Chapter 16: The Portfolio Management Process

Are preferred shares considered equity investments or fixed-income investments?

Fixed-income investments

Preferred shares typically pay a fixed dividend and therefore are considered fixed-income investments. Secondly, much as with bonds, the market value of preferred shares has an inverse relationship with changes in interest rates.

1. would a conservative investor prefer a high or low sharpe ratio?

2. would a conservative investor prefer a high or low alpha?

All investors, regardless of risk tolerance, would prefer a high alpha (i.e. the value that the manager adds) and a high Sharpe ratio (i.e. the return per unit of risk).

what are two secondary investment objectives?

1. liquidity

2. tax minimization

Primary objectives:

1. Safety (capital preservation)

2. Income

3. Growth (capital appreciation)

Of the three asset allocation techniques, which one is used to set the portofoli’s long-term desired asset allocation?

strategic asset allocation

one method of selecting the strategic asset allocation is to illustrate the different combinations of stocks and bonds along with the expected return of each combination.

What does the Shape ratio measure?

the return per unit of risk as measured by the standard deviation of the investment or portfolio

a higher ratio means you are getting more return for the risk you are taking. All else being equal, the higher the Sharpe ratio, the better.

what asset allocation technique addresses when and how often the asset mix will be readjusted back to the strategic asset mix?

dynamic asset allocation

How is a client’s investment time horizon typically measured?

from the present until the next major change in circumstances, which could be the birth of a child, starting university, buying a home, retirement.

how is the sharpe ratio calculated?

sharpe ratio = (return of portfolio - risk-free rate)/ standard deviation of portfolio

What asset allocation technique involves the temporary shifting of asset allocation in a portfolio to gain investment opportunities in one asset class before reverting to the long-term strategic asset allocation?

Tactical asset allocation

why might an individual’s tax requirements be considered an investment constraint?

Individuals in a high tax bracket, for example, may need to be more aware of the types of income each investment will generate and how that income is taxed. for example, capital gains attract less tax than interest income.

what are the three main asset allocation techniques?

1. strategic asset allocation

2. dynamic asset allocation

3. tactical asset allocation

what is a portfolio manager return usually measured against?

a benchmark

managers are often compared to a predetermined benchmark. For example, an equity fund manager’s performance could be measured against the S&P/TSX Composite Index, which is an indicator of how the overall Canadian equity market is performing.

In what phase of the equity cycle are interest rates falling?

Trough Phase

the “trough phase” of the equity cycle is characterized as follows:

1. inflation falls, followed by a fall in interest rates

2. lower interest rates ignite the economy

3. when interest rates hit their lowest level, sell you bonds (sell high) and buy common shares (buy low)

with reference to the construction of a bond portfolio, what does “laddering” refer to?

constructing a bond portfolio with various durations.

what asset allocation technique determines when and how often the asset mix will be adjusted back to the strategic asset mix?

dynamic asset allocation

over time, the actual asset mix will likely move away from the long-term strategic asset allocation. This will occur if one asset class performs differently from another. the “dynamic asset allocation” technique determines when and how the asset mix would be adjusted back to the original target asset mix.

what is the main purpose of holding equities within a portfolio?

to generate capital gains

while equities may also produce dividend income, as per the course, their main purpose is to generate capital gains

what are the seven steps of the portfolio approach?

1. investment objectives

2. investment policy statement

3. develop asset mix

4. select securities to be held in portfolio

5. monitor the situation

6. evaluate performance

under what asset class would derivatives such as option contracts, warrants and rights fall?

equity securities

Why do convertible bonds fall under the equity portion of a portfolio?

convertible bonds are typically convertible into common shares (i.e. equity) and therefore will often behave like equities. In other words, the market value of the convertible bond will likely be impacted by changes in the market price of the issuer’s common shares.

what are the three primary investment objectives?

1. safety

2. income

3. growth

is it possible for a portfolio to have a negative sharpe ratio?

yes, the sharpe ratio measures the return per unit of risk. Since it is possible to have a negative return, it is also possible to have a negative Sharpe ratio.

what is considered the most important step in structuring a portfolio?

asset allocation

how can diversification benefit a portfolio?

the risk over the entire portfolio will be less than the weighted average risk of the investments held.