18. Is Reinfeldt’s statement regarding credit derivatives most likely correct?
A. Yes.
B. No, he is incorrect about marking to market.
C. No, he is incorrect about transferring credit risk.
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Gregory Dodson Case Scenario
Gregory Dodson, CFA, is an investment consultant who advises individual and institutional clients on
their equity portfolios. During a typical workweek, he is called upon to evaluate a variety of situations
and provide expert advice. This week, he is meeting with three clients.
Dodson’s first client meeting is with the Magnolia Foundation, a small not-for-profit organization.
Magnolia currently uses three long-only portfolio managers for its equity investments. Details of those
investments, including expected performance relative to Magnolia’s equity benchmark, the S&P 500
Index, are provided below.
Exhibit 1
Magnolia Foundation Equity Portfolio Managers
Investment Size
Expected
(in millions)
Alpha
Tracking Error
Manager A USD140 0% 0%
Manager B USD40 1.5% 2.5%
Manager C USD20 2.0% 4.0%
The Magnolia Foundation’s goal for its total equity investment is expected alpha greater than 0.40% and
expected tracking error less than 1.00%.
Dodson’s second client meeting is with Sarah Tan, a wealthy individual who is actively involved in
managing her investments. Tan wants to add a USD100 million allocation to U.S. midcap stocks,
represented by the U.S. S&P 400 Midcap Index, to her long-term asset allocation. No investment has
been made to meet this new allocation. Tan has not found any manager capable of generating positive
alpha in U.S. midcap stocks. She has, however, identified a long-only portfolio manager of Canadian
equities who she believes will produce positive alpha. This manager uses the S&P/TSX (Toronto Stock
Exchange) Index as a benchmark. Tan wants to create a portable alpha strategy that will earn the alpha
of the Canadian equity portfolio and meet the new benchmark allocation to U.S. midcap stocks. She asks
Dodson for advice to establish this strategy. Tan provides some information about the security selection
methods used by the Canadian equity portfolio manager. He uses a proprietary discounted cash flow
model to analyze all stocks in the S&P/TSX Index, purchasing those with market prices most below the
intrinsic value estimated by his model, regardless of their P/E ratios.
Dodson’s third client meeting is with the chief investment officer (CIO) of the Susquehana Industries’
pension fund. The fund needs to establish a USD50 million portfolio that replicates the Russell 2000, an
index of small-cap U.S. equities. The CIO’s goal is to minimize trading costs. Dodson has been asked to
suggest an investment approach that will meet this goal. The CIO also outlines his portfolio managers’
sell discipline with respect to the pension fund’s actively managed value and growth equity portfolios.
Currently, the managers monitor the P/E (price-to-earnings) ratio of each stock held. A value stock is
sold when its P/E ratio rises to its 10-year historical average. A growth stock is sold when its P/E ratio
falls to its 10-year historical average.
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