Questions 43 to 48 relate to Monitoring and Rebalancing
Adele Ramos, CFA, Case Scenario
Adele Ramos, CFA, is a senior investment advisor at Stoke Advisory, an investment
advisory firm which manages the portfolios of individual client accounts. Ramos is
seeking to implement a disciplined rebalancing approach for two of her clients’ accounts,
Jerry Hayes and Carlos Alvarez.
She holds a meeting with each client in an effort to determine their desire for a particular
rebalancing strategy. She also collects information on the two clients’ investment
portfolios to aid her decision.
Jerry Hayes
Hayes’ $25 million investment portfolio is invested in US equities and Treasury bills in
the proportion 65%/35%, respectively. The client expresses his preference for a calendar
rebalancing approach by stating, “I would like the timing of portfolio rebalancing to
correspond to my monthly portfolio review schedule; this will enable me to track
rebalancing trades.”
Ramos is concerned that Hayes’ preferred rebalancing approach may incur significant
transaction costs and increase his portfolio’s present value of expected losses particularly
if constituent weights have diverged substantially from their target by the rebalancing
date.”
Carlos Alvarez
The majority of Alvarez’s $50 million investment portfolio comprises of financial wealth
inherited from his deceased father’s estate. Alvarez has an above average willingness and
ability to tolerate risk. Upon further discussion with the client, Ramos elects to employ
the percentage-of-portfolio rebalancing approach and implements a daily schedule for
monitoring portfolio weights.
Ramos established corridors for the asset classes comprising Alvarez’s portfolio which
she presents in an exhibit alongside their respective current weights (Exhibit).
Exhibit:
Corridors for Alvarez’s Portfolio
Asset Class Current Weight (%) Corridor
Domestic US equities 43.0 40% ± 5.0%
International equities 18.1 20% ± 3.5%
Corporate bonds 22.0 15% ± 3.0%
Real estate 6.0 7% ± 1.2%
Private equity 10.9 18% ± 2.8%
After concluding her meeting with Alvarez, Ramos makes three observations which she
feels could influence the chosen rebalancing discipline, which include:
Observation 1: A portion of the private equity funds in which Alvarez is invested have
been taken public via an IPO. Alvarez continues to maintain his holdings
in these funds.
Observation 2: A recent decline in mortgage rates has increased the frequency of the
refinancing of mortgage loans and decreased the returns on Alvarez’s real
estate investments.
Observation 3: Tax on long-term capital gains has increased from 13% to 15%.
Ramos is unsatisfied with the rebalancing discipline specified for Hayes’ portfolio as it
does not account for market movements. She decides to implement a constant-mix
rebalancing strategy by setting the multiplier equal to a value of 0.5. She also determines
that US equities are expected to generate a return of 12% in the coming month.
Ramos shares the results of the new rebalancing strategy with Hayes and justifies her
choice by stating, “You can expect to achieve superior performance results by
maintaining stable systemic risk characteristics and a contrarian stance in trending
markets.”
43. In light of their respective portfolio holdings, liquidity represents a greater
concern for:
A. Hayes.
B. Alvarez.
C. both of the clients.
44. With respect to the impact of Hayes’ rebalancing strategy on present value of
expected losses, are Ramos’ concerns valid, and which transaction costs is she
referring to?
Impact on Present
Value of
Expected Losses? Transaction Costs?
A. No Taxes
B. No Liquidity
C. Yes Market impact
45. Using the data in the Exhibit, which of the following asset classes least likely
needs to be rebalanced?
A. Private equity
B. Corporate bonds
C. Domestic equities
46. Considering each of Ramos’ observations in isolation, which of the following
most accurately highlights the necessary change in the corridor width of the
relevant asset class?
Observation 1: Observation 2: Observation 3:
A. Widen Widen Narrow
B. Narrow No effect Widen
C. No effect No effect Widen
47. Assuming Ramos’ forecasts concerning US equities materialize, the action
required to rebalance the portfolio will be to sell equities worth:
A. $2.25 million.
B. $3.75 million.
C. $5.70 million.
48. Ramos’ justification of the constant mix strategy is most likely incorrect because
these strategy:
A. supplies liquidity to markets.
B. underperforms in the identified market conditions.
C. does not maintain stable systemic risk characteristics.
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