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Chapter 27
The Theory of Active Portfolio Management
Multiple Choice Questions
3. If you begin with a ______ and obtain additional data from an experiment you can form a
______.
A. posterior distribution; prior distribution
B. prior distribution; posterior distribution
C. tight posterior; Bayesian analysis
D. tight prior; Bayesian analysis
E. None of these is true.
27-1
5. Benchmark 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 these is true.
6. ____________ 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
8. The ____________ model allows the private views of the portfolio manager to be
incorporated with market data in the optimization procedure.
A. Black-Litterman
B. Treynor-Black
C. Treynor-Mazuy
D. Black-Scholes
E. None of these is true.
27-2
10. The Black-Litterman model is geared toward ____________ while the Treynor-Black
model is geared toward ____________.
A. security analysis; security analysis
B. asset allocation; asset allocation
C. security analysis; asset allocation
D. asset allocation; security analysis
E. None of these is true.
27-3
13. The tracking error of an optimized portfolio can be expressed in terms of the
____________ of the portfolio and thus reveals ____________.
A. return; portfolio performance
B. total risk; portfolio performance
C. beta; portfolio performance
D. beta; benchmark risk
E. relative return; benchmark risk
14. The Treynor-Black model is a model that shows how an investment manager can use
security analysis and statistics to construct __________.
A. a market portfolio
B. a passive portfolio
C. an active portfolio
D. an index portfolio
E. a balanced portfolio
15. If a portfolio manager consistently obtains a high Sharpe measure, the manager's
forecasting ability __________.
A. is above average
B. is average
C. is below average
D. does not exist
E. cannot be determined based on the Sharpe measure
27-4
18. The critical variable in the determination of the success of the active portfolio is
________.
A. alpha/systematic risk
B. alpha/nonsystematic risk
C. gamma/systematic risk
D. gamma/nonsystematic risk
E. None of these is true.
20. Active portfolio managers try to construct a risky portfolio with __________.
A. a higher Sharpe measure than a passive strategy
B. a lower Sharpe measure than a passive strategy
C. the same Sharpe measure as a passive strategy
D. very few securities
E. None of these is true.
27-5
21. The beta of an active portfolio is 1.20. The standard deviation of the returns on the market
index is 20%. The nonsystematic variance of the active portfolio is 1%. The standard
deviation of the returns on the active portfolio is __________.
A. 3.84%
B. 5.84%
C. 19.60%
D. 24.17%
E. 26.0%
22. The beta of an active portfolio is 1.36. The standard deviation of the returns on the market
index is 22%. The nonsystematic variance of the active portfolio is 1.2%. The standard
deviation of the returns on the active portfolio is __________.
A. 3.19%
B. 31.86%
C. 42.00%
D. 27.57%
E. 2.86%
23. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected
return on the market index is 16%. The variance of return on the market portfolio is 4%. The
nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%. The
beta of the active portfolio is 1. The optimal proportion to invest in the active portfolio is
__________.
A. 0%
B. 25%
C. 50%
D. 100%
E. None of these is true.
27-6
24. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected
return on the market index is 16%. The variance of the return on the market portfolio is 4%.
The nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%.
The beta of the active portfolio is 1.05. The optimal proportion to invest in the active portfolio
is __________.
A. 48.7%
B. 50.0%
C. 51.3%
D. 100.0%
E. None of these is true.
25. There appears to be a role for a theory of active portfolio management because
A. some portfolio managers have produced sequences of abnormal returns that are difficult to
label as lucky outcomes.
B. the "noise" in the realized returns is enough to prevent the rejection of the hypothesis that
some money managers have outperformed a passive strategy by a statistically small, yet
economic, margin.
C. some anomalies in realized returns have been persistent enough to suggest that portfolio
managers who identified these anomalies in a timely fashion could have outperformed a
passive strategy over prolonged periods.
D. some portfolio managers have produced sequences of abnormal returns that are difficult to
label as lucky outcomes; and the "noise" in the realized returns is enough to prevent the
rejection of the hypothesis that some money managers have outperformed a passive strategy
by a statistically small, yet economic, margin.
E. some portfolio managers have produced sequences of abnormal returns that are difficult to
label as lucky outcomes; the "noise" in the realized returns is enough to prevent the rejection
of the hypothesis that some money managers have outperformed a passive strategy by a
statistically small, yet economic, margin; and some anomalies in realized returns have been
persistent enough to suggest that portfolio managers who identified these anomalies in a
timely fashion could have outperformed a passive strategy over prolonged periods.
