Unit study guide · NISM Series XXI-B
Equity Portfolio Management Strategies
14 questions in this unit
What this unit covers
- What is the primary objective of a portfolio designed for index tracking?
- What does a value-investing approach primarily seek when selecting an equity security?
- Which selection rule most directly represents an equity momentum approach?
- What does an active sector-rotation strategy intentionally change over time?
- An index contains many small, difficult-to-trade holdings. Which tracking method may use a representative subset instead of buying every constituent?
- A portfolio uses a broad passive allocation for most assets and smaller specialist active allocations. Which management structure is this?
- Which description best fits a rules-based smart-beta equity strategy?
- A two-stock portfolio has weights 70% and 30%, against benchmark weights 40% and 60%. What is its active share?
- A manager’s information coefficient doubles while independent breadth falls by 75%. Under the fundamental law, what happens to the predicted information ratio?
- An equity desk reviews an unhedged foreign sleeve. Its shares gain 10% in local currency while that currency loses 5% against the rupee, with no distributions or costs. What is the sleeve’s rupee return?
- For a domestic sleeve, the equity desk buys 1,000 shares at ₹200 and matching puts with strike ₹190 for ₹5 per share. At expiry the share price is ₹160, and all positions are settled with no other costs. What is the combined result?
- As a separate alternative, the equity desk buys a share at ₹200 and writes a matching call with strike ₹220 for a ₹4 premium. At expiry the share is ₹250 and the call is settled, with no other costs. What is the covered-call profit per share?
- The equity desk manages a ₹2 crore portfolio with beta 1.2 and wants beta 0.3 without selling its shares. Assume each hypothetical index futures contract has ₹12 lakh notional value, unit beta and a matching market exposure. How many contracts should it sell?
- The equity desk reports 4 percentage points of return above a broad benchmark before fees. A matched size-and-value analysis attributes 3 percentage points of that excess to factor exposure, and fees reduce return by 1 percentage point. What unexplained excess return remains after both adjustments?
Key ideas
From the practice bank · 1
What is the primary objective of a portfolio designed for index tracking?
Index tracking aims to closely match the selected index’s performance. Implementation costs and practical differences can still create a return gap. Remember: A passive objective is benchmark matching rather than guaranteed outperformance.
Hint Distinguish matching a benchmark from making an active forecast. Common mistake: Assuming passive management removes the market risk of the chosen index.
XXI-B-109From the practice bank · 2
What does a value-investing approach primarily seek when selecting an equity security?
Value investing seeks a price below a reasoned estimate of value. The estimate can be wrong, and a low price alone is not sufficient evidence. Remember: Cheap in absolute rupees and undervalued are different ideas.
Hint Compare price with an economic assessment rather than with other rupee prices. Common mistake: Calling every low-priced share a value investment.
XXI-B-110From the practice bank · 3
Which selection rule most directly represents an equity momentum approach?
A momentum approach favours securities with stronger recent relative performance under its specified rule. Past momentum can reverse and does not assure a future gain. Remember: Momentum and value use different reasons for selecting securities.
Hint Consider a strategy that studies persistence in relative market performance. Common mistake: Treating recent outperformance as a certainty that prices will keep rising.
XXI-B-111From the practice bank · 4
What does an active sector-rotation strategy intentionally change over time?
Sector rotation changes relative industry exposures based on the manager’s outlook. It can create active risk relative to the benchmark’s sector mix. Remember: Sector rotation expresses views through industry overweights and underweights.
Hint Identify the portfolio choice linked to expectations for different parts of the economy. Common mistake: Confusing a reporting change with a change in economic exposure.
XXI-B-112From the practice bank · 5
An index contains many small, difficult-to-trade holdings. Which tracking method may use a representative subset instead of buying every constituent?
Sampling uses a representative subset to approximate the index’s characteristics. It may reduce implementation burdens but can introduce tracking differences. Remember: Sampling trades exact constituent replication for a practical approximation.
Hint Distinguish a representative portfolio from an exact constituent copy. Common mistake: Assuming a sampled index portfolio must hold every index constituent.
XXI-B-113From the practice bank · 6
A portfolio uses a broad passive allocation for most assets and smaller specialist active allocations. Which management structure is this?
This is a core-and-satellite structure because a broad central allocation is complemented by smaller specialist positions. The satellites can alter active risk and total costs. Remember: Core and satellite combines broad exposure with selected active or specialist allocations.
Hint Think about a stable central allocation complemented by smaller specialised parts. Common mistake: Assuming the passive core makes the entire portfolio passive or risk-free.
XXI-B-114From the practice bank · 7
Which description best fits a rules-based smart-beta equity strategy?
Smart-beta strategies use systematic rules to obtain selected factor exposures or alternative weights. Their performance depends on those exposures and implementation, not a guarantee. Remember: Rules-based factor investing is not the same as guaranteed alpha.
Hint Separate the portfolio-construction rule from any claim about future performance. Common mistake: Interpreting a smart-beta label as evidence that the strategy always beats a broad index.
