Chapter 6: Q4B (page 662)
For Questions 1–4, answer true or false. Explain your answer.
Question: A currency-hedged foreign-stock portfolio return is the weighted average of the foreign stock returns in local currency.
True
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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: Calculate the amount by which the Primo portfolio out- (or under-) performed the market over the period, as well as the contribution to performance of the pure sector allocation and security selection decisions.
Suppose that the spot price of the euro is currently \(1.30. The one-year futures price is \)1.35. Is the U.S. interest rate higher than the euro 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?
Consider the following information regarding the performance of a money manager in a recent month. The table presents the actual return of each sector of the manager’s portfolio in column (1), the fraction of the portfolio allocated to each sector in column (2), the benchmark or neutral sector allocations in column (3), and the returns of sector indexes in column (4).
a. What was the manager’s return in the month? What was her over- or under - performance?
b. What was the contribution of security selection to relative performance?
c. What was the contribution of asset allocation to relative performance? Confirm that the sum of selection and allocation contributions equals her total “excess” return relative to the bogey.
The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 Index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month.
a. If he holds a \(3 million portfolio of Waterworks stock and wishes to hedge market exposure for the next month using one-month maturity S&P 500 futures contracts, how many contracts should he enter? Should he buy or sell contracts? The S&P 500 currently is at 1,000 and the contract multiplier is \)250.
b. What is the standard deviation of the monthly return of the hedged portfolio?
c. Assuming that monthly returns are approximately normally distributed, what is the probability that this market-neutral strategy will lose money over the next month?
Assume the risk-free rate is .5% per month.
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