AS A RUSSELL 2000 INDEX FUND, FOR OUR SMALL-CAP STOCK PORTFOLIO. THE...

3:

as a Russell 2000 index fund, for our small-cap stock portfolio. The market for

small-cap stocks tends to be more efficient than the market for large-cap stocks

and would provide more opportunities for us to benefit from active

management."

Identify whether or not you agree or disagree with each of Stone's statements. Support each

decision with one reason.

Grading Guide

Answer for Question 4

Comment Circle

one Supporting statement

More public information

"Large-cap stocks are the most appropriate place for

available on large caps

active management because managers can take big

Incorrect

makes efficient pricing

enough positions to capitalize on pockets of

more likely and generating

inefficiency."

excess return less likely.

S&P is market-value

"Because the S&P 500 Index is price-weighted, out-

weighted.

performing stocks tend to have more and more

influence on its value."

"The Shailor College endowment should employ a

Small cap stocks tend to

passive index vehicle, such as a Russell 2000 index

receive less research and

be less efficient, making it

fund, for our small-cap stock portfolio. The market for

small-cap stocks tends to be more efficient than the

easier to generate alpha

market for large-cap stocks and would provide more

with small caps.

opportunities for us to benefit from active

Candidate discussion: Maximum 9 points. 1 point for each correct/incorrect decision that is

correct. 2 points for each supporting statement as long as the correct/incorrect decision is

correct.

(Study Session 12, LOS 25.b, d, i)

QUESTION 5 HAS ONE PART FOR A TOTAL OF 12 MINUTES

Amy Morgan manages a $4 billion global equity fund and has discretion to invest in the stocks of

firms located in both developed and emerging markets as long as she maintains guideline

weights in each. Partly due to a disagreement over her most recent performance appraisal, she

has suggested changes to her benchmark. She makes the following statements:

"For a benchmark to be considered valid, it must be investable. To be investable, I should be

able to recreate and hold the benchmark as a portfolio."

"Although I agree with you that market value-weighted benchmarks are generally considered the

most valid, the benchmark you have applied in my performance appraisal is not truly market

value-weighted because you have not included the total market capitalization of all the

benchmark firms."

"Perhaps as an alternative we could use a multi-factor model-based benchmark. Factor model-

based benchmarks are considered valid benchmarks and, since they are based on sound

statistical methods, their results are irrefutable."

"If you do not like the idea of multi-factor-based benchmarks, we can always go back to

comparing my performance to the average equity manager. At least that way I know exactly who

I'm up against."

Select whether you agree or disagree with each of Morgan's statements. If you

disagree, support your decision with one reason related to the characteristics of valid

benchmarks.

Answer for Question 5

Agree

If you disagree, support your

or

decision with one reason

Comment

disagree

related to the characteristics of

(circle

valid benchmarks

one)

"For a benchmark to be considered valid, it

must be investable. To be investable, I should

be able to recreate and hold the benchmark as a

portfolio."

"Although I agree with you that market value-

weighted benchmarks are generally considered

It is typical and appropriate to

the most valid, the benchmark you have applied

float-adjust the benchmark by

Disagree

in my performance appraisal is not truly market

removing shares that do not trade

value-weighted because you have not included

and cannot be purchased.

the total market capitalization of all the

"Perhaps as an alternative we could use a multi-

Multifactor models can be

factor model-based benchmark. Factor model-

appropriate but they are not

based benchmarks are considered valid

unambiguous. There are different

models based on different factors

benchmarks and, since they are based on sound

that lead to different results.

Comparing to the average

"If you do not like the idea of multi-factor-

manager is common but not a

based benchmarks, we can always go back to

valid benchmark. It cannot be

comparing my performance to the average

specified in advance and is not an

equity manager. At least that way I know

investable alternative to active

exactly who I'm up against."

management.

Candidate discussion: Maximum 12 points. 3 points for agreeing with first statement. 1 point

each for disagreeing with remaining three statements. 2 points for each correct explanation only

ifagree/disagree decision is correct.

(Study Session 17, LOS 33.f)

QUESTION 6 HAS THREE PARTS (A, B, C) FOR A TOTAL OF 11 MINUTES

Sid Mulder, CFA, manages a $250 million fixed-income portfolio. The portfolio duration is