27-7
27. Which of the following are not true regarding the Treynor-Black model?
A. considers both macroeconomic and microeconomic risks
B. considers security selection only
C. is nearly impossible to implement
D. considers both macroeconomic and microeconomic risks and is nearly impossible to
implement
E. considers security selection only and is nearly impossible to implement
28. To improve future analyst forecasts using the statistical properties of past forecasts, a
regression model can be fitted to past forecasts. The intercept of the regression is a
__________ coefficient, and the regression beta represents a __________ coefficient.
A. bias; precision
B. bias; bias
C. precision; precision
D. precision; bias
E. None of these is true.
27-8
27-9
34. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected
return on the market index is 18%. The standard deviation of the return on the market
portfolio is 25%. The nonsystematic standard deviation of the active portfolio is 15%. The
risk-free rate of return is 6%. The beta of the active portfolio is 1.2. The optimal proportion to
invest in the active portfolio is __________.
A. 50.0%
B. 69.4%
C. 72.3%
D. 80.6%
E. 100.0%
35. According to the Treynor-Black model, the weight of a security in the active portfolio
depends on the ratio of __________ to __________.
A. the degree of mispricing; the nonsystematic risk of the security
B. the degree of mispricing; the systematic risk of the security
C. the market sensitivity of the security; the nonsystematic risk of the security
D. the nonsystematic risk of the security; the systematic risk of the security
E. the total return on the security; the nonsystematic risk of the security
27-10
36. One property of a risky portfolio that combines an active portfolio of mispriced securities
with a market portfolio is that, when optimized, its squared Sharpe measure increases by the
square of the active portfolio's
A. Sharpe ratio.
B. information ratio.
C. alpha.
D. Treynor measure.
E. None of these is true.
38. A manager who uses the mean-variance theory to construct an optimal portfolio will
satisfy
A. investors with low risk-aversion coefficients.
B. investors with high risk-aversion coefficients.
C. investors with moderate risk-aversion coefficients.
D. all investors, regardless of their level of risk aversion.
E. only clients with whom she has established long-term relationships, because she knows
their personal preferences.
39. Ideally, clients would like to invest with the portfolio manager who has
A. a moderate personal risk-aversion coefficient.
B. a low personal risk-aversion coefficient.
C. the highest Sharpe measure.
D. the highest record of realized returns.
E. the lowest record of standard deviations.
27-11
41. 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
42. 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%
27-12
43. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected
return on the market index is 11%. The variance of return on the market portfolio is 6%. The
nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 4%. The
beta of the active portfolio is 1.1. The optimal proportion to invest in the active portfolio is
__________.
A. 45%
B. 25%
C. 50%
D. 100%
E. None of these is true.
44. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected
return on the market index is 10%. The variance of the return on the market portfolio is 4%.
The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%.
The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio
is __________.
A. 48.7%
B. 98.3%
C. 51.3%
D. 100.0%
E. None of these is true.
45. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected
return on the market index is 12%. The variance of the return on the market portfolio is 4%.
The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%.
The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio
is __________.
A. 48.7%
B. 98.3%
C. 47.6%
D. 100.0%
E. None of these is true.
27-13
46. Perfect timing ability is equivalent to having __________ on the market portfolio.
A. a call option
B. a futures contract
C. a put option
D. a commodities contract
E. None of these is true.
47. Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be
willing to pay for active management, over and above the fee charged by a passive index
fund, depends on
I) the investor's coefficient of risk aversion.
II) the value of at-the-money call option on the market portfolio.
III) the value of out-of-the-money call option on the market portfolio.
IV) the precision of the security analyst.
V) the distribution of the squared information ratio of in the universe of securities.
A. I, II, IV
B. I, III, V
C. II, IV, V
D. I, IV, V
E. II, III, V
48. Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be
willing to pay for active management, over and above the fee charged by a passive index
fund, does not depend on
I) the investor's coefficient of risk aversion.
II) the value of at-the-money call option on the market portfolio.
III) the value of out-of-the-money call option on the market portfolio.
IV) the precision of the security analyst.
V) the distribution of the squared information ratio of in the universe of securities.
A. I, II, IV
B. II, III, V
C. II, III
D. I, IV, V
E. II, IV, V
27-14
50. You have a record of an analyst's past forecasts of alpha. Describe how you would use this
information within the context of the Treynor-Black model to determine the forecasting
ability of the analyst.