XXI-B-115From the practice bank · 8
A two-stock portfolio has weights 70% and 30%, against benchmark weights 40% and 60%. What is its active share?
Active share is 30% because it is half the sum of absolute weight differences. Differences are |70% − 40%| = 30% and |30% − 60%| = 30%. Active share = (30% + 30%) ÷ 2 = 30%. Remember: Active share measures holdings differences, not realised excess return.
Hint Measure the unmatched holdings without counting each active shift twice. Common mistake: Cancelling signed deviations or forgetting the one-half adjustment.
XXI-B-116From the practice bank · 9
A manager’s information coefficient doubles while independent breadth falls by 75%. Under the fundamental law, what happens to the predicted information ratio?
The predicted information ratio is unchanged because higher forecasting skill offsets fewer independent investment decisions. The information coefficient measures forecasting skill, and breadth counts independent decisions. The fundamental law uses information ratio ≈ information coefficient × √breadth. Doubling the coefficient multiplies the result by 2. Reducing breadth to 25% multiplies its square root by 0.5. Combined effect = 2 × 0.5 = 1. Remember: The fundamental law depends on independent breadth and its square root.
Hint Consider how breadth enters the fundamental law rather than counting decisions linearly. Common mistake: Equating more correlated trades with proportionately greater independent investment breadth.
XXI-B-117From the practice bank · 10
An equity desk reviews an unhedged foreign sleeve. Its shares gain 10% in local currency while that currency loses 5% against the rupee, with no distributions or costs. What is the sleeve’s rupee return?
The rupee return is 4.50% because asset and currency growth factors multiply. Working: (1 + 0.10) × (1 − 0.05) − 1 = 1.10 × 0.95 − 1 = 0.045, or 4.50%. Remember: Unhedged foreign-equity returns combine asset performance and currency movement.
Hint Translate the changed foreign asset value at the changed exchange rate. Common mistake: Adding percentage returns when both changes act on the same investment value.
XXI-B-118From the practice bank · 11
For a domestic sleeve, the equity desk buys 1,000 shares at ₹200 and matching puts with strike ₹190 for ₹5 per share. At expiry the share price is ₹160, and all positions are settled with no other costs. What is the combined result?
The combined result is a ₹15,000 loss because the put offsets part of the share-price fall. Share loss = (₹160 − ₹200) × 1,000 = −₹40,000. Put payoff = (₹190 − ₹160) × 1,000 = ₹30,000. Premium = ₹5 × 1,000 = ₹5,000. Total = −₹40,000 + ₹30,000 − ₹5,000 = −₹15,000. Remember: A protective put can limit a defined downside but its premium is a real cost.
Hint Combine the share result with the option result after its premium. Common mistake: Ignoring the premium when calculating the protected position’s result.
XXI-B-119From the practice bank · 12
As a separate alternative, the equity desk buys a share at ₹200 and writes a matching call with strike ₹220 for a ₹4 premium. At expiry the share is ₹250 and the call is settled, with no other costs. What is the covered-call profit per share?
Covered-call profit is ₹24 per share because gains above ₹220 are offset by the call obligation. Share gain = ₹250 − ₹200 = ₹50. Call loss = ₹250 − ₹220 = ₹30. Add the ₹4 premium: ₹50 − ₹30 + ₹4 = ₹24. Remember: A covered call earns premium while capping part of the share position’s upside.
Hint A written call offsets the share’s gains above the strike. Common mistake: Keeping the share’s full upside while forgetting the matching short-call obligation.
XXI-B-120From the practice bank · 13
The equity desk manages a ₹2 crore portfolio with beta 1.2 and wants beta 0.3 without selling its shares. Assume each hypothetical index futures contract has ₹12 lakh notional value, unit beta and a matching market exposure. How many contracts should it sell?
The desk should sell 15 hypothetical contracts to reduce beta exposure by 0.9. Exposure to remove = (1.2 − 0.3) × ₹200 lakh = ₹180 lakh. Contracts = ₹180 lakh ÷ ₹12 lakh = 15. This calculation assumes the stated hedge relationship and ignores basis risk and costs. Remember: A beta hedge targets the difference between current and desired market exposure.
Hint Hedge the unwanted beta exposure, not the entire portfolio value. Common mistake: Hedging the full beta when a nonzero target beta is intended.
XXI-B-121From the practice bank · 14
The equity desk reports 4 percentage points of return above a broad benchmark before fees. A matched size-and-value analysis attributes 3 percentage points of that excess to factor exposure, and fees reduce return by 1 percentage point. What unexplained excess return remains after both adjustments?
No unexplained excess remains after the two stated adjustments. Gross excess = 4 percentage points. Deduct 3 percentage points explained by factors and 1 percentage point of fee drag. Remaining excess = 4 − 3 − 1 = 0 percentage points. Remember: Broad-benchmark outperformance need not represent skill after factor and cost adjustments.
Hint Separate explained systematic exposure and costs from unexplained performance. Common mistake: Calling every gross benchmark difference alpha attributable to manager skill.
XXI-B-122