LOMA 357

Chapter 6
Reference: c. 6, pp. 2-3
Investors achieve (diversification / hedging) by purposely spreading a portfolio’s
holdings to represent a reasonably broad selection of risk exposures. Purchasing
insurance against a specified risk is considered to be a form of (diversification /
hedging).

A. diversification / diversification
B. diversification / hedging
C. hedging / diversification
D. hedging / hedging
Reference: c. 6, p. 3
Investment professionals recognize two approaches to portfolio management:
bottom-up and top-down investing. (Bottom-up / Top-down) investing consists of
starting an investment process by broadly analyzing economic conditions. For
most purposes, institutional investors generally start with a (bottom-up / top-down)
approach.

A. Bottom-up / bottom-up
B. Bottom-up / top-down
C. Top-down / bottom-up
D. Top-down / top-down
Reference: c. 6, p. 6
Institutional investors, such as pension plans, life insurance companies, property-
casualty insurance companies, and endowments or foundations, have different
investment objectives. Of these institutional investors, the ones that typically have
a short-term investment horizon are

A. pension plans
B. life insurance companies
C. property-casualty insurance companies
D. endowments or foundations
Reference: c. 6, p. 8
Peer review analysis is one technique commonly used in determining a portfolio’s asset
allocation. From the answer choices below, select the response that correctly identifies
whether peer review analysis focuses exclusively on past results and whether it explicitly
addresses differences in the risk exposures of the various competitors.

Focuses exclusively on past results? Addresses differences in risk exposures?

A. Yes yes
B. Yes no
C. No yes
D. No no
Reference: c. 6, p. 9
An investor’s portfolio includes two asset classes, A and B. Whenever the return
on Class A increases by one percent, the return on Class B decreases by one
percent. This information indicates that correlation between Classes A and B is

A. partial positive correlation

B. perfect positive correlation
C. perfect negative correlation
D. absent
Reference: c. 6, pp. 9-10
Portfolio Excalibur contains only large-cap U.S. stocks. Excalibur’s portfolio manager hopes to gain diversification benefits
by adding a new asset class to the asset allocation. The portfolio manager has access to the following correlation
coefficients for pairings of several alternative new asset classes with the existing large-cap U.S. stock asset class:

New Asset Class Correlation Coefficient

Emerging market stocks 0.90
Mid-cap U.S. stocks 0.20
U.S. corporate bonds –0.85
U.S. Treasury securities –0.10

Based on this information, Excalibur’s portfolio manager would achieve strong diversification benefits by adding to Excalibur
the asset class of

A. emerging market stocks

B. mid-cap U.S. stocks
C. U.S. corporate bonds
D. U.S. Treasury securities
Reference: c. 6, p. 12
An efficient portfolio represents a theoretically ideal asset allocation. An efficient
portfolio has the following characteristic(s):

A) An investor can add assets to an efficient portfolio to obtain a higher expected

return without triggering an increase in portfolio risk.
B) An investor can reduce the risk of an efficient portfolio without decreasing the
expected return.

I. Both A and B
II. A only
III. B only
IV. Neither A nor B
Reference: c. 6, p. 11-12
The following statements are about the efficient frontier and efficient portfolios. Three of the
statements are true, and one of the statements is false. Select the answer choice containing
the FALSE statement.

A. An investor can add assets to an efficient portfolio to obtain a higher expected return
without triggering an increase in portfolio risk.
B. Relative to efficient portfolios, inefficient portfolios can offer the same return for greater
risk exposure; lower return for the same risk exposure; or lower return for greater risk
exposure.
C. For a given set of modeling inputs, an efficient portfolio is one that earns the highest
expected return for a given level of risk.
D. An investor cannot reduce the risk of an efficient portfolio without decreasing the
expected return.
Reference: c. 6, p. 7-8, 14
One analytical technique used in determining a portfolio’s asset allocation is peer review analysis.
The following statements are about peer review analysis. Three of the statements are true, and
one of the statements is false. Select the answer choice containing the FALSE statement.

A. To conduct a peer review analysis, an institutional investor constructs a composite peer

portfolio that reflects the mean and median asset mix of the actual portfolios of the peer
group.
B. Unlike other portfolio analysis methods, peer review analysis does not apply historical data
as the basis for its modeling approaches.
C. One limitation of peer review analysis is that an analyst may have difficulty finding relevant
public data to support this analysis.
D. Peer review analysis is the most generally accessible approach to creating an asset-class
allocation.
Reference: c. 6, p. 15
The following statement(s) can correctly be made about investors’ expectations relating to the investment
performance of actively managed portfolios and passively managed portfolios:

A) Generally, investors expect the actual performance of an actively managed portfolio to beat the
relevant securities market overall.

B) Investors generally expect the actual performance of a passively managed portfolio to perform close to
the securities market overall.

I. Both A and B
II. A only
III. B only
IV. Neither A nor B
Reference: c. 6, pp. 15, 17
Investment professionals often use a market index as a market proxy to represent the
average of activity for a given asset class. The following statements are about market
indexes. Three of the statements are true, and one of the statements is false. Select the
answer choice containing the FALSE statement.

A. All asset classes have a public market index suitable to serve as a market proxy.
B. A market index serves as a quantitative record of the average performance of
investments in a designated market.
C. Market indexes are useful as market proxies because they conform to specific rules
and guidelines, and their results are objectively stated and readily available.
D. Sometimes the statistics from one index are blended with those from another index or
indexes to obtain the optimum statistics for use in asset selection and portfolio
evaluation.
Reference: c. 6, p. 17
Market proxies are central to the development of a strategic portfolio. However, insurance
companies may need to make adjustments to market index data used to create market
proxies. The following statement(s) can correctly be made about the reasons for these
adjustments:

A) Most insurance companies and retirement plan funds invest heavily in private placements
securities, whereas market indexes reflect pricing of securities in public markets.
B) Bond indexes typically are derived from the behaviors of securities having a much wider
variety of expected maturities than those included in a particular institutional portfolio.

A. Both A and B
B. A only
C. B only
D. Neither A nor B
Reference: c. 6, pp. 18, 19
Investment professionals should consider certain factors when using portfolios as
benchmarks for investment performance. For instance, benchmark portfolios
(should / should not) be divisible into components. A benchmark portfolio (should /
should not) be regarded as a standalone control mechanism for guiding portfolio
management.

A. should / should
B. should / should not
C. should not / should
D. should not / should not
Reference: c. 6, p. 21
Judy Little, a portfolio manager, adopts an investment style that seeks
opportunities to buy or sell specific securities when the majority of investors
appear to be doing the opposite. This information indicates that Ms. Little uses the
investment strategy known as

A. market timing
B. Sortino investing
C. safe-harbor investing
D. contrarian investing
Reference: c. 6, p. 21
One strategy relevant to tactical management of an investment portfolio is contrarian
investing. By definition, an institutional investor that practices contrarian investing
would

A. attempt to beat a benchmark portfolio by using a different approach to duration or

credit risk than is used in the designated benchmark
B. seek opportunities to buy or sell specific securities when the majority of investors
appear to be doing the opposite
C. ignore any rules that place limits on the portion of a portfolio that may be invested
in a single category
D. change a portfolio’s strategic asset allocation in response to market conditions
Reference: c. 6, p. 23
A portfolio’s excess return can be calculated arithmetically or geometrically. The following statement(s) can
correctly be made about arithmetic excess return and geometric excess return:

A) Arithmetic excess return is widely used because it is easier to understand.

B) The geometric excess return can only be used when measuring a portfolio’s excess return over a single period.

C) Geometric excess return compares a portfolio’s excess return relative to its benchmark to the portfolio’s initial
value.

I. A, B, and C
II. A and B only
III. B and C only
IV. A only
V. C only