6. Is Seyfried most likely correct about the limitations of the fundamental law?
A. Yes.
B. No, incorrect about high correlation in fixed-income returns due to credit risk and
duration risk.
C. No, incorrect about breadth being not equal to the number of individual assets.
The following information relates to questions 7 – 9.
Karlene Burnell is the new chief investment officer at Prost & Ingsol Foundation which finances
secondary school education. The foundation has €1 billion in assets managed by outside
portfolio managers. Burnell is responsible for selecting and evaluating portfolio managers.
Burnell is meeting with Ray Peterson, a newly hired member of her team, to gauge his
knowledge regarding manager selection and evaluation. She starts by asking, "How is value
added to a portfolio?" Peterson responds by making the following statements:
I. “Value is added when the portfolio return is greater than the benchmark return.
II. Positive value is added when securities with returns greater than the benchmark are
overweighted and those with lower than benchmark returns are underweighted.
III. Value added can be from asset allocation and security selection.”
Burnell then asks Peterson to review the information for Brye Investment Consultants and
include the information ratio.
Exhibit 1: Brye Investment Consultants Selected Data
Fund average annual
return (%) 15.58 Benchmark standard
deviation (%) 8.03
Fund standard
deviation (%) 8.9 Sharpe ratio 1.41
Benchmark average
annual return (%) 15.25 Active risk 1.38
Burnell comments, “The information ratio helps assess the active performance of a manger for
incurring the level of active risk and is useful in selecting managers.” She asks Peterson about
his understanding of the information ratio. Peterson remarks:
I. For any given asset class, the manger with the highest expected skill as measured by
the information ratio should be chosen.
II. The information ratio of a portfolio without constraints is unaffected if the active
weights deviate from the benchmark weights.
III. The information ratio of a combined portfolio will be unaffected if cash is added or
leverage is used.
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