Review Category Portfolio Management

28/08/2023, 18:24Question 10 of 21Review Category Portfolio Management (1)IncorrectCorrect Answer Your AnsweAThoms Investment Advisory Case ScenarioBThoms Investment Advisory (TIA) is an investment management firmfocused on health care equities in various global markets, TIA bases itsCXinvestment process on the belief that common factors affect mean equityreturns, and these common factors vary in degrees of importance byregion or country.Senior portfolio manager Thilo Singh is discussing characteristics of thefirm's portfolios with junior analyst Douglas Park. Singh states, "We usefactor models when analyzing regional health care index expectedreturns. In order for our analysts to understand our security selectionprocess, they must first have a working knowledge of factor models."Park adds, "Factor models are based on the arbitrage pricing theory(APT), which, similar to the CAPM, is an expression for the expectedreturn of an asset or portfolio. The APT makes three key assumptions:Assumption 1 A factor model describes asset returns.Assumption 2 A well-diversified portfolio can eliminate factor risk.Assumption 3 A state of financial market equilibrium exists amongwell-diversified portfolios."Park continues: "I have examined three of the regional portfolios using ouravailable information, and have determined that they show sensitivity toa return-on-equity (ROE) factor as shown in Exhibit 1. That implies that anarbitrage opportunity could exist and be exploited by buying the PacificRim portfolio while selling short a portfolio composed of 60% of theEurozone portfolio and 40% of the North America portfolio."Exhibit 1Portfolio Sensitivities to ROE Factor1/5 28/08/2023, 18:241Question 10 of 21North America10.7%0.8IncorrectPacific Rim13.7%0.5Correct Answer Your AnsweSingh elaborates, "Our securities analysis is actually based on a three-Afactor model, which we use to compare the mean expected return of theregional health care index with an individual security's expected return.BUsing a risk-free rate of 0.50% we focus on regional sensitivity to theCXfollowing three factors, the characteristics of which are shown in Exhibit2."Factor 1 An ROE factor that measures the difference betweenreturns of stocks of firms in the highest quartile of ROE andthe returns of firms in the lowest quartile of ROE.Factor 2 A sector excess return factor that compares local healthcaresector returns with the entire local equity market (MKT).Factor 3A capital investment factor that is determined by rankingfirms according to their level of capital investment andcomparing the returns of the firms in the highest quartilewith those in the lowest quartile (INV).Exhibit 2Panel A: Factor Model and Portfolio CharacteristicsMeanLocalSectorIndexInformationTrackingRegionReturnBROEBINVRatioErrorEurozone8.5%0.30.201.50.9713.500%North6.0%0.90.900.41.1924.000%AmericaPacific9.0%0.60.930.90.5099.375%RimJapan5.0%0.90.880.61.6203,000%12/5 28/08/2023, 18:24Question 10 of 21Eurozone0.0200.040.070IncorrectNorth America0.0750.030.033Correct Answer Your AnswePacific Rim0.0200.020.070AJapan0.0310.050.066BCXQ. According to the data in Exhibit 2, the expected return for the Japansector portfolio is closest to:A. 11.7%B. 14.7%C. 11.2%SolutionA is correct. The three-factor model is described in the followingequation:E(Rp) = BROE + + BINV + RfSo, (0.9 x 0.031) + (0.88 x 0.05) + (0.6 x 0.066) + 0.5 = 0.1165 or 11.7%B is incorrect because it simply sums up the factor values,C is incorrect because it does not include the risk-free rate.Discuss iFilterDiscussionWhat do you want to discuss (required)This is APT model not fundamental modelMSEditIn the APT model the intercept is RFRIn fundamental model the intercept is intercept (recression intercept- - nothing else)3/5 28/08/2023, 18:24Question 10 of 21SOLAIRAJReply to this CommentNRReally cant see why the Rf rate was added its a Fundamental Factor ModelAnsweTags: missing, error3 replies I Last Activity: a day agoCreated 11 days ago by Nerval RobertsHide All repliesReply to this Comment+1DDDrishti Deepak Khemani replied 9 days agoVVIts APT, not FF modelVeera Venkata Surya Satya Gopal Nethi replied a day agoCarhartt modelJBJad Bitar replied a day agotopicSBhe answer should be 16.15%0.05 + (0.9* 0.031) + 0.88 . 0.05) + (0.6 0.66) = 0.1615Created 2 days ago by SEKHAR BHAGAVATHY1 reply I Last Activity: 2 days agoSUBRAMANIShow All replies Reply to this CommentMRHow are they even getting a.5 Rf rate?Created 5 days ago by Matthew Ray0 replies I Last Activity: 5 days agoReply to this CommentNM0.031) (0.88 x 0.05) + (0.6 x 0.066) + 0.5 = 0.6115 not 0.1165 right?Created a month ago by Nashalie Maria De Silva3 replies I Last Activity: 5 days agoHide All replies Reply to this CommentRAthey've made a typo, should be (0.9 x 0.031) + (0.88 x 0.05) + (0.6 x 0.066) + 0.005Ronald Ang replied a month agoNPThe answer should add a Rf rate of 0.05 and not 0.005Nikhil Purohit replied a month agoSDRF = 0.5% = 0.005 !! 11.7% is good Refer to first paragraph after ex.1 to find RF.Samuel Duguay replied 5 days ago4/5 28/08/2023, 18:24Question 10 of 21Reply to this CommentNJIt should come to 16.2AnsweCreated a month ago by Nishant Jaiswal2 replies I Last Activity: 14 days agoShow All repliesReply to this CommentIt is fundamental factor model and nowhere in the book it's been indicated that risk-free rate should be taken asNAintercept Does anyone know why they added risk free rate in this case?Tags: question0 replies I Last Activity: 17 days agoCreated 17 days ago by NIJAT ALISHOVReply to this CommentAABut this model looks like a Fundamental Factor Model, where we don't use risk-free rate. Is it correct?Created a month ago by Aleksandr Alekseevskii1 reply I Last Activity: 20 days agoShow All repliesReply to this CommenttopicKWthought the error term might be included, 14.7% was a coincidenceCreated 3 months ago by Kaiyu Wang1 reply I Last Activity: a month agoShow All repliesReply to this CommentLoad More5/5