Portfolio Management Exam General Study Notes

PORTFOLIO MANAGEMENT
Q&A
QUESTION 1: Determine two benefits and two drawbacks of exchange traded funds versus mutual
funds.

QUESTION 2: Explain the function of convexity in bond portfolio and how modified duration and
convexity are used to approximate the bond’s percentage change in price, given a large change in
interest rates

QUESTION 3: The Capital Asset Pricing Model contends that there is a systematic and unsystematic risk
for an individual security. Which is the relevant risk variable and why is it relevant? Why is the other risk
variable not relevant?

QUESTION 4: The standard deviation of Maxis Ltd stock is 14%. The standard deviation of Jeans Co. stock
is 10.5%. The covariance between these two stocks is 100. What is the correlation between Maxis and
Jeans stock? How does the correlation affect the standard deviation and expected return of a portfolio?

QUESTION 5: Mac is considering investing in either a risk free asset or a risky asset. Her expected rate of
return is 15% and standard deviation is 25%. The risk free asset offers a rate of return of 6.5%. Assuming
that Lily’s risk aversion parameter is 4, which asset do you think that Mac would prefer to invest in?
Explain

QUESTION 6: Briefly explain the risk exposures as defined by Burmeister, Roll and Ross (1994) to analyse
the predictive ability of a multifactor model

QUESTION 7: The standard deviation of Caltex Ltd stock is 20%. The standard deviation of Calmax Ltd
stock is 16%. The covariance between these two stocks is 100. What is the correlation between Caltex
and Calmax stock? How does the correlation affect the standard deviation and expected return of a
portfolio?

QUESTION 8: Illustrate and explain graphically the types of risk in the portfolio and how to measure
diversification?

QUESTION 9: A newly issued bond has a maturity of 10 years and pays a 7% coupon rate (annual
payments). The bond sells at par value.

QUESTION 10: Illustrate the five price sensitivity characteristics of Macaulay duration and explain.

AND MORE

,PORTFOLIO MANAGEMENT EXAM GENERAL NOTES, AUGUST 2020


QUESTION 1: Determine two benefits and two drawbacks of exchange traded funds versus
mutual funds.
ANSWERS:
Benefits of ETF over Mutual Funds:
•ETFs are continuously traded and can be sold or purchased on margin.
•There are no capital gains tax
•Investors buy from brokers, thus eliminating the cost of direct marketing to
individual small investors. This implies lower management fees.


Drawbacks of ETFs as compared to Mutual funds:
•Prices can depart from NAV (unlike an open ended fund)
•There is a broker fee when buying and selling (unlike a no load fund)


QUESTION 2: Explain the function of convexity in bond portfolio and how modified duration
and convexity are used to approximate the bond’s percentage change in price, given a large
change in interest rates.


ANSWERS: Convexity measures the rate of change in modified duration as yields
change. Convexity refers to the shape of the price yield relationship and can be used to
refine the modified duration approximation of the sensitivity of prices to the interest rate
changes. Convexity shows the extent to which bond prices rise at a greater rate than they
fall. The effect of duration on price and the effect of convexity on price should be added
together to obtain an improved approximation of the change in price for a given change in
yield.

, QUESTION 3: The Capital Asset Pricing Model contends that there is a systematic and
unsystematic risk for an individual security. Which is the relevant risk variable and why is it
relevant? Why is the other risk variable not relevant?


ANSWERS: In CAPM world the relevant risk variable is the security’s systematic risk-
its covariance of return with all other risky assets in the market. This risk cannot be
eliminated. The unsystematic risk is not relevant because it can be eliminated through
diversification- for instance, when you hold a large number of securitied, the poor
management capability, etc of some companies will be offset by the above average
capability of others.


QUESTION 4: The standard deviation of Maxis Ltd stock is 14%. The standard deviation of
Jeans Co. stock is 10.5%. The covariance between these two stocks is 100. What is the
correlation between Maxis and Jeans stock? How does the correlation affect the standard
deviation and expected return of a portfolio?


ANSWERS:
Correlation = 1/(0.14)(0.15) = 0.68 (2)
• The higher the correlation the higher the portfolio standard deviation
• The lower the correlation the lower the portfolio standard deviation
• Correlation does not have impact towards the expected return of the
portfolio