate Term
Significant
ii. Discuss appropriate client objectives:
a) Risk
b) Return
Above Average
Not Significant
Multistage
Long Term
Not Significant
Chapter 3
LightSpeed Connections
Hugh Donovan is chief financial officer (CFO) of LightSpeed Connections (LSC), a rapidly growing
U.S technology company with a traditional defined-benefit pension plan. Because of LSC’s young
workforce, Donovan believes the pension plan has no liquidity needs and can thus invest aggressively to
maximize returns. He also believes that U.S. Treasury bills and bonds, yielding 5.4% and 6.1%,
respectively, have no place in a portfolio with such long time horizon. His strategy, which has produced
excellent returns for the past two years, has been to invest the portfolio as follows:





50% in a concentrated pool (15 to 20 stocks) of initial public offerings in technology and Internet
companies, managed internally by Donovan
25% in a small-capitalization growth fund
10% in a venture capital fund
10% in an S&P 500 index fund
5% in an international equity fund
Working with LSC’s Investment Committee, the firm’s president, Eileen Jeffries has produced a
formal investment policy statement, which reads as follows:
“The LSC Pension Plan’s return objective should focus on real total returns that will fund its longterm obligations on an inflation-adjusted basis. The “time-to-maturity” of the corporate workforce is a
key element for any defined pension plan; given our young workforce, LSC’s Plan has a long investment
horizon and more time available for wealth compounding to occur. Therefore, the Plan can pursue an
aggressive investment strategy and focus on the higher return potential of capital growth. Under
present U.S. tax laws, pension portfolio income and capital gains are not taxed. The portfolio should
focus primarily on investments in businesses directly related to our main business to leverage our
knowledge base.”
A. Evaluate Donovan’s investment strategy with respect to its effect on each of the following:
i.
LSC’s pension plan beneficiaries
ii.
Managing pension assets in relation to LSC’s corporate strength
B. Evaluate LSC’s investment policy statement in the context of the following:
i.
Return requirement
ii.
Risk tolerance
iii.
Time horizon
iv.
Liquidity
Chapter 5
For the following types of investors, appraise the importance of using the specified asset class
for strategic asset allocation.
A. Long-term bonds for a life insurer and for a young investor.
B. Common stock for a bank and for a young investor.
C. Domestic tax-exempt bonds for an endowment and for a mid-career professional.
D. Private equity for a major foundation and for a young investor.
2. The table below shows William Smith’s financial and human capital in constant dollars terms
at 30, 50, and 65 years of age. Smith’s target asset allocation for total wealth (i.e., financial plus
human capital) is 60/40 stocks/bonds. Assume that his human capital is approximately risk free
and uncorrelated with stock returns. Determine Smith’s optimal asset allocation for stocks and
bonds in his financial portfolio at the following ages:
A. 30
B. 50
C. 65
D. Discuss whether your conclusions in Parts A, B, and C are consistent with experience based
approaches to asset allocation.
Age
30
50
65
Financial capital
$ 100,000
$ 900,000
$ 2,000,000
Human capital
$ 2,100,000
$ 1,300,000
$ 200,000
Chapter 7
1. How would you characterize the following pooled fund in terms of style? Explain your answer.
Number of stocks
Average market capitalization
Dividend Yield
P/E
P/B
EPS growth (5-year projected)
Sector
Consumer discretionary
Consumer staples
Energy
Finance
Health care
Industrials
Information technology
Materials
Telecommunications
Utilities
Fund
80
$37 billion
2.5%
16
1.6
11%
Benchmark
600
$40 billion
2.1%
19
1.9
12%
16%
9
9
15
9
12
8
5
7
10
10%
12
9
20
7
9
7
8
10
7
2. Jason Smith is a consultant evaluating a market neutral long-short strategy for his client. Based on the
holdings data he receives from his client, Smith notices a small but persistent difference between the
alphas generated on the long side and those generated from the short side. State which of the two
alphas is more likely the larger one, and provide three reasons why that might be the case.
3. Mary Nettle has been asked to manage a FTSE 100 index mutual fund. Because the index's 10 largest
stocks make up of more than 50 percent of its weights, Nettle is considering using optimization to build
the portfolio using many fewer than 100 stocks. All 100 stocks are considered very liquid. What are the
pros and cons of optimization (using fewer stocks) versus full replication (holding all the stocks in the
index)?
Chapter 8
1. Jane Farkas tells Susan DiMarco that she has seen exciting data on the performance of marketneutral, convertible arbitrage, and global macro hedge funds. Farkas states: ‘‘The Sharpe ratios of all of
these hedge fund strategies are much higher than for traditional equities or bonds, which means they
have a great risk/return profile. We should definitely plan a major investment in hedge funds.’’ DiMarco
responds: ‘‘There are several reasons that the Sharpe ratio may be misleading.’’
i. Discuss the situations that could cause an upward bias in the calculation of the Sharpe ratio.
ii. Evaluate the reasons that statistically indicate that the Sharpe ratio is not the most appropriate
measure of risk for hedge funds.
2. Capital market analysts John Lake and Julie McCoy are reviewing the information in Exhibit 8-13 (in
our textbook). Lake and McCoy note that the Sharpe ratio for the GSCI is significantly lower than that of
the S&P 500 and the Lehman Government/Corporate Bond indices. They also note that the minimum
monthly returns for the GSCI and S&P 500 are similar. Lake states to McCoy: ‘‘Based on the historical
record, I don’t understand why we would invest in the GSCI when the annualized return for the GSCI is
lower than that of the S&P 500 and Lehman Government/Corporate indices, the minimum monthly
return is similar to that of the S&P 500, and the Sharpe ratio is significantly lower than either of the
domestic equity or bond asset classes. The risk measure in the Sharpe ratio should completely capture a
commodity index’s risk.’’
i. Critique Lake’s statement, focusing on the GSCI.
McCoy shows Lake in Exhibit 8-15 (in our textbook) and suggests that these more recent data, which
show a significant outperformance of commodity returns versus domestic and international equities and
bonds, make a much stronger case for investing in commodities. McCoy also states that the low
correlations of commodities with the other asset classes indicate that inclusion of commodities will
provide significant diversification benefits to the portfolio.
ii. Judge the validity of McCoy’s conclusions regarding returns and correlations of the various asset
classes, again focusing on the GSCI.
3. Real estate investments
i. Summarize the major categories of direct and indirect investment in real estate.
ii. Using the data in Exhibit 8-3 in our textbook, evaluate the historical relative diversification benefits of
both forms of investment when added to a 50 percent stock/50 percent bond portfolio. Use the
National Council of Real Estate Investment Fiduciaries (NCREIF) Index unsmoothed to represent direct
investment and the National Association of Real Estate Investment Trusts (NAREIT) Index to represent
indirect investment.