Charles Connor, CFA, is a portfolio manager at Apple Investments, LLC . Apple is a U .S .-based firm offering a wide spectrum of investment products and services. Connor manages the Biogene Fund, a domestic equity fund specializing in small capitalization growth stocