Question #1 of 12

C) lacks statistical reliability.

Explanation

McDaniel's returns-based benchmark is likely not a valid benchmark because it is not statistically

reliable. She uses only 12 data points (the monthly returns over the past year), and this is not

enough data points to generate a statistically reliable model. Returns-based benchmarks are

measurable, investable, and unambiguous.

Question #2 of 12

B) both are incorrect.

Explanation

McDaniel is incorrect. Although the null hypothesis is stated correctly (the manager adds no value),

McDaniel's definition of a Type I error is incorrect. A Type I error is when the null hypothesis is

rejected when it is true. Peterson is also incorrect. A Type II error is failure to reject the null when it is

false.

Question #3 of 12

C) only one is correct.

Explanation

McDaniel is correct. One advantage to using a returns-based benchmark is that it is useful where the

only information available is account returns. Peterson is incorrect. Returns- based benchmarks are

generally easy to use and intuitive.

Question #4 of 12

C) Yes, in both capital goods and financial sectors.

Explanation

To answer this question, we must first examine the return for the overall benchmark versus the

return for the benchmark in both sectors. The overall return for the benchmark is given at 0.86%.

The capital goods sector return in the benchmark was -5.00%. For the financial sector, it was 4.00%.

Thus, relative to the overall benchmark return of 0.86%, the capital goods sector was an

underperforming sector and the financial sector outperformed. Now determine whether Matson

overweighted or underweighted each sector. He underweighted the weak capital goods sector

(8.00% allocation for the manager versus 9.00% for the benchmark), and he overweighted the

strong financial sector (20.00% allocation for the manager versus 18.00% for the benchmark).

Because Matson underweighted a weak sector and he overweighted a strong sector, he made

correct decisions for both.

No calculations are needed to reach the above conclusions. However, the sector allocation returns

can be calculated by multiplying the difference between the portfolio and benchmark allocation by

the difference in sector benchmark return and overall benchmark return for each sector. For the

capital goods sector, it is (8.0% - 9.0%) × (-5.00% - 0.86%) = 0.0586%. For the financial sector, it is

(20.0% - 18.0%) × (4.00% - 0.86%) = 0.0628%.

Question #5 of 12

B) Yes, but only in the technology sector.

Explanation

To answer this question, examine the return for the manager against the return for the benchmark in

each sector. Matson's return in the consumer durables sector was 2% versus 3% for the benchmark,

so he did not outperform the benchmark for security selection in this sector. However, the return for

the manager in the technology sector was 2.6% versus -2% for the benchmark, so he did outperform

the benchmark for security selection in this sector.

No calculations are needed to reach the above conclusions. However, the within-sector allocation

returns can be calculated by multiplying the difference between the portfolio and benchmark return in

each sector by the benchmark's weight. For the consumer durables sector, it is (2.0% - 3.0%) × 35%

= -0.35%. For the technology sector, it is (2.6% + 2.0%) × 16% = 0.736%.

Question #6 of 12

B) Yes, in both agricultural and utilities sectors.

Explanation

To answer this question, multiply the difference in weightings for the manager and the benchmark by

the difference in returns for the manager and the benchmark in each sector. In the agricultural

sector, this is (4% - 6%) × (-2% + 1%) = 0.02%. In the utilities sector, this is (12% - 10%) × (4% +

2%) = 0.12%.

Question #7 of 12

B) both are incorrect.

Explanation

Willis is incorrect. Endowments are not taxable entities so the tax advantage of the municipal bonds

is not a valid reason for the endowment to consider the municipal bonds. Dunn is incorrect.

Endowments typically have a high ability and willingness to take risk because of their infinite time

horizon. It is also imprudent for Dunn to state whether an investment is appropriate for National until

he has reviewed the investment policy statement.

Question #8 of 12

C) 6.70%.

Explanation

The M-squared measure for the Jaguar fund is 11.11%.

To calculate the M-squared ratio for Jaguar, use the following formula:

Comparing the 11.11% to the return on the market of 10%, the Jaguar fund has superior

performance. The M-squared measure for the Theta fund is 11.22%, which indicates that the Theta

fund has superior performance relative to both the market and Jaguar fund.

Question #9 of 12

B) 0.32.

Explanation

The Sharpe ratio for Theta would be calculated as:

The Sharpe ratio for the Jaguar fund is 0.31, which indicates that the Theta fund has superior

performance relative to the Jaguar fund.

Question #10 of 12

C) 9.1.

Explanation

The Treynor ratio for Theta would be calculated as:

The Treynor ratio for the Jaguar fund is 15.0, which indicates that the Jaguar fund has superior

performance relative to the Theta fund.

Question #11 of 12

B) 7.6%.

Explanation

The ex post alpha for Jaguar would be calculated as:

The ex post alpha for the Theta fund is 4.5%, which indicates that the Jaguar fund has superior

performance relative to the Theta fund.

Question #12 of 12

C) only one is correct.

Explanation

Willis is correct. By the Sharpe ratio and M-squared measures, which use total risk (standard

deviation), the Theta fund has superior performance. By the Treynor ratio and ex post alpha, which

use systematic risk (beta), the Jaguar fund has superior performance. The discrepancy is because

the Jaguar fund is poorly diversified. Dunn is incorrect. National's current endowment is well

diversified and thus the appropriate measure of risk for additional investments would be beta.

Because the Jaguar fund has a better Treynor ratio and ex post alpha, it is the better fund to add to

the endowment.

