AAMS Investment Strategies 3 — Questions and Answers
Question 1: Which fixed-income strategy involves purchasing bonds with various maturities spread evenly across a time horizon to manage reinvestment risk?
- Bond barbell
- Bond ladder (Correct answer)
- Bond bullet
- Duration matching
Correct answer: Bond ladder
A bond ladder staggers maturities evenly, so proceeds from maturing bonds are reinvested periodically, smoothing reinvestment rate risk.
Question 2: When interest rates are expected to fall significantly, which bond strategy is most likely to produce the highest total return?
- Shortening portfolio duration to minimize sensitivity
- Extending portfolio duration to maximize price appreciation (Correct answer)
- Moving entirely to floating-rate notes
- Concentrating in Treasury bills
Correct answer: Extending portfolio duration to maximize price appreciation
Longer-duration bonds exhibit greater price sensitivity to falling rates, so extending duration amplifies capital gains when rates decline.
Question 3: A covered call strategy on an existing stock position generates premium income but:
- Eliminates all downside risk on the underlying stock
- Caps the upside potential above the strike price (Correct answer)
- Requires margin and adds leverage to the portfolio
- Provides unlimited profit if the stock rises sharply
Correct answer: Caps the upside potential above the strike price
Writing covered calls caps gains above the strike price because the shares may be called away, limiting upside participation.
Question 4: In the context of alternative investments, what distinguishes a hedge fund's use of 'absolute return' from traditional benchmarked strategies?
- Absolute return funds must outperform the S&P 500 each year
- Absolute return funds seek positive returns regardless of market direction (Correct answer)
- Absolute return strategies only invest in government securities
- Absolute return funds cannot use leverage or derivatives
Correct answer: Absolute return funds seek positive returns regardless of market direction
Absolute return strategies aim for positive performance in any market environment, rather than measuring success relative to a market benchmark.
Question 5: Which portfolio construction technique minimizes variance for a given level of expected return, producing the efficient frontier?
- Black-Litterman optimization
- Mean-variance optimization (Correct answer)
- Risk parity weighting
- Equal-weight indexing
Correct answer: Mean-variance optimization
Mean-variance optimization, developed by Markowitz, finds the minimum-variance portfolio for each level of expected return to map the efficient frontier.
Question 6: An investor uses a 'portable alpha' strategy by overlaying an alpha-generating hedge fund position on top of a passive index exposure. The net result is:
- Reduced market beta and eliminated active risk
- Market beta from the index plus alpha from the active overlay (Correct answer)
- Full replacement of index exposure with active management
- A leveraged short position against the benchmark
Correct answer: Market beta from the index plus alpha from the active overlay
Portable alpha separates alpha generation from beta exposure, layering the hedge fund's excess return on top of an index's market return.
Question 7: Which risk measure captures the average loss in the worst X% of scenarios, making it more sensitive to tail risk than Value at Risk (VaR)?
- Standard deviation
- Conditional Value at Risk (CVaR) / Expected Shortfall (Correct answer)
- Sharpe ratio
- Maximum drawdown
Correct answer: Conditional Value at Risk (CVaR) / Expected Shortfall
CVaR (Expected Shortfall) averages losses beyond the VaR threshold, providing a more complete picture of tail risk than VaR alone.
AAMS Investment Strategies 3
Which fixed-income strategy involves purchasing bonds with various maturities spread evenly across a time horizon to manage reinvestment risk?