Title Portfolio Management - Solution.pdf ✅

CFA Program Level I for February 2024 1 Portfolio Management (Solution) 1. A. Incorrect because the risk tolerance for defined benefit pension plans will vary with the maturity of the plan, but is typically quite high. B. Incorrect because defined contribution pension plans are managed for individual investors, therefore the risk tolerance of each plan varies with the individual. Some individuals will be investing for growth and will therefore seek assets that have the potential for capital gains. Others, such as retirees, may need to draw an income from their assets and may therefore choose to invest more in fixed-income and dividend-paying shares. The investment needs of individuals will depend in part on their broader financial circumstances, such as their employment prospects and whether or not they own their own residence. They may also need to consider such issues as building up a cash reserve and the purchase of appropriate insurance policies before undertaking longer-term investments. The risk tolerance of an individual investor varies by individual. C. Correct because defined benefit pension plans (DB plans) are company-sponsored plans that offer employees a predefined benefit on retirement. The future benefit is defined because the DB plan requires the plan sponsor to specify the obligation stated in terms of the retirement income benefits owed to participants. Portfolio Management: describe defined contribution and defined benefit pension plans 2. A. Incorrect because risk management is not about minimizing risk; it is about actively understanding and embracing those risks that best balance the achievement of goals with an acceptable chance of failure, quantifying the exposure, and continually monitoring and modifying it. B. Correct because risk management is the process by which an organization or individual defines the level of risk to be taken, measures the level of risk being taken, and adjusts the latter toward the former, with the goal of maximizing the company's or portfolio's value... Said differently, risk management comprises all the decisions and actions needed to best achieve organizational or personal objectives while bearing a tolerable level of risk. C. Incorrect because risk management is not even about predicting risks. The Doctrine of No Surprises' is a key mantra among many risk managers, but it does not mean they are expected to predict what will happen. Portfolio Management: define risk management
CFA Program Level I for February 2024 2 3. A. Incorrect because to achieve the best results for an organization, risk governance should take an enterprise-wide view. B. Incorrect because good governance should include defining an organization's risk tolerance and providing risk oversight. C. Correct because risk governance is the top-down [not bottom-up] process and guidance that directs risk management activities to align with and support the overall enterprise. Portfolio Management: define risk governance and describe elements of effective risk governance 4. A. Incorrect because a return objective can be a required rate of return. The return objective could be a required return- that is, the amount the investor needs to earn to meet a particular future goal-such as a certain level of retirement income. C. Correct because a benchmark is used as a relative return objective and a good benchmark should be investable. B. Incorrect because the return objective must be consistent with the client's risk objective (high expected returns are unlikely to be possible without high levels of risk) Portfolio Management: describe risk and return objectives and how they may be developed for a client 5. A. Incorrect because a combination of the risk-free asset and a risky asset can result in a better risk-return trade-off than an investment in only one type of asset because the risk- free asset has zero correlation with the risky asset. The optimal risky portfolio is a risky asset, and thus has zero correlation with the risk-free asset. B. Correct because a combination of the risk-free asset and a risky asset can result in a better risk-return trade-off than an investment in only one type of asset because the risk- free asset has zero correlation with the risky asset. The optimal risky portfolio is a risky asset, and thus has zero correlation with the risk-free asset. C. Incorrect because a combination of the risk-free asset and a risky asset can result in a better risk-return trade-off than an investment in only one type of asset because the risk- free asset has zero correlation with the risky asset. The optimal risky portionio is a risky asset and thus has zero correlation with the risk-free asset. Portfolio Management: describe the implications of combining a risk-free asset with a portfolio of risky assets
