2019 CFA level 3 qbank reading 28 active equity investing strategy questions

It is most likely that: A Both manager A and manager B are following quantitative active equity approaches B Manager A is following a fundamental active equity approach and manager B is

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Question #1 of 27

Consider two equity portfolios with the same benchmark index composed of 943 constituents

Active equity manager A has constructed a portfolio of 45 high conviction ideas which are

continuously monitored to assess whether their weights in the portfolio remain appropriate

Active equity manager B has active bets on 550 stocks with automatic rebalancing conducted

on regular monthly intervals It is most likely that:

A) Both manager A and manager B are following quantitative active equity approaches

B) Manager A is following a fundamental active equity approach and manager B is

following a quantitative active equity approach

C) Manager A follows a quantitative active equity approach and manager B follows a

fundamental active equity approach

Competitive positioning and environmental, social and governance (ESG) characteristics of a

company are most likely to be used as information sources for:

A) Neither quantitative nor fundamental active equity managers

B) Both quantitative and fundamental active equity managers

C) Fundamental active managers only

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The table below provides information on three stocks being considered for investment by a

bottom-up equity manager

Company Price ($)

12-Month Forward EPS

3-Year EPS Growth Forecast

Dividend ($) Industry Sector

Sector Average P/E

S 5 0.25 20% 0.00 Pharmaceuticals 20

T 95 4.75 3% 0.08 Defence 25

U 15 5.5 -5% 0.03 Utilities 12

Which stock is most likely to be the best opportunity for investors that use a relative value

approach?

A) Stock S

B) Stock T

C) Stock U

A fundamental active equity investment manager screens the stocks in their universe in order

to create an equally weighted portfolio of securities that have a price-to-book ratio of less than

one Which of the following pitfalls of fundamental active investing is this manager most likely

to be subject to?

A) The value trap

B) Behavioural biases

C) The growth trap

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An analyst is backtesting a quantitative investment process which investigates the relationship

between EPS announcements and subsequent month stock returns The analyst notes that one

speci c company in the universe frequently revises earnings – for example 2017 EPS was

initially announced in March 2018 as $2 when the market expected earnings of $2.10 These

2017 earnings were subsequently revised down to a loss of $1 per share in June 2018 due to

accounting fraud coming to light In order to avoid look ahead bias, when backtesting the

performance of the stock in April 2018, the manager should use an EPS value of:

A) $2

B) $2.10

C) -$1

An analyst who wishes to capture the most accurate and up-to-date style exposure of an

investment manager should:

A) Prefer to use returns-based analysis

B) Prefer to use holdings-based analysis

C) Be indi erent between using holdings based and returns based analyses

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An analyst conducting a returns-based style analysis on an active equity fund constructs the

following monthly multivariate regression:

Where:

rt = the fund return in period t

LC = large cap style index

SC = small cap style index

εt = residual return not explained by style factors

The value added by the fund manager is closest to:

A) 0.5% plus the residual return, εt

B) The residual return, εt

C) 0.5%

A quantitative active equity investment manager gathers the following data regarding

information coe cients (ICs) when backtesting the value, growth and size factors in their

investment universe:

Factor Pearson IC Spearman Rank IC

Value insigni cant signi cantly positive

Growth signi cantly positive signi cantly positive

Size signi cantly positive insigni cant

If the manager is concerned about biases caused by outliers in the data, they should most likely

conclude that the factors with strong predictive powers for subsequent returns are:

A) Value and Growth

B) Growth and Size

C) Value, Growth and Size

= 0.005 + 0.7LC + 0.3SC +

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Which of the following statements regarding activist equity investing is most accurate?

A) Activist investors tend to target companies that have lower than average revenue

growth with negative price momentum

B) Activist investors tend to target companies that have multi-class share structures

C) The assets under management of activist hedge funds decreased sharply during the

global nancial crisis of 2008/2009 and have since failed to recover to pre-crisis levels

Company A announces a cash-only purchase of Company B In order to pro t from this event, a

merger-arbitrage hedge fund manager would most likely:

A) Purchase the shares of Company B prior to the deal being announced

B) Purchase the share of Company B and short sell the shares of Company A after the deal

is announced

C) Purchase the shares of Company B after the deal is announced

Which of the following statements is most accurate with respect to factor-mimicking portfolios?

A) Factor mimicking portfolios are usually constructed using long only portfolios

B) Factor mimicking portfolios are commonly used in factor-tilting portfolios

C) Factor mimicking portfolios are relatively expensive to construct

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Which of the following statements regarding market-microstructure arbitrage strategies is least

accurate?

A) The typical time horizon of a trade is a few minutes

B) High-frequency trading techniques are a fundamental part of the strategy

C) The strategy analyses limit order books of exchanges to identify very short-term

mispricing opportunities

Company Price

($)

T 95 4.75 3% 0.08 Defence 25

U 15 5.5 -5% 0.03 Utilities 12

Which stock is most likely to be the best opportunity for investors that use a deep value

approach?

A) Stock U

B) Stock S

C) Stock T

With regards to the potential pitfalls in investment strategies, which of the following statements

is likely to be most accurate?

