| Year | Characterization of capital market valuation | ||
| 1998-1999 | There was a bubble in stock prices. | ||
| 2000-2001 | Stock prices subsequently corrected. | ||
| 2002-2003 | The downward trend in stock prices, due to an overcorrection; that is, prices fell significantly below fundamental values. |
Assume that the characterization of capital market valuation above is correct. According to the theory of active portfolio management, in which period(s) of time did large numbers of investors turn their attention to actively managed funds?
A. The period 1998-1999 only.
B. The period 2000-2001 only.
C. The periods 1998-1999 and 2002-2003.
Answer: B
According to the theory of active portfolio management, one of the justifications for active management is that market equilibrium results from the activity of active managers who are seeking misvalued securities. That is, the actions of active managers result in fairly valued securities.
Capital markets were corrected from 2000 to 2001. This would result from large numbers of investors turning their attention to actively managed funds.
The misvaluations in the periods 1998-1999 and 2002-2003 would be from not enough assets being deployed to active management.
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