Chapter 21 (9 Questions)

Question 1

the steps of the asset allocation process

Answer 1

Step 1: Determine the objectives and constraints of the asset owner.

Step 2: Create the investment policy statement (IPS).

Step 3: Determine the asset allocation based on the IPS.

Step 4: Allocate capital.

Step 5: Monitor and evaluate investments.

Question 2

A Well Diversified Portfolio reduces what type of risk?

Answer 2

Business

Question 3

Tactical Asset Allocation

Answer 3

short-term portfolio adjustments that adjust the portfolio mix between asset classes in consideration of current market conditions and investor sentiment

Question 4

Strategic Asset Allocation

Answer 4

the proportion of various types of investments composing a long-term investment portfolio. constructs a portfolio that mirrors a market index, such as the S&P 500.

Question 5

Fundamental Analysis

Answer 5

evaluate broad-based economic trends, current business conditions within an industry, and the quality of a particular corporation’s business, finances, and management.

Question 6

Technical analysts

Answer 6

attempt to predict the direction of prices on the basis of charts reflecting price and trading volume patterns of specific securities without regard to the issuer’s profitability

Question 7

Dividend Discount Model

Answer 7

This model attempts to estimate the current price of a stock.

Question 8

Dividend Growth Model

Answer 8

This model assumes that the amount of the annual dividend will grow at a constant rate

Question 9

Short Interest Theory

Answer 9

Short interest =number of shares that have been sold short. Because short positions must be repurchased eventually, some analysts believe that short interest= mandatory demand that creates a support level for stock prices. High short interest is a bullish indicator, and low short interest is a bearish indicator.

Question 10

Odd-Lot Theory

Answer 10

transactions of fewer than 100 shares. Odd-lot theorists believe that small investors invariably buy and sell at the wrong times. When odd-lot traders buy, odd-lot analysts are bearish. When odd-lot traders sell, odd-lot analysts are bullish.

Question 11

Advance/Decline Theory

Answer 11

The number of issues closing up or down on a specific day reflects market breadth. The number of advances and declines can be a significant indication of the market’s relative strength.

Question 12

Indexing

Answer 12

investing in a strategy that mirrors an index

Question 13

Growth Style

Answer 13

management focus on stocks of companies whose earnings are growing faster than most other stocks and are expected to continue to do so

Question 14

Value

Answer 14

management concentrate on undervalued or out-of-favor securities whose price is low relative to the company’s earnings or book value and whose earnings prospects are believed to be unattractive by investors and securities analysts.

Question 15

Market Capitalization

Answer 15

A company’s market capitalization (usually referred to as market cap) is the product of the number of outstanding shares and the current market price per share.

Question 16

Stochastic modeling

Answer 16

attempts to forecast how investment returns on different asset classes vary over time by using thousands of simulations to produce probability distributions for various outcomes– IE the Monte Carlo

Question 17

Barbell Strategy

Answer 17

the investor purchases bonds maturing in one or two years and an equal amount maturing in 10 (or more) years with no bonds in between.

Question 18

Bullet Strategy

Answer 18

example:A picture of this active strategy would reveal bonds purchased at different times but all maturing at the same time. This tends to allow the investor to capture current interest rates as they change rather than having the entire portfolio locked into one rate.

Question 19

Ladder strategy

Answer 19

bonds are all purchased at the same time but mature at different times

Question 20

Capital Market Theory

Answer 20

builds on a foundation of assumptions about investors’ behavio the goal of maximizing returns while minimizing risk-

Question 21

Modern portfolio theory (MPT)

Answer 21

emphasizes determining the relationship between risk and reward in the total portfolio rather than analyzing specific securities. Under the CAPM, the investor should be rewarded for the risks taken, so it is proper to assume that the higher the risk, the higher the return

Question 22

optimal portfolio

Answer 22

returns the highest rate of return consistent with the amount of risk an investor is willing to take.

Question 23

Capital Market Line

Answer 23

vides an expected return based on the total level of risk as measured by the standard deviation. The equation for the CML uses the:

expected return of the portfolio;
risk-free rate;
return on the market;
standard deviation of the market; and
standard deviation of the portfolio.

Question 24

efficient market hypothesis (EMH)

Answer 24

security prices adjust rapidly to new information with security prices fully reflecting all available information

Question 25

Weak Form Market Efficiency

Answer 25

holds that current stock prices have already incorporated all historical market data and that historical price trends are, therefore, of no value in predicting future price changes

Question 26

Semi-Strong Form Market Efficiency

Answer 26

holds that current stock prices not only reflect all historical price data but also reflect data from analyzing financial statements, industry, or current economic outlook. Thus, even fundamental analysis is of no value in this form, and only insider information may produce above-market returns. Technical analysis is also of no value.

Question 27

Strong Form Market Efficiency

Answer 27

security prices fully reflect all information from both public and private sources

Question 28

portfolio insurance strategy

Answer 28

the purchase of a protective put. Any profits in the stock are offset by the cost of the put premiums.

Question 29

covered call

Answer 29

a call written (sold) on a stock an investor owns. The covered call writer reduces the risk of that long stock position and generates income with the dollars received in premiums from selling the call. If the call is not exercised, the call writer keeps the premium. If the call is exercised, the covered call writer can deliver the stock owned. The covered call writer limits potential gain in exchange for the partial protection against a loss.

Question 30

Partial protection

Answer 30

by writing a covered call and receiving the premium, an investor, in effect, reduces the stock cost by the premium amount. If the stock price falls below the purchase price minus the premium received, the investor incurs a loss. Should the stock price rise dramatically, the stock will likely be called.