THROUGH 24 RELATE TO EQUITY PORTFOLIO MANAGEMENT. WILLIAM...

Questions 19 through 24 relate to Equity Portfolio Management.

William Pugh Case Scenario

William Pugh is a portfolio manager for the pension plan of the FMJ Corporation. Pugh

is evaluating portfolio managers for the pension plan.

PMA Asset Management follows a passive investment strategy that is implemented using

ETF’s rather than conventional mutual funds. PMA proposes to offer a new index

portfolio that reflects the Russell 2000 small-cap value index. PMA indicates that the

technique used to construct the new index portfolio assumes that the factors used to

explain stock returns are uncorrelated.

ASM Partners is an active manager. A common strategy that ASM implements is a pairs

trade where they take equal long and short positions in two common stocks in a single

industry. These positions are constructed so that they have no correlation with equity

market returns.

CKI Financial Advisors also follows an active portfolio strategy. A portfolio analysis for

CKI is provided below in Exhibit 1.

Exhibit 1

Portfolio Analysis for CKI

Portfolio Benchmark

Number of Stocks 25 700

Weighted Average Market Cap $25 billion $50 billion

Dividend Yield 3.7% 1.8%

P/E 12 22

P/B 1.2 2.5

Projected EPS growth 8% 13%

Pugh is also evaluating another active manager, the DCM Group. Selected information

for all three active managers as well as their normal and investor benchmarks are

presented in Exhibit 2

Exhibit 2

Active Portfolio Managers’ Characteristics

and Benchmark Information

Normal Investor Total Misfit

Portfolio Manager Benchmark Benchmark Active Active

Manager Return Return Return Risk Risk

ASM 15.00% 11.25% 8.50% 6.05% 4.40%

CKI 13.20% 14.25% 7.50% 4.68% 3.40%

DCM 12.75% 15.00% 10.00% 5.50% 4.00%

Pugh proposes to construct a core-satellite portfolio with the following allocations: 45

percent in PMA, 15 percent in ASM, 20 percent in CKI and 20 percent in DCM. The

investment management committee for the pension plan has stated that it expects the

core-satellite portfolio to achieve a total active return of at least 2.1 percent and have total

active risk of no more than 1.8 percent. Pugh assumes that the managers’ active returns

are uncorrelated. Furthermore, since PMA follows a passive strategy, he assumes that

active return and active risk for PMA are 0 percent.

19. A characteristic of PMA Asset Management’s investment strategy is that it:

A. is more tax efficient.

B. has lower license fees.

C. has higher expenses due to fund level accounting.

20. The most appropriate technique for constructing PMA’s new portfolio is:

A. optimization.

B. full-replication.

C. stratified sampling.

21. Relative to a long-only strategy, the expected alpha of ASM Partners’ investment

strategy is most likely:

A. half.

B. twice.

C. similar.

22. Based on the information presented in Exhibit 1, CKI Financial Advisors most

likely follows a:

A. value strategy.

B. growth strategy.

C. market-oriented strategy.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to

23. Based on the information in Exhibit 2, does the portfolio proposed by Pugh meet

the investment management committee’s stated thresholds of risk and return?

A. Yes.

B. No, portfolio active risk is above the threshold.

C. No, portfolio active return is below the threshold.

24. Based on the information presented in Exhibit 2, the “true” active risk for ASM

Partners is closest to:

A. 1.65%.

B. 4.15%.

C. 6.05%.