) IS GATCHELL'S STATEMENT REGARDING TRUE ACTIVE RETURN AND MISFIT A...

6.) Is Gatchell's statement regarding true active return and misfit active return correct?

A. Yes

B. No, he is incorrect about misfit active return

C. No, he is incorrect about true active return

Whitney

Mark Whitney, CFA, is the chief investment officer of Granite State Partners, a fixed-income

investment boutique serving institutional pension funds. Paula Norris, a partner at consulting

firm Franconia Notch Associates, is conducting due diligence of Granite’s capabilities. At a

meeting, they go over a presentation Whitney has prepared.

The first page of the presentation addresses Granite’s investment style for managing portfolios.

It states:

“Granite adjusts the portfolio’s duration slightly from the benchmark and attempts to increase

relative return by tilting the portfolios in terms of sector weights, varying the quality of issues,

and anticipating changes in term structure. The mismatches are expected to provide additional

returns to cover administrative and management costs.”

Norris asks Whitney about Granite’s ability to successfully reflect, in its portfolios, its views on

the market and the direction of interest rates. Whitney makes the following statements:

Statement 1: Granite uses effective duration to measure the sensitivity of the portfolio’s price

to a relatively small parallel shift in interest rates. For large parallel changes in

interest rates, we make a convexity adjustment to improve the accuracy of the

estimated price change. We believe that parallel shifts in the yield curve are

relatively rare; thus duration by itself is inadequate to capture the full effect of

changes in interest rates.

Statement 2: We address yield curve risk by using key rate durations. When using this

method, we stress the spot rates for all points along the yield curve

simultaneously. By changing the spot rates across maturities, we are able to

measure a portfolio’s sensitivity to those changes.

Statement 3: We also measure spread duration contribution. This analysis is not related to

interest rate risk. This measure describes how securities, such as corporate

bonds or mortgages, will change in price as a result of the widening or

narrowing of the spread to Treasuries.

Norris provides information on three clients she might refer to Whitney for portfolio

management services and asks him to design a dedication strategy for each. Whitney makes the

following recommendations:

Client 1: This bank has sold a five-year guaranteed investment contract that guarantees an

interest rate of 5.00% per year. I would purchase a bond with a target yield of