C) lacks statistical reliability.

Explanation

McDaniel's returns-based benchmark is likely not a valid benchmark because it is not statistically

reliable. She uses only 12 data points (the monthly returns over the past year), and this is not

enough data points to generate a statistically reliable model. Returns-based benchmarks are

measurable, investable, and unambiguous.

Question #2 of 12

B) both are incorrect.

Explanation

McDaniel is incorrect. Although the null hypothesis is stated correctly (the manager adds no value),

McDaniel's definition of a Type I error is incorrect. A Type I error is when the null hypothesis is

rejected when it is true. Peterson is also incorrect. A Type II error is failure to reject the null when it is

false.

Question #3 of 12

C) only one is correct.

Explanation

McDaniel is correct. One advantage to using a returns-based benchmark is that it is useful where the

only information available is account returns. Peterson is incorrect. Returns- based benchmarks are

generally easy to use and intuitive.

Question #4 of 12

C) Yes, in both capital goods and financial sectors.

Explanation

To answer this question, we must first examine the return for the overall benchmark versus the

return for the benchmark in both sectors. The overall return for the benchmark is given at 0.86%.

The capital goods sector return in the benchmark was -5.00%. For the financial sector, it was 4.00%.

Thus, relative to the overall benchmark return of 0.86%, the capital goods sector was an

underperforming sector and the financial sector outperformed. Now determine whether Matson

overweighted or underweighted each sector. He underweighted the weak capital goods sector

(8.00% allocation for the manager versus 9.00% for the benchmark), and he overweighted the

strong financial sector (20.00% allocation for the manager versus 18.00% for the benchmark).

Because Matson underweighted a weak sector and he overweighted a strong sector, he made

correct decisions for both.

No calculations are needed to reach the above conclusions. However, the sector allocation returns

can be calculated by multiplying the difference between the portfolio and benchmark allocation by

the difference in sector benchmark return and overall benchmark return for each sector. For the

capital goods sector, it is (8.0% - 9.0%) × (-5.00% - 0.86%) = 0.0586%. For the financial sector, it is

(20.0% - 18.0%) × (4.00% - 0.86%) = 0.0628%.

Question #5 of 12

B) Yes, but only in the technology sector.

Explanation

To answer this question, examine the return for the manager against the return for the benchmark in

each sector. Matson's return in the consumer durables sector was 2% versus 3% for the benchmark,

so he did not outperform the benchmark for security selection in this sector. However, the return for

the manager in the technology sector was 2.6% versus -2% for the benchmark, so he did outperform

the benchmark for security selection in this sector.

No calculations are needed to reach the above conclusions. However, the within-sector allocation

returns can be calculated by multiplying the difference between the portfolio and benchmark return in

each sector by the benchmark's weight. For the consumer durables sector, it is (2.0% - 3.0%) × 35%

= -0.35%. For the technology sector, it is (2.6% + 2.0%) × 16% = 0.736%.

Question #6 of 12

B) Yes, in both agricultural and utilities sectors.

Explanation

To answer this question, multiply the difference in weightings for the manager and the benchmark by

the difference in returns for the manager and the benchmark in each sector. In the agricultural

sector, this is (4% - 6%) × (-2% + 1%) = 0.02%. In the utilities sector, this is (12% - 10%) × (4% +

2%) = 0.12%.

Question #7 of 12

B) both are incorrect.

Explanation

Willis is incorrect. Endowments are not taxable entities so the tax advantage of the municipal bonds

is not a valid reason for the endowment to consider the municipal bonds. Dunn is incorrect.

Endowments typically have a high ability and willingness to take risk because of their infinite time

horizon. It is also imprudent for Dunn to state whether an investment is appropriate for National until

he has reviewed the investment policy statement.

Question #8 of 12

C) 6.70%.

Explanation

The M-squared measure for the Jaguar fund is 11.11%.

To calculate the M-squared ratio for Jaguar, use the following formula:

Comparing the 11.11% to the return on the market of 10%, the Jaguar fund has superior

performance. The M-squared measure for the Theta fund is 11.22%, which indicates that the Theta

fund has superior performance relative to both the market and Jaguar fund.

Question #9 of 12

B) 0.32.

Explanation

The Sharpe ratio for Theta would be calculated as:

The Sharpe ratio for the Jaguar fund is 0.31, which indicates that the Theta fund has superior

performance relative to the Jaguar fund.

Question #10 of 12

C) 9.1.

Explanation

The Treynor ratio for Theta would be calculated as:

The Treynor ratio for the Jaguar fund is 15.0, which indicates that the Jaguar fund has superior

performance relative to the Theta fund.

Question #11 of 12

B) 7.6%.

Explanation

The ex post alpha for Jaguar would be calculated as:

The ex post alpha for the Theta fund is 4.5%, which indicates that the Jaguar fund has superior

performance relative to the Theta fund.

Question #12 of 12

C) only one is correct.

Explanation

Willis is correct. By the Sharpe ratio and M-squared measures, which use total risk (standard

deviation), the Theta fund has superior performance. By the Treynor ratio and ex post alpha, which

use systematic risk (beta), the Jaguar fund has superior performance. The discrepancy is because

the Jaguar fund is poorly diversified. Dunn is incorrect. National's current endowment is well

diversified and thus the appropriate measure of risk for additional investments would be beta.

Because the Jaguar fund has a better Treynor ratio and ex post alpha, it is the better fund to add to

the endowment.

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