CFA Program Level I for February 2024 3 6. A. Incorrect because a lending portfolio is a portfolio that has a positive investment in the risk-free asset. A portfolio's expected return, E(Rp), is calculated as: E(Rp) = w1Rf + (1 - w1)E(Rm), where w1 is the proportion invested in the risk-free asset, returning Rf, and E(Rm) is the expected return on the market portfolio. Thus, 0.18 = w1 x 0.03 + (1 - w1) x 0.15 0.18 - 0.15W = w1 x (0.03 - 0.15) 0.03 = w1 x (-0.12) w1 = 0.03/(-0.12) W1 = -0.25 A negative proportion invested in the risk-free rate implies a leveraged, not a lending, portfolio. B. Correct because a leveraged portfolio is a portfolio that has a negative investment in the risk-free asset. A portfolio's expected return, E(R), is calculated as: E(R) = w1R,+ (1 - w1)E(R), where w, is the proportion invested in the risk-free asset, returning R,, and E(R) is the expected return on the market portfolio. Thus, 0.18 = w1 x 0.03 + (1 - w1) x 0.15 0.18 - 0.15 = w1 (0.03 - 0.15) 0.03 = w1 x (-0.12) w1 = 0.03/(-0.12) W1 =-0.25 A negative proportion invested in the risk-free rate implies a leveraged portfolio. C. Incorrect because the expected market return is 15%, while the expected portfolio return is 18%. Since the two returns are different, the investor's portfolio is different from the optimal risky (market) portfolio. Portfolio Management: explain the capital allocation line (CAL) and the capital market line (CML) 7. A. Incorrect because a risk-free asset (σ 2 = 0) generates the same utility for all individuals B. Correct because a risk-free asset (σ 2 = 0) generates the same utility for all individuals. If σ 2 = 0, then U = E(r) - 1/2(A)( σ 2 ) = E(r) for all individuals C. Incorrect because a risk-free asset (σ 2 = 0) generates the same utility for all individuals. Portfolio Management: explain risk aversion and its implications for portfolio selection
CFA Program Level I for February 2024 4 8. A. Incorrect because a risk-seeking investor would maximize both risk and return. A risk- neutral investor maximizes return irrespective of risk. That is, a risk-neutral investor deliberately seeks to maximize only return, not risk. It is possible that a risk-neutral investor could end up maximizing risk by maximizing return, but he only seeks to maximize return and risk is not a consideration B. Correct because A risk-neutral investor would maximize return irrespective of risk. This is because such an investor cares only about return and not about risk, so higher return investments are more desirable even if they come with higher risk. C. Incorrect because only risk-averse investors want to minimize their risk for the same amount of return, and maximize their return for the same amount of risk. A risk-neutral investor seeks to maximize return irrespective of risk, not for a given level of risk. Portfolio Management: explain risk aversion and its implications for portfolio selection 9. A. Correct Correct because provides a measure of portfolio return that is adjusted for the total risk of the portfolio and is computed asM2 = [E(Rp) - R(σm ∕ σp) + Rt = SR x σm + Rt , where SR = Sharpe ratio, σm = market standard deviation of returns, and R,= risk-free rate. Thus, M2 = 0.8 x 0.12 + 0.02 0.116. The difference between the risk- adjusted performance of the portfolio and the performance of the market is frequently referred to as M2 alpha. Thus, M2 alpha = 0.116 -0.08 -0.0363.6%. B. Incorrect because it computes M2 = 0.02+0.8 x 0.12 = 0.116. M2 alpha is wrongly calculated as 0.116 - (0.08 - 0.02) = 0.056 ≈ 5.6%. C. Incorrect because it computes M2 instead of M2 alpha, which is an intermediate step in the correct calculation: M2 = 0.02 + 0.8 x 0.12 = 0.116 ≈ 11.6%. Portfolio Management: calculate and interpret the Sharpe ratio, Treynor ratio, M 2, and Jensen's alpha 10. A. Correct because overconfidence bias is a bias in which people demonstrate unwarranted faith in their own abilities. As a result of overconfidence bias, FMPs (financial market participants] may hold poorly diversified portfolios, which may result in significant downside risk. B. Incorrect because this is a potential consequence of endowment bias, not overconfidence bias. Endowment bias is an emotional bias in which people value an asset more when they