RFC Investment Analysis & Selection 3 — Questions and Answers
Question 1: A mutual fund that consistently underperforms its benchmark by 0.5% annually, but closely tracks it, MOST likely has a:
- High tracking error
- Low expense ratio
- High expense ratio and low tracking error (Correct answer)
- Positive alpha
Correct answer: High expense ratio and low tracking error
Consistent underperformance by a fixed amount with tight tracking suggests costs (expense ratio) are dragging returns rather than poor security selection.
Question 2: Which portfolio construction technique seeks to minimize variance for a given level of expected return?
- Factor investing
- Modern Portfolio Theory (MPT) (Correct answer)
- Dollar-cost averaging
- Tactical asset allocation
Correct answer: Modern Portfolio Theory (MPT)
MPT, developed by Harry Markowitz, identifies portfolios on the efficient frontier that minimize variance for each level of expected return.
Question 3: An investor holds a diversified portfolio with a beta of 1.4. If the market rises 10%, the portfolio is expected to return approximately:
- 10%
- 14% (Correct answer)
- 4%
- 1.4%
Correct answer: 14%
A beta of 1.4 means the portfolio is expected to move 1.4 times the market; 1.4 × 10% = 14% expected return.
Question 4: Which of the following BEST describes a 'closed-end' fund?
- A fund that issues new shares daily at NAV
- A fund with a fixed number of shares trading on an exchange (Correct answer)
- A fund that closes to new investors after reaching a size limit
- A fund that only accepts institutional investors
Correct answer: A fund with a fixed number of shares trading on an exchange
Closed-end funds issue a fixed number of shares through an IPO, then trade on exchanges at prices that may differ from their NAV.
Question 5: An RFC client wants income with modest capital appreciation. Which asset allocation is MOST appropriate?
- 100% equities
- 80% equities / 20% bonds
- 40% equities / 60% bonds (Correct answer)
- 100% money market instruments
Correct answer: 40% equities / 60% bonds
A 40/60 equity-to-bond split provides fixed-income income while the equity allocation offers some growth potential, balancing the stated objectives.
Question 6: Which technical analysis concept refers to a price level where selling pressure has historically prevented further price increases?
- Support level
- Resistance level (Correct answer)
- Moving average crossover
- Relative strength
Correct answer: Resistance level
A resistance level is a price ceiling where supply tends to overwhelm demand, causing repeated price reversals.
Question 7: The 'efficient market hypothesis' (EMH) in its strong form holds that:
- Only public information is reflected in prices
- Only past price data is reflected in prices
- All public and private information is reflected in prices (Correct answer)
- No information is reflected in prices
Correct answer: All public and private information is reflected in prices
Strong-form EMH asserts that stock prices fully reflect all information, including insider or non-public data, making it impossible to earn consistent excess returns.
RFC Investment Analysis & Selection 3
A mutual fund that consistently underperforms its benchmark by 0.5% annually, but closely tracks it, MOST likely has a: