Session 18 - Reading 69 The Theory of Active Portfolio Management-LOS b

Session 18-Reading 69 The Theory of Active Portfolio Management-LOS b (Practice Questions, Sample Questions) Session 18: Portfolio Management: Capital Market Theoryand the Portfolio Management ProcessReading 69: The Theory of Active Portfolio ManagementLOS b: Discuss the steps and the approach of theTreynor-Black model for security selection. 1. An asset’s alpha returns are returns earned in addition to the asset’s: A) ex ante returns.B) projected returns. C) required returns (Explanation — Alpha returns are returns beyond the required return expected on anasset given its level of risk ) 2. Expected returns beyond required returns are referred to as an asset’s: A) beta. B) alpha. (Explanation — Alpha returns are returns beyond the required return expected on an asset givenits level of risk ) C) ex ante returns 3. Rosemary Stone, CFA, uses the Treynor-Black active portfolio optimization model. Stone attempts to quantify

the importance of security selection in the model. Stoneshould conclude that security selection is of highimportance if the actively managed portfolio ischaracterized by:Alpha Unsystematic risk A) Large Small (Explanation — The Treynor-Black portfolio optimization model assigns greater weight tothe actively managed portfolio if its alpha is largerelative to its unsystematic risk. As more weight isgiven to the actively managed portfolio, moreimportance is placed on active security selection(from which the actively managed portfolio iscreated) ) B) Large LargeC) Small Large 4. MPT Associates selects optimal portfolios using the Treynor-Black model. Randall Morgan and Charles Alverson,research associates at MPT, debate the assumptions of themodel. Morgan states that the model assumes that largenumbers of assets are mispriced. Alverson states that themodel places high importance on diversification.Regarding these statements: A) only Alverson is incorrect.B) both are incorrect. C) only Morgan is incorrect (Explanation — The Treynor-Black model combines modern portfolio theoryand market inefficiency. The model is based on thepremise that markets are nearly efficient, implyingthat the number of mispriced assets is small.Therefore, Morgan’s statement is not correct. Incontrast, Alverson’s statement is correct. TheTreynor-Black model incorporates active security

selection within an optimally diversified portfoliocontext. Therefore, the model places large value onthe importance of diversification ) 5. Amanda Keene, CFA, works for an investment firm that employs the Treynor-Black portfolio optimization model.Keene predicts that the market index return will movehigher next year as markets move closer to equilibrium.Keene advises a client, whose risk aversion will remainunchanged next year. Using the Treynor-Black framework,Keene should make which of the following changes in herclient’s allocations, with respect to the percentage ofactively managed and passively managed portfolios, notingthat the remaining percentage is allocated to cash? A) Decrease only actively managed portfolios.(Explanation — The client’s risk aversion will remain unchanged next year, which suggests that thepercentage allocated to cash will not change. A highermarket return suggests greater weight should be placedon the passively managed portfolio, especially inlight of Keene’s prediction that markets will movecloser to equilibrium. Less emphasis is placed onactive management as markets move toward equilibrium(alphas move closer to zero) ) B) Decrease both portfolios.C) Decrease only passively managed portfolios