Chapter 6: Q3B (page 622)
Could portfolio A show a higher Sharpe ratio than that of B and at the same time a lower M2 measure? Explain.
No
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Suppose you could defer capital gains tax to the last year of your retirement (Spreadsheet 21.9). Would it be worthwhile given the progressivity of the tax code.
Carl Karl, a portfolio manager for the Alpine Trust Company, has been responsible since2015 for the City of Alpine’s Employee Retirement Plan, a municipal pension fund.
Alpine is a growing community, and city services and employee payrolls have expanded ineach of the past 10 years. Contributions to the plan in fiscal 2020 exceeded benefit paymentsby a three-to-one ratio.
The plan’s board of trustees directed Karl five years ago to invest for total return over thelong term. However, as trustees of this highly visible public fund, they cautioned him thatvolatile or erratic results could cause them embarrassment. They also noted a state statute thatmandated that not more than 25% of the plan’s assets (at cost) be invested in common stocks.
At the annual meeting of the trustees in November 2020, Karl presented the followingportfolio and performance report to the board.
Karl was proud of his performance and was chagrined when a trustee made the followingcritical observations:
a. “Our one-year results were terrible, and it’s what you’ve done for us lately thatcounts most.”
b. “Our total fund performance was clearly inferior compared to the large sample of otherpension funds for the last five years. What else could this reflect except poor managementjudgment?”
c. “Our common stock performance was especially poor for the five-year period.”
d. “Why bother to compare your returns to the return from Treasury bills and the actuarialassumption rate? What your competition could have earned for us or how we wouldhave fared if invested in a passive index (which doesn’t charge a fee) are the only relevantmeasures of performance.”
e. “Who cares about time-weighted return? If it can’t pay pensions, what good is it!”
Appraise the merits of each of these statements and give counterarguments that Karlcan use.
Under the flat tax (Spreadsheet 21.4), will a 1% increase in ROR offset a 1% increase in the tax rate?
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?
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: If Primo decides to use return-based style analysis, will the R2 of the regression equation of a passively managed fund be higher or lower than that of an actively managed fund?
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