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A) A fundamental active equity investor who seeks information that agrees with their

existing beliefs is exhibiting availability bias

B) Over tting is more likely to be a pitfall for a fundamental manager than a quantitative

active equity manager

C) The behavioural bias of overcon dence is more likely to be a pitfall for a fundamental

manager than a quantitative active equity manager

Company Price ($)

T 95 4.75 3% 0.08 Defence 25

U 15 5.5 -5% 0.03 Utilities 12

Which stock is most likely to be the best opportunity for investors that use GARP?

A) Stock T

B) Stock U

C) Stock S

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Consider the following three companies:

Company Listing Return on Assets Asset Turnover Cash Balance

SBD Nasdaq Low Low High

JBC Amex High Average Average

LLB Unlisted Low Low Low

Which of the above companies is most likely to o er an opportunity for activist investing?

A) LLB

B) JBC

C) SBD

Consider the following two statements regarding the hedged portfolio approach to

implementing factor-based active equity investing strategies:

Statement 1: Restrictions on short selling securities will likely prevent the strategy being

implemented

Statement 2: When constructed properly, hedged portfolios represent pure exposure to the

factors they are designed to represent

It is most likely that:

A) Both statements are false

B) Both statements are true

C) Statement 1 is true and statement 2 is false

Data for US companies show that in the years after activist investing, companies on average

have:

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A) Higher return on equity and leverage levels

B) Lower return on equity and lower leverage levels

C) Higher return on equity and lower leverage levels

A factor-based quantitative active equity investment manager is investigating the relationship

between treasury yields and factor returns They regress both contemporaneous and

subsequent month factor returns against the 10-year treasury bond yield The factors used are

systematic risk (beta), size (market capitalisation) and value (book-to-market) The regression

coe cients are displayed in the chart below:

Based on the regression coe cients above, which of the following strategies is most likely to be

pro table:

A) Short high beta securities and long value securities in months subsequent to treasury

yields being high

B) Long high beta securities and short value securities in months where treasury yields are

high

C) Long high beta securities and short value securities in months subsequent to treasury

yields being high

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A top down portfolio manager using a short straddle position to express their view on market

volatility will most likely earn excess returns when:

A) Implied volatility is lower than realized market volatility

B) Market volatility levels fall

C) Realised market volatility is lower than implied volatility

A portfolio overlay derivatives strategy can be employed by a portfolio manager for all the

following purposes, except:

A) Removal of unintended macro exposures created by a bottom-up fundamental

investment process

B) Adding active returns that are not correlated with the underlying portfolio strategy

C) Identifying overvalued/undervalued securities for stock selection

The Information coe cient is best de ned as:

A) The correlation of the performance of a hedged portfolio representing returns to a

factor and a fundamental driver of factor performance such as interest rates across i

B) The cross-sectional correlation of factor scores verses subsequent stock returns across

an investment universe

C) The correlation of the performance of a hedged portfolio representing returns to a

factor and the returns of the manager’s portfolio

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According to Morningstar's classi cation criteria for Value/Growth stocks, a security with a net

style score of close to zero is classi ed as

A) Growth

B) Value

C) Core

When comparing fundamental and quantitative approaches to active equity investing, which of

the following statements is most accurate?

A) Manager judgement plays a large role in fundamental active equity approaches, but

plays no role in quantitative active equity approaches

B) Company nancial statements would likely be a source of information for fundamental

approaches but not for quantitative active equity approaches

C) Factor based modelling is likely to play a greater role in quantitative approaches than

fundamental approaches to active management

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An analyst is investigating potential pairs trades for a statistical arbitrage fund She gathers the

following information about three potential pairs:

Pair 1 consists of two car manufacturers One of the companies is a small new manufacturer of electric self-drive vehicles, the other companies is one of the largest car manufacturers in the world established over 100 years ago The mature company has recently made signi cant investment in new electric vehicles The historical correlation of the two companies has been low

Pair 2 consists of two mature advertising agencies that have comparable future earnings prospects Both typically trade on similar valuations and the historical correlation of share prices has been high The ratio of share prices is currently 1.5 standard deviations below its moving average

Pair 3 consists of two mature companies: one is a cement manufacturer and the other is a

thermal coal company Although the companies operate in di erent markets and have di erent

business models the stock prices have historically shown high correlation A recent news

announcement has caused the ratio of share prices to deviate from the long-term average

The pairs trade the analyst should most likely recommend is:

A) Pair 3

B) Pair 1

C) Pair 2

Which of the following investment strategies is least likely to be a top-down investment

strategy?

A) Volatility based strategies

B) Special situations strategies

C) Thematic investment strategies

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When creating a fundamental active investment strategy an active equity manager should

assign a price target that they believe to be the fair value of the security Which of the following

statements regarding this price target is most accurate?

A) The price target should not be adjusted after it is set at the outset in order to avoid

su ering from behavioural biases such as loss aversion

B) Adjusting the price target down in response to negative news ow until it is lower then

the current market price would trigger a sale or reduction in the position size

C) The stock position should always be fully liquidated as soon as the security reaches the

price target

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