27-15
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-16
3. If you begin with a ______ and obtain additional data from an experiment you can form a
______.
A. posterior distribution; prior distribution
B. prior distribution; posterior distribution
C. tight posterior; Bayesian analysis
D. tight prior; Bayesian analysis
E. None of these is true.
If you begin with a prior distribution and obtain additional data from an experiment you can
form a posterior distribution.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-17
5. Benchmark 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 these is true.
Benchmark portfolio risk can be constrained to keep a Treynor-Black portfolio within
reasonable weights.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
6. ____________ 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
Regression analysis can be used to measure forecast quality and guide in the proper
adjustment of forecasts.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-18
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
8. The ____________ model allows the private views of the portfolio manager to be
incorporated with market data in the optimization procedure.
A. Black-Litterman
B. Treynor-Black
C. Treynor-Mazuy
D. Black-Scholes
E. None of these is true.
The Black-Litterman model allows the private views of the portfolio manager to be
incorporated with market data in the optimization procedure.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-19
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
10. The Black-Litterman model is geared toward ____________ while the Treynor-Black
model is geared toward ____________.
A. security analysis; security analysis
B. asset allocation; asset allocation
C. security analysis; asset allocation
D. asset allocation; security analysis
E. None of these is true.
The Black-Litterman model is geared toward asset allocation while the Treynor-Black model
is geared toward security analysis.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-20
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-21
13. The tracking error of an optimized portfolio can be expressed in terms of the
____________ of the portfolio and thus reveals ____________.
A. return; portfolio performance
B. total risk; portfolio performance
C. beta; portfolio performance
D. beta; benchmark risk
E. relative return; benchmark risk
The tracking error of an optimized portfolio can be expressed in terms of the beta of the
portfolio and thus reveal benchmark risk.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
14. The Treynor-Black model is a model that shows how an investment manager can use
security analysis and statistics to construct __________.
A. a market portfolio
B. a passive portfolio
C. an active portfolio
D. an index portfolio
E. a balanced portfolio
The Treynor-Black model is a model that shows how an investment manager can use security
analysis and statistics to construct an active portfolio.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
27-22
15. If a portfolio manager consistently obtains a high Sharpe measure, the manager's
forecasting ability __________.
A. is above average
B. is average
C. is below average
D. does not exist
E. cannot be determined based on the Sharpe measure
The manager with the highest Sharpe measure presumably has true forecasting abilities.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
27-23
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
18. The critical variable in the determination of the success of the active portfolio is
________.
A. alpha/systematic risk
B. alpha/nonsystematic risk
C. gamma/systematic risk
D. gamma/nonsystematic risk
E. None of these is true.
A portfolio with a positive alpha is outperforming the market. If this portfolio also has a low
degree of nonsystematic risk, the portfolio is adequately diversified.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-24
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
20. Active portfolio managers try to construct a risky portfolio with __________.
A. a higher Sharpe measure than a passive strategy
B. a lower Sharpe measure than a passive strategy
C. the same Sharpe measure as a passive strategy
D. very few securities
E. None of these is true.
A higher Sharpe measure than a passive strategy is indicative of the benefits of active
management.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-25
21. The beta of an active portfolio is 1.20. The standard deviation of the returns on the market
index is 20%. The nonsystematic variance of the active portfolio is 1%. The standard
deviation of the returns on the active portfolio is __________.
A. 3.84%
B. 5.84%
C. 19.60%
D. 24.17%
E. 26.0%
s = [(1.2)2(0.2)2 + 0.01]1/2 = [0.0676]1/2 = 26.0%.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
22. The beta of an active portfolio is 1.36. The standard deviation of the returns on the market
index is 22%. The nonsystematic variance of the active portfolio is 1.2%. The standard
deviation of the returns on the active portfolio is __________.
A. 3.19%
B. 31.86%
C. 42.00%
D. 27.57%
E. 2.86%
s = [(1.36)2(0.22)2 + 0.012]1/2 = [0.10152]1/2 = 31.86%.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
27-26
23. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected
return on the market index is 16%. The variance of return on the market portfolio is 4%. The
nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%. The
beta of the active portfolio is 1. The optimal proportion to invest in the active portfolio is
__________.
A. 0%
B. 25%
C. 50%
D. 100%
E. None of these is true.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Scrambling: LockedAnswer: D
Topic: Active management
24. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected
return on the market index is 16%. The variance of the return on the market portfolio is 4%.
The nonsystematic variance of the active portfolio is 1%. The risk-free rate of return is 8%.
The beta of the active portfolio is 1.05. The optimal proportion to invest in the active portfolio
is __________.
A. 48.7%
B. 50.0%
C. 51.3%
D. 100.0%
E. None of these is true.
wO = [1%/1%]/[(16% 8%)/4%] = 0.5; w* = 0.5/[1 + (1 1.05)0.5] = 0.513, or 51.3%.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
27-27
25. There appears to be a role for a theory of active portfolio management because
A. some portfolio managers have produced sequences of abnormal returns that are difficult to
label as lucky outcomes.
B. the "noise" in the realized returns is enough to prevent the rejection of the hypothesis that
some money managers have outperformed a passive strategy by a statistically small, yet
economic, margin.
C. some anomalies in realized returns have been persistent enough to suggest that portfolio
managers who identified these anomalies in a timely fashion could have outperformed a
passive strategy over prolonged periods.
D. some portfolio managers have produced sequences of abnormal returns that are difficult to
label as lucky outcomes; and the "noise" in the realized returns is enough to prevent the
rejection of the hypothesis that some money managers have outperformed a passive strategy
by a statistically small, yet economic, margin.
E. some portfolio managers have produced sequences of abnormal returns that are difficult to
label as lucky outcomes; the "noise" in the realized returns is enough to prevent the rejection
of the hypothesis that some money managers have outperformed a passive strategy by a
statistically small, yet economic, margin; and some anomalies in realized returns have been
persistent enough to suggest that portfolio managers who identified these anomalies in a
timely fashion could have outperformed a passive strategy over prolonged periods.
There appears to be a role for a theory of active portfolio management because some portfolio
managers have produced sequences of abnormal returns that are difficult to label as lucky
outcomes, the "noise" in the realized returns is enough to prevent the rejection of the
hypothesis that some money managers have outperformed a passive strategy by a statistically
small, yet economic, margin, and some anomalies in realized returns have been persistent
enough to suggest that portfolio managers who identified these anomalies in a timely fashion
could have outperformed a passive strategy over prolonged periods.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
27-28
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
27. Which of the following are not true regarding the Treynor-Black model?
A. considers both macroeconomic and microeconomic risks.
B. considers security selection only.
C. is nearly impossible to implement.
D. considers both macroeconomic and microeconomic risks and is nearly impossible to
implement.
E. considers security selection only and is nearly impossible to implement.
The Treynor-Black model considers both macroeconomic and microeconomic risks. Other
answers are false.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
27-29
28. To improve future analyst forecasts using the statistical properties of past forecasts, a
regression model can be fitted to past forecasts. The intercept of the regression is a
__________ coefficient, and the regression beta represents a __________ coefficient.
A. bias, precision
B. bias, bias
C. precision, precision
D. precision, bias
E. None of these is true.
The estimated equation adjusts future forecasts for direction and magnitude of bias and degree
of imprecision in past forecasts.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
27-30
AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: Active management
AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: Active management
27-31
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Active management
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Active management
27-32
34. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected
return on the market index is 18%. The standard deviation of the return on the market
portfolio is 25%. The nonsystematic standard deviation of the active portfolio is 15%. The
risk-free rate of return is 6%. The beta of the active portfolio is 1.2. The optimal proportion to
invest in the active portfolio is __________.
A. 50.0%
B. 69.4%
C. 72.3%
D. 80.6%
E. 100.0%
wO = [3%/2.25%]/[(18% 6%)/6.25%] = 0.6944; w* = 0.6944/[1 + (1 1.2)0.6944] =
0.8064, or 80.6%.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
35. According to the Treynor-Black model, the weight of a security in the active portfolio
depends on the ratio of __________ to __________.
A. the degree of mispricing; the nonsystematic risk of the security
B. the degree of mispricing; the systematic risk of the security
C. the market sensitivity of the security; the nonsystematic risk of the security
D. the nonsystematic risk of the security; the systematic risk of the security
E. the total return on the security; the nonsystematic risk of the security
The weight of the mispriced security in the active portfolio depends on the degree of
mispricing (alpha) in proportion to the nonsystematic risk added by holding the security.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Active management
27-33
36. One property of a risky portfolio that combines an active portfolio of mispriced securities
with a market portfolio is that, when optimized, its squared Sharpe measure increases by the
square of the active portfolio's
A. Sharpe ratio.
B. information ratio.
C. alpha.
D. Treynor measure.
E. None of these is true.
When optimized, a property of the overall risky portfolio is that its squared Sharpe measure
increases by the square of the active portfolio's information ratio.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-34
38. A manager who uses the mean-variance theory to construct an optimal portfolio will
satisfy
A. investors with low risk-aversion coefficients.
B. investors with high risk-aversion coefficients.
C. investors with moderate risk-aversion coefficients.
D. all investors, regardless of their level of risk aversion.
E. only clients with whom she has established long-term relationships, because she knows
their personal preferences.
