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Multiple Choice Questions 1. In the Treynor-Black model A) portfolio weight are sensitive to large alpha values which can lead to infeasible long or short position for many portfolio managers. B) portfolio weight are not sensitive to large alpha values which can lead to infeasible long or short position for many portfolio managers. C) portfolio weight are sensitive to large alpha values which can lead to the optimal portfolio for most portfolio managers. D) portfolio weight are not sensitive to large alpha values which can lead to the optimal portfolio for most portfolio managers. E) none of the above. Answer: A Difficulty: Moderate 2. Benchmark portfolio risk is defined as A) the return difference between the portfolio and the benchmark B) the variance of the return of the benchmark portfolio C) the variance of the return difference between the portfolio and the benchmark D) the variance of the return of the actively-managed portfolio E) none of the above. Answer: C Difficulty: Moderate 3. Benchmark portfolio risk A) is inevitable and is never a significant issue in practice. B) is inevitable and is always a significant issue in practice. C) cannot be constrained to keep a Treynor-Black portfolio within reasonable weights. D) can be constrained to keep a Treynor-Black portfolio within reasonable weights. E) none of the above. Answer: D Difficulty: Moderate 4. ____________ can be used to measure forecast quality and guide in the proper adjustment of forecasts. A) regression analysis B) exponential smoothing C) ARIMA D) moving average models E) GAUSS Answer: A Difficulty: Moderate
Strategy ___ is the dominant strategy because __________. A) 1, it is riskless B) 1, it has the highest reward/risk ratio C) 2, its return is at least equal to Strategy 1 and sometimes greater D) 2, it has the highest reward/risk ratio E) both strategies are equally preferred. Answer: C Difficulty: Moderate Rationale: Strategy 2 dominates Strategy 1, even though it is riskier, because it always returns at least as much as Strategy 1 and sometimes more. 26. The Treynor-Black model assumes that A) the objective of security analysis is to form an active portfolio of a limited number of mispriced securities. B) the cost of less than full diversification comes from the nonsystematic risk of the mispriced stock. C) the optimal weight of a mispriced security in the active portfolio is a function of the degree of mispricing, the market sensitivity of the security, and its degree of nonsystematic risk. D) all of the above are true. E) none of the above is true. Answer: D Difficulty: Moderate Rationale: All of the statements correctly describe assumptions of the Treynor-Black model.
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Answer: C Difficulty: Difficult Rationale: The active manager can use both the Sharpe measure and mean-variance analysis. The risk-free asset can be included as called for by market conditions. The active manager is seeking out mispricings and will want to exploit them. If there are a few very attractive securities the manager might have a concentration of these in the portfolio, which could lead to poor diversification. 34. To determine the optimal risky portfolio in the Treynor-Black Model, macroeconomic forecasts are used for the _________ and composite forecasts are used for the __________. A) passive index portfolio; active portfolio B) active portfolio, passive index portfolio C) expected return; standard deviation D) expected return ; beta coefficient E) alpha coefficient; beta coefficient Answer: A Difficulty: Moderate Rationale: The two factors combine to determine the optimal risky portfolio. 35. The beta of an active portfolio is 1.45. The standard deviation of the returns on the market index is 22%. The nonsystematic variance of the active portfolio is 3%. The standard deviation of the returns on the active portfolio is __________. A) 36.30% B) 5.84% C) 19.60% D) 24.17% E) 26.0% Answer: A Difficulty: Difficult Rationale: s = [(1.45)2(0.22)2 + 0.03]1/2 = [0.13176]1/2 = 36.3%.
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Answer: D Difficulty: Moderate Essay Questions 41. Discuss the Treynor-Black model. Difficulty: Moderate Answer: The Treynor-Black estimates the alpha, beta, and residual risk of securities under consideration for a portfolio. The model uses these estimates to determine the optimal weights of each of these securities in the portfolio. These composite estimates for the active portfolio and the macroeconomic forecasts for the passive index portfolio are used to determine the optimal risky portfolio, which will be a combination of the passive and active portfolios. The purpose of this question is to ascertain if the student understands the basic concepts behind this model, which allows the portfolio manager to utilize both active and passive components of portfolio building to obtain an optimal portfolio.
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forecasts. If there is no bias a =0 and a =1. The forecast errors are uncorrelated with the
0 1
2 2 2 f = +
To measure the value of the forecast, you would use the squared correlation coefficient between the forecasts and the realizations. This can also be determined by the formula 2 2 = 2 2 + . If the analyst has perfect forecasting ability the correlation coefficient will be 1. If the analyst has no ability then the correlation coefficient will be 0. For values in between 0 and 1 you can adjust the forecasts by multiplying by the correlation. The value of active management depends on the analyst's ability to forecast accurately. The best way to exploit analysts' forecasts is with the Treynor-Black model.
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