CFA level 3 CFA level 3 volume III applications of economic analysis and asset allocation finquiz item set answers, study session 12, reading 25

Reading 25

Equity Portfolio Management

FinQuiz.com

FinQuiz.com
CFA Level III Item-set - Solution
Study Session 12
June 2018

Copyright © 2010-2018. FinQuiz.com. All rights reserved. Copying, reproduction or
redistribution of this material is strictly prohibited.

FinQuiz.com © 2018 - All rights reserved.


Reading 25

Equity Portfolio Management

FinQuiz.com

FinQuiz Level III 2018 – Item-sets Solution
Reading 25: Equity Portfolio Management.
1. Question ID: 17100
Correct Answer: A
Passive investing is characterized by zero active returns and zero active risks. Manager A’s
investment strategy generates an active return of 4% (22% ─ 18%) as well as active risk. Manager
B’s investment strategy generates an active return of – 1% (35% – 36%) as well as active risk.
2. Question ID: 17101

Correct Answer: C
A stratified sampling approach uses a matrix to replicate factor exposures of the benchmark index
without holding all the stocks in the benchmark. This strategy is less costly.
3. Question ID: 17102
Correct Answer: A
Strategy 2 reflects a long-short equity strategy. A long-short strategy provides exposure to two alphas;
one on the long and one on the short position. Such a strategy will increase the active risk and
possibly active return of TC’s investment portfolio; i.e. is inappropriate.
Strategy 3 reflects investment in an exchange-traded fund (ETF). This approach reflects a passive
investment approach and is appropriate given TC’s investment mandate.
4. Question ID: 17103
Correct Answer: C
Comment 2 is incorrect. One of the drawbacks to value investing is that investors tend to
misapprehend the cheapness of stocks and do not appreciate the economic reasoning behind the
currently undervaluation of value stocks.
Value investors justify their investment approach by stating that earnings multiples will expand as
earnings revert to their mean (historical average).
5. Question ID: 17104
Correct Answer: C
True active return is the return attributed to security selection.
True active return = Manager’s portfolio return – Normal benchmark return
= 34% – 25%
= 9%
Misfit active return is the return attributed to manager style.
Misfit active return = Normal benchmark return – Investor benchmark
= 25% – 20%
= 5%

FinQuiz.com © 2018 - All rights reserved.

Reading 25

Equity Portfolio Management

FinQuiz.com

Total active return = True active return + Misfit active return
= 9% + 5%
= 14%
64% (9%/14%) of the total active return is attributed to security selection and 36% (5%/14%) is
attributed to manager style.
6. Question ID: 17105
Correct Answer: C
Given that West’s expertise lies in developed market corporate bonds, the correct approach would be
to invest in an ETF tracking a developed corporate bond index. This investment will provide beta
exposure to NLEF’s portfolio.
Given that NLEF’s requirements with respect to emerging market corporate bonds, the correct
approach would be to sell futures on an emerging corporate bond index. This will help eliminate
systematic risk exposures associated with its emerging market bond investments; requires no cash;
and helps generate alpha.

FinQuiz.com © 2018 - All rights reserved.