AAMS Investment Strategies 5 — Questions and Answers
Question 1: Which option strategy creates a 'collar' to protect against downside loss on a long stock position?
- Buying a call and selling a put at the same strike price
- Buying a protective put and simultaneously selling a covered call (Correct answer)
- Selling both a put and a call with the same expiration
- Buying a straddle with at-the-money options
Correct answer: Buying a protective put and simultaneously selling a covered call
A collar combines a long put (downside protection) with a short call (premium income that offsets put cost), limiting both downside and upside.
Question 2: In a rising interest rate environment, which bond characteristic best protects an investor from significant price decline?
- Long duration and low coupon
- Short duration and high coupon (Correct answer)
- High credit rating and long maturity
- Zero-coupon structure with 30-year maturity
Correct answer: Short duration and high coupon
Short duration bonds reprice quickly and return principal sooner, while higher coupons reduce duration, minimizing price sensitivity to rising rates.
Question 3: The 'quality' factor in smart-beta investing typically selects stocks based on which criteria?
- High beta and strong recent price momentum
- High return on equity, low debt, and stable earnings (Correct answer)
- Low valuation multiples relative to peers
- Small market capitalization relative to sector average
Correct answer: High return on equity, low debt, and stable earnings
Quality factor strategies favor companies with strong profitability metrics, low financial leverage, and consistent earnings—characteristics linked to long-term outperformance.
Question 4: A 'global macro' hedge fund strategy primarily generates returns by:
- Taking long-only positions in undervalued domestic equities
- Making directional bets on currencies, interest rates, and economies across countries (Correct answer)
- Arbitraging price differences between identical securities in different markets
- Focusing exclusively on merger arbitrage situations
Correct answer: Making directional bets on currencies, interest rates, and economies across countries
Global macro funds take positions across currencies, sovereign bonds, equity indices, and commodities based on macroeconomic analysis of different countries.
Question 5: Which concept explains why adding a low-correlation asset to a portfolio can reduce overall portfolio volatility even if that asset has higher standalone volatility?
- The law of large numbers applied to equity returns
- Diversification benefit from correlation less than 1.0 (Correct answer)
- Regression to the mean in asset pricing
- The efficient market hypothesis
Correct answer: Diversification benefit from correlation less than 1.0
When asset correlations are below 1.0, combining them reduces portfolio variance below the weighted average of individual variances, producing diversification benefits.
Question 6: A 'dynamic asset allocation' strategy that systematically reduces equity exposure as markets decline (to lock in gains) is known as:
- Constant-proportion portfolio insurance (CPPI) (Correct answer)
- Buy-and-hold indexing
- Contrarian mean-reversion strategy
- Equal-weight rebalancing
Correct answer: Constant-proportion portfolio insurance (CPPI)
CPPI uses a floor value and multiplier to dynamically shift between risky assets and safe assets, reducing equity as portfolio value falls toward the floor.
Question 7: When evaluating active managers, which metric adjusts return for risk by dividing the manager's excess return above the benchmark by the portfolio's tracking error?
- Sharpe ratio
- Information ratio (Correct answer)
- Treynor ratio
- Jensen's alpha
Correct answer: Information ratio
The information ratio measures a manager's active return per unit of active risk (tracking error), assessing the efficiency of active management decisions.
AAMS Investment Strategies 5
Which option strategy creates a 'collar' to protect against downside loss on a long stock position?