The optimal portfolio will be the one with the highest reward-to-variability ratio. Investors
can choose for themselves how they want to combine this portfolio with the risk-free asset to
take on more or less risk.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
39. Ideally, clients would like to invest with the portfolio manager who has
A. a moderate personal risk-aversion coefficient.
B. a low personal risk-aversion coefficient.
C. the highest Sharpe measure.
D. the highest record of realized returns.
E. the lowest record of standard deviations.
The Sharpe measure is commonly used to measure the performance of professional managers.
A good manager has a steeper CAL than the one from following a passive strategy.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
27-35
AACSB: Analytic
Bloom's: Remember
Difficulty: Challenge
Topic: Active management
41. 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
The two factors combine to determine the optimal risky portfolio.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-36
42. 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%
s = [(1.45)2(0.22)2 + 0.03]1/2 = [0.13176]1/2 = 36.3%.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
43. Consider the Treynor-Black model. The alpha of an active portfolio is 1%. The expected
return on the market index is 11%. The variance of return on the market portfolio is 6%. The
nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 4%. The
beta of the active portfolio is 1.1. The optimal proportion to invest in the active portfolio is
__________.
A. 45%
B. 25%
C. 50%
D. 100%
E. None of these is true.
wO = [1%/2%]/[(11% 4%)/6%] = .4286, or 42.86%; w* = .4286/[1 + (1 1.1).4286] =
0.4478.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
27-37
44. Consider the Treynor-Black model. The alpha of an active portfolio is 3%. The expected
return on the market index is 10%. The variance of the return on the market portfolio is 4%.
The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%.
The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio
is __________.
A. 48.7%
B. 98.3%
C. 51.3%
D. 100.0%
E. None of these is true.
wO = [3%/2%]/[(10% 3%)/4%] = 0.857; w* = 0.857/[1 + (1 1.15)0.857] = .983., or
98.3%.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
45. Consider the Treynor-Black model. The alpha of an active portfolio is 2%. The expected
return on the market index is 12%. The variance of the return on the market portfolio is 4%.
The nonsystematic variance of the active portfolio is 2%. The risk-free rate of return is 3%.
The beta of the active portfolio is 1.15. The optimal proportion to invest in the active portfolio
is __________.
A. 48.7%
B. 98.3%
C. 47.6%
D. 100.0%
E. None of these is true.
wO = [2%/2%]/[(12% 3%)/4%] = 0.444; w* = 0.444/[1 + (1 1.15) 0.444] = .476., or
47.6%.
AACSB: Analytic
Bloom's: Apply
Difficulty: Challenge
Topic: Active management
27-38
46. Perfect timing ability is equivalent to having __________ on the market portfolio.
A. a call option
B. a futures contract
C. a put option
D. a commodities contract
E. None of these is true.
Perfect foresight is equivalent to holding a call option on the equity portfolio.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Active management
47. Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be
willing to pay for active management, over and above the fee charged by a passive index
fund, depends on
I) the investor's coefficient of risk aversion
II) the value of at-the-money call option on the market portfolio
III) the value of out-of-the-money call option on the market portfolio
IV) the precision of the security analyst
V) the distribution of the squared information ratio of in the universe of securities
A. I, II, IV
B. I, III, V
C. II, IV, V
D. I, IV, V
E. II, III, V
Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be willing
to pay for active management, over and above the fee charged by a passive index fund,
depends on the investor's coefficient of risk aversion, the precision of the security analyst, and
the distribution of the squared information ratio of in the universe of securities.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-39
48. Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be
willing to pay for active management, over and above the fee charged by a passive index
fund, does not depend on
I) the investor's coefficient of risk aversion
II) the value of at-the-money call option on the market portfolio
III) the value of out-of-the-money call option on the market portfolio
IV) the precision of the security analyst
V) the distribution of the squared information ratio of in the universe of securities
A. I, II, IV
B. II, III, V
C. II, III
D. I, IV, V
E. II, IV, V
Kane, Marcus, and Trippi (1999) show that the annualized fee that investors should be willing
to pay for active management, over and above the fee charged by a passive index fund,
depends on the investor's coefficient of risk aversion, the precision of the security analyst, and
the distribution of the squared information ratio of in the universe of securities.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Active management
27-40
50. You have a record of an analyst's past forecasts of alpha. Describe how you would use this
information within the context of the Treynor-Black model to determine the forecasting
ability of the analyst.
You can use the index model and valid estimates of beta, you can estimate the ex-post alphas
from the average realized return and the return on the market index. The equation is
.
Then you would estimate a regression of the forecasted alphas on the realized alphas as in the
equation
. The coefficients a0 and a1 reflect the bias in the forecasts. If
there is no bias a0=0 and a1=1. The forecast errors are uncorrelated with the true alpha, so the
variance of the forecast is
.
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
. 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.
Feedback: 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.
27-41