THROUGH 54 RELATE TO EQUITY INVESTMENTS AMANDA GARY AND H...

Questions 49 through 54 relate to Equity Investments Amanda Gary and Harrod Dickson Case Scenario Amanda Gary, CFA and Harrod Dickson, CFA are senior analysts at Wealth Management Associates (WM). WM provides portfolio management services and investment advice to wealthy individuals and institutional clients. Gary and Dickson discuss the fundamental law of active management and its application in evaluating managers’ performances. During their discussion, Gary makes two statements. Statement 1: “In the fundamental law of active management, investor’s breadth represents the number of independent active decisions made each year. This implies that the greater the size of the investor’s research universe, the greater the breadth and consequently the greater the information ratio.” Statement 2: “A manager’s style of investing can be identified using two approaches with one based on analyzing the characteristics of overall individual security holdings while the other based on analyzing the characteristics of the overall portfolio.” Dickson has gathered some data on three portfolio managers at WM. 1. Macklin holds a long position in S&P 500 Futures contracts and a cash position. He focuses on generating alpha by altering the duration of his cash position. Correlation between Macklin’s forecasted returns and actual returns is 0.04. 2. Carter holds a long-short portfolio which involves 500 stocks in the S&P 500 index and uses a stock-based semi-active strategy to generate active returns. Correlation between Carter’s forecasted returns and actual returns is 0.07. 3. Bernard holds a long-only portfolio consisting of 500 stocks of the S&P 500 index and focuses on generating active returns through over- or under weighting individual stocks based on his expectations for those stocks. Correlation between Bernard’s forecasted returns and actual returns is 0.04. Walter Tobler, Dickson’s subordinate, is concerned about the effects of a long-only constraint on investing activities. In response to those concerns, Dickson states: Statement 3: “A long-only constraint only limits an investor’s ability to take advantage

CFA Level III Mock Exam 3 – Solutions (PM)

On hearing that, Tobler asks Dickson about the types of risks long-only investors are exposed to. James Chan, WM’s client, indicates that he might invest a total of USD 100 million. While having a discussion with Robert Andrew, CFA, a portfolio manager at WM, Chan says: Statement 4: “Although I am highly risk averse, I am interested in taking a systematic risk exposure along with the opportunity to earn skill-based active returns.” In response to Chan, Andrew says the strategy that best serves Chan’s interest is an equitized market neutral long-short strategy. Andrew is also analyzing different funds to pursue a core-satellite approach for Chan. Relevant data on these funds is given in Exhibit 1. Exhibit 1 Potential Funds for the a Core-Satellite Approach Fund A Fund B Fund C Fund D Fund E Expected α 0% 5% 0% 3% 2% Expected Tracking Risk 0% 9% 0% 6% 5% Total Investment $50 million $10 million $15 million $40 million $45 million Andrew is also working with another client, Rainbow Foundation (RF). RF seeks to achieve two specific objectives. Objective 1: To earn skill-based active returns along with beta exposure but without altering the strategic asset allocation of our portfolio. Objective 2: To capture value added from active management along with matching overall portfolio’s risk to its benchmark. 43. Is Gary correct with regard to Statement 1 and with regard to Statement 2: which style analysis would result in greater need for buffering? A. Yes; holdings-based analysis. B. No; composition-based analysis. C. No; return-based analysis. 44. With regard to the data provided on the three portfolio managers, which of the following statements is most likely incorrect? A. Macklin will have a higher information ratio than Bernard. B. Carter will have a higher information ratio than Bernard. C. Macklin will have a lower information ratio than Carter. 45. With regard to Statement 3 and Dickson’s response to Tobler, respectively, which of the following is most likely correct? A. Statement 3 is correct; long-only investors are exposed to both systematic and unsystematic risk. B. Statement 3 is incorrect; long-only investors are exposed to both systematic and unsystematic risk. C. Statement 3 is incorrect; long-only investors are exposed to systematic risk only. 46. Is Andrew’s proposed strategy appropriate for Chan? A. Yes. B. No; the most appropriate strategy is an alpha-beta separation strategy. C. No; the most appropriate strategy is a short extension strategy. 47. Based on Exhibit 1 and Statement 4, in order to pursue the core-satellite approach, which of the following funds would be most appropriate for Chan as a core investment? A. Fund A. B. Fund C. C. Fund E. 48. In order to meet RF’s objectives, the most appropriate investment approach is: A. short-extension strategy for objective 1; completeness fund for objective 2. B. equitized market neutral long-short strategy for objective 1; bias control fund for objective 2. C. short-extension strategy for objective 1; portfolio indexed to broad market for objective 2.