Vignette: Jacquie Chan is an analyst with Stars Investments Management Inc. She is studying value at risk as a means to measure and manage risk. Jacquie believes that using a risk budgeting program based on VAR could significantly enhance SIM's risk management processes. When presenting her idea to senior members of the firm, Jacquie receives the following responses:
Arnie Swassnicker, Chief Market Strategist: We have a solid process in place to determine the optimal asset allocation for various market conditions. Risk budgeting is basically another way to conduct asset allocation.
Bruce Li, Chief Compliance Officer: We have guidelines in place that include principal limits, sensitivity limits, and leverage limits. The thresholds set under a risk budget program accomplish the same thing.
Sylvia Staloan, Director of Portfolio Management: We already use tools such as beta, standard deviation, and duration to determine risk. These tools are widely used in the market and provide all the risk measurement we need.
Question: Which of the following is the least effective response for Chan to use in countering Li's argument?
Select an Answer: VAR-based measures place tighter control on hedging. VAR-based measures can better account for more complex assets. VAR-based measures all use the same units, thus allowing for better comparisons. Because VAR-based risk budgets are expressed in terms of tracking error, they will capture the effects of leverage.
Rationale:
VAR-based measures actually allow more flexibility in hedging. Risk sensitivities measure whether an item can be defined as a hedge, while a VAR measure can monitor products and strategies that are difficult to cover in investment guidelines by simply having a hedge decrease VAR by a certain amount. The other statements all distinguish VAR-based risk budgets from investment guidelines - they can be used effectively for more complex assets, they are directly comparable by being expressed in like units, and they are more useful in capturing the effects of leverage.
2025-04-03
Vignette: Doug Brag is the CEO of Alternative Foods Inc., which is a rapidly growing small-cap food service company based in southern California. Alternative provides its employees with a defined benefit pension plan.
Alternative's workforce has a median age of 28 and, therefore, Doug feels the plan has no liquidity needs and can invest aggressively to grow plan assets. Doug also feels that fixed-income investments are not appropriate for the plan given its long time horizon.
The asset allocation that Doug has placed the fund's assets into is as follows:
Other food service stocks
40%
U.S. small-cap growth stocks
30%
U.S. large-cap stocks
15%
International stocks
8%
Venture capital fund
7%
Question: With regard to Doug's statement on the liquidity requirements of the company, which statement is correct?
Select an Answer: Doug is incorrect in stating that the liquidity needs of the plan are low, as vested benefits and the possibility of transferring those vested benefits would require the fund to have moderate liquidity needs. Doug is correct in stating that the liquidity needs of the plan are low due to the aggressive investment strategy of the plan. Doug is correct in stating that the liquidity needs of the plan are low. Doug is incorrect in stating that the liquidity needs of the plan are low because as a going concern and with a active workforce the fund would have moderate liquidity needs.
Rationale:
Liquidity needs of the plan are very low due to the young median age of the workforce and very long time horizon.
2025-04-02
Vignette: The choice of a benchmark must be suited to the individual investor. The performance of the manager must be measured against the appropriate benchmark. The benchmark specified must reflect the client's investment objectives from a risk/return perspective.
The benchmark chosen has risks unique to each. Jen, a portfolio manager with Kappa Capital Management, must address the following question from juniors in the firm.
Question: Jen is asked: What is the most appropriate description of call risk?
Select an Answer: The risk that the cost of the firm's interest rate sensitive-liabilities exceeds the return on its assets in an environment of rising interest rates. The risk that economic surplus will change. The risk that the firm's liabilities will be cancelled when interest rates fall and need to be replaced at a lower rate. The risk that the investment for which the borrowed cash is used receives a fixed interest rate, a negative spread will result.
Rationale:
Call risk occurs when the cash the investor borrows to invest has a call feature whereby the party it borrows from may request and receive the invested cash back. This occurs in a rising rate environment. Hence, the investor will have to refinance at the higher rate of interest.
2025-04-01
Vignette: Doug Brag is the CEO of Alternative Foods Inc., which is a rapidly growing small-cap food service company based in southern California. Alternative provides its employees with a defined benefit pension plan.
Alternative's workforce has a median age of 28 and, therefore, Doug feels the plan has no liquidity needs and can invest aggressively to grow plan assets. Doug also feels that fixed-income investments are not appropriate for the plan given its long time horizon.
The asset allocation that Doug has placed the fund's assets into is as follows:
Other food service stocks
40%
U.S. small-cap growth stocks
30%
U.S. large-cap stocks
15%
International stocks
8%
Venture capital fund
7%
Question: Which of the following statements most accurately describes Doug's decision to manage the pension assets in relation to the company's strength?
Select an Answer: By concentrating plan assets heavily in the food service industry, the company may face the prospect of having to provide additional funding to the plan at a time when the company's cash flow may be weak. By concentrating the plan assets heavily in the food service industry, the company allows for a quicker reaction time to adjust plan assets in the event of an economic downturn. Managing the pension assets to the company's strength is irrelevant. Managing the plan assets to the company's strength is the appropriate strategy, as the matching of company assets and liabilities isolates the company from providing additional funding.
Rationale:
By concentrating plan assets heavily in the food service industry, the company may face the prospect of having to provide additional funding to the plan at a time when the company's cash flow may be weak.
2025-03-31
Vignette: Frank Qusis manages a bond portfolio for Velvet Capital. Frank is addressing some issues related to spread duration. The details of the portfolio are outlined below.
Bond
Sector Weight (%)
Duration
Spread Duration
A
20%
4.16
2.23
B
35%
6.28
4.56
C
15%
7.15
5.32
D
30%
8.62
6.21
Question: How would Frank interpret an increase of all spread sectors by 100 basis points with no change in treasuries for the above portfolio?
Select an Answer: The value of the portfolio should decrease by 33.64%. The value of the portfolio should increase by 18.32%. The value of the portfolio should decrease by 18.32%. The value of the portfolio should decrease by 4.70%.
Rationale:
The spread duration of the portfolio is 4.7. Therefore, an increase in interest rates with no change in Treasury yields will result in a 4.70% decrease in portfolio value.
