Apply Portfolio Techniques - Series 65

1. Identify the limitation: In a steadily rising market, DCA often underperforms what alternative approach?

   Lump-sum investing at the start. In rising markets, lump-sum investing captures full growth from the outset, outperforming DCA's gradual entry at higher average prices.

2. Which type of risk is primarily reduced by diversification: systematic or unsystematic?

   Unsystematic risk. Diversification mitigates unsystematic risk, which is specific to individual companies or industries, unlike systematic risk that affects the entire market.

3. Which sector is typically considered defensive and often holds up in recessions: utilities or consumer discretionary?

   Utilities. Utilities provide essential services with stable demand, making them resilient during economic downturns compared to discretionary sectors.

4. Which sector often benefits most from falling interest rates: financials or utilities?

   Utilities. Falling interest rates reduce borrowing costs for capital-intensive utilities, boosting their profitability and attractiveness to investors.

5. Calculate average cost: invest $100 at $10 and $100 at $20; what is avg cost/share?

   $13.33 per share (approximately). With 10 shares at $10$ and 5 at $20$, total $200$ buys 15 shares, yielding an average cost of $200 / 15 approx $13.33$.

6. Which statement is correct: DCA guarantees a profit, reduces timing risk, or increases market risk?

   DCA reduces timing risk; it does not guarantee a profit. Dollar-cost averaging spreads investments over time to minimize the risk of investing a lump sum at a market peak.

7. What does a correlation of $+1$ imply about diversification benefit between two assets?

   No diversification benefit; returns move perfectly together. A correlation of $+1$ means assets move in perfect unison, eliminating diversification benefits as risks are not offset.

8. What is rebalancing, stated as a portfolio maintenance action?

   Resetting holdings to target weights after drift. Rebalancing maintains the desired risk level by adjusting asset weights back to strategic targets after market movements cause deviations.

9. Which statement best describes the key risk of sector rotation for many investors?

   It depends on correct market-cycle timing, which is difficult. Sector rotation requires accurate prediction of economic phases, a challenge that can lead to underperformance if timing is incorrect.

10. What is diversification in portfolio management, stated in one sentence?

    Spreading investments across assets to reduce unsystematic risk. Diversification reduces unsystematic risk by allocating investments across various assets, minimizing the impact of any single asset's poor performance.

11. Identify the technique: investing a fixed dollar amount at regular intervals regardless of price.

    Dollar-cost averaging (DCA). Dollar-cost averaging involves periodic fixed investments to average purchase costs over time, mitigating the impact of market timing.

12. Which statement best describes portfolio drift as markets move?

    Actual weights deviate from target weights over time. Portfolio drift occurs as varying asset performances alter allocation percentages, potentially shifting the portfolio's risk profile away from objectives.

13. Calculate shares bought: invest $200 at $25 per share; how many shares are purchased?

    $8$ shares. Dividing the investment amount by the share price determines shares purchased, as in $200 / $25 = 8$ shares.

14. Which sector is typically more cyclical: consumer discretionary or consumer staples?

    Consumer discretionary. Consumer discretionary sectors fluctuate with economic conditions, as spending on non-essentials varies more than on staples.

15. Which market pattern best supports DCA benefits: steady rise, steady fall, or volatility?

    Volatility. Volatility allows dollar-cost averaging to purchase more shares at lower prices and fewer at higher, optimizing average cost.

16. What is sector rotation as an investment strategy, stated in one sentence?

    Shifting exposure among sectors based on the business cycle. Sector rotation capitalizes on economic cycles by overweighting sectors expected to outperform in the current phase, enhancing returns.

17. Which correlation sign best supports diversification benefits: positive, zero, or negative?

    Negative correlation (or low/near-zero correlation). Negative or low correlation enhances diversification by allowing one asset's gains to offset another's losses, reducing overall portfolio volatility.

18. Which sector often benefits from rising interest rates due to net interest margin: financials or utilities?

    Financials. Rising interest rates widen banks' net interest margins, increasing profitability in the financial sector unlike rate-sensitive utilities.

19. What is correlation, in portfolio context, stated as a relationship between returns?

    The degree to which two assets' returns move together. Correlation measures how closely the returns of two assets covary, aiding in assessing diversification potential in a portfolio.

20. What is the primary goal of asset allocation in a diversified portfolio?

    Match risk/return to objectives using multiple asset classes. Asset allocation aims to align the portfolio's risk and return profile with investor goals by distributing investments across diverse classes.

21. Which action best describes rebalancing discipline: sell winners and buy losers, or the reverse?

    Sell winners and buy losers to restore target weights. Rebalancing enforces discipline by trimming overperforming assets and adding to underperformers, maintaining the intended asset allocation.

22. What does a correlation of $-1$ imply about diversification potential between two assets?

    Maximum diversification potential; returns move oppositely. A correlation of $-1$ provides optimal diversification as one asset's positive returns counterbalance the other's negative returns.

23. What is the key reason diversification cannot eliminate systematic (market) risk?

    Systematic risk affects most securities simultaneously. Systematic risk impacts the broader market, making it impossible for diversification to eliminate as it correlates across most assets.

24. What is the main effect of dollar-cost averaging on average cost per share in volatile markets?

    It tends to lower average cost by buying more shares at low prices. In volatile markets, dollar-cost averaging buys more shares when prices are low, resulting in a lower overall average cost per share.

25. State the formula for average cost per share under DCA using total dollars and total shares.

    $\text{Avg cost} = \frac{\text{Total dollars invested}}{\text{Total shares purchased}}$. The formula calculates the effective average cost by dividing total investment by shares acquired, reflecting weighted purchases in DCA.

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