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Question: 1<br />
HAS THREE PARTS FOR A TOTAL OF 23 MINUTES Aaron Bell, a portfolio manager, is focusing his<br />
attention on investment style, and whether style should be a factor in investment decision making.<br />
Bell decides to play it safe and investigate how he can use different instruments related to style<br />
indices or indexing strategies to see if he can add value to his customers’ portfolios.<br />
A. Explain holdings-based style analysis. Discuss one disadvantage of holdings-based style analysis<br />
and one advantage over returns-based style analysis.<br />
B. Explain returns-based style analysis. Reproduce the general form of the regression equation used<br />
for returns-based style analysis, including any constraints, and label each component of the<br />
equation. Discuss one disadvantage of returns-based style analysis and one advantage over holdingsbased<br />
style analysis.<br />
C. Bell is considering indexing strategies and a colleague has suggested three alternatives: full<br />
replication; stratified sampling; and optimization. Explain each along with the conditions under<br />
which each would be appropriate to use and provide one disadvantage for each.<br />
Question: 2<br />
Answer: A<br />
HAS THREE PARTS Wyatt Washington is the portfolio manager for Mark Beitia, a recent retiree. He is<br />
currently exploring a change in Beitia’s strategic asset allocation. He gathers data on the expected<br />
returns, standard deviations, and correlations for five assets. Using these market expectations, he<br />
derives an efficient frontier. Washington uses the following information in his construction of the<br />
asset allocation:<br />
• Beitia’s asset base = $5,000,000.<br />
• Annual after-tax spending amount = $150,000.<br />
• Estimate of future inflation = 3.5%.<br />
• Beitia will donate $750,000 to his alma mater in one year in one lump sum.<br />
• Risk-free rate = 4.0%.<br />
• Beitia’s income tax rate = 25%.<br />
Washington forms four corner portfolios from his efficient frontier and calculates the following<br />
expected returns and standard deviations: