Also, I’m a bit worried about whether my answers are complete enough.
For instance, Question 6 in Mock 2011 asks you to describe the trades that a Portfolio Manager should do based on economic forecasts, and justify each trade.
1. Guideline Answer:
Bonds to buy: Consumer cyclicals
Bonds to sell: Consumer non-cyclicals or utilities
Justify each trade, based on economist’s forecast: “A sector rotation trade is used to move out of a sector that is expected to weaken and move into a sector that is expected to strengthen. When there is an increase in economic activity, the consumer cyclicals sector tends to outperform other sectors. Consumers go forward with purchases that have been delayed and purchases of non-essential goods. Since the economist has forecast a significant economic improvement, an appropriate sector rotation trade for Wang would be to increase Consumer cyclicals holdings (Wang is already overweight this sector relative to the benchmark index). Either consumer non-cyclicals or utilities can be sold to fund the purchase. Given that Wang’s portfolio is already underweight in Consumer non-cyclicals relative to the benchmark index, he is more likely to reduce his exposure to utilities, which also behave in a non-cyclical fashion”.
2. My Answer:
Bonds to buy: Consumer cyclicals
Bonds to sell: Consumer non-cyclicals and utilities
Justify each trade, based on economist’s forecast:
- The economic forecast states that consumer confidence will increase and unemployment will fall, which will lead to an improvement of the general economy.
- When there is such an improvement, companies that are sensitive to the economic cycle will perform better than those less affected by the economic cycle, since their products and services will be more demanded.
- Hence, Wang should buy consumer cyclical bonds to benefit from the economic improvements, and should sell the consumer non-cyclical and utilities, because they will underperform compared to the cyclical bonds.
Any thoughts on how this answer would be graded? I gave myself full credit, as it seems I am saying exactly the same but going more to the point.
Cheers