Chapter 6: Q21_2B (page 711)
The same ship owner advertises a tariff whereby the freight charged for all cargo will be the same. What kind of good can the ship owner expect to attract?
Adverse selection
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Use the following information to answer Problems l2–16:
Primo Management Co. is looking at how best to evaluate the performance of its managers. Primo has been hearing more and more about benchmark portfolios and is interested in trying this approach. As such, the company hired Sally Jones, CFA, as a consultant to educate the managers on thebest methods for constructing a benchmark portfolio, how best to choose a benchmark, whether the style of the fund under management matters, and what they should do with their global funds in terms of benchmarking.
For the sake of discussion, Jones put together some comparative two-year performance numbers that relate to Primo’s current domestic funds under management and a potential benchmark.
As part of her analysis, Jones also takes a look at one of Primo’s global funds. In this particular portfolio, Primo is invested 75% in Dutch stocks and 25% in British stocks.
The benchmark invested 50% in each—Dutch and British stocks. On average, the British stocks outperformed the Dutch stocks. The euro appreciated 6% versus the U.S. dollar over the holding period, while the pound depreciated 2% versus the dollar. In terms of the local return, Primo outperformed the benchmark with the Dutch investments but underperformed the index with respect to the British stocks.
Question: What is the within-sector selection effect for each individual sector?
With respect to hedge fund investing, the net return to an investor in a fund of funds would be lower than that earned from an individual hedge fund because of:
a. Both the extra layer of fees and the higher liquidity offered.
b. No reason; funds of funds earn returns that are equal to those of individual hedge funds.
c. The extra layer of fees only.
During a particular year, the T-bill rate was 6%, the market return was 14%, and a portfolio manager with beta of .5 realized a return of 10%. Evaluate the manager based on the portfolio alpha.
Suppose a U.S. investor wishes to invest in a British firm currently selling for £40 per share.
The investor has \(10,000 to invest, and the current exchange rate is \)2/£
a. How many shares can the investor purchase?
b. Fill in the table below for rates of return after one year in each of the nine scenarios (three possible prices per share in pounds times three possible exchange rates).
| Price per share (￡) | Price denominated return (%) | Dollar-Denominated Return (%) for Year-End Exchange Rate | ||
1.80/￡ | 2.00/￡ | 2.20/￡ | ||
￡35 | ||||
￡40 | ||||
￡45 | ||||
c. When is the dollar-denominated return equal to the pound-denominated return?
Suppose a hedge fund follows the following strategy: Each month it holds \(100 million of an S&P 500 Index fund and writes out-of-the-money put options on \)100 million of the index with exercise price 5% lower than the current value of the index. Suppose the premium it receives for writing each put is $.25 million, roughly in line with the actual value of the puts.
a. Calculate the Sharpe ratio the fund would have realized in the period October 1982–September 1987. Compare its Sharpe ratio to that of the S&P 500. Use the data from the previous problem available at the Online Learning Center, and assume the monthly risk-free interest rate over this period was .7%.
b. Now calculate the Sharpe ratio the fund would have realized if we extend the sample period by one month to include October 1987. What do you conclude about performance evaluation and tail risk for funds pursuing option like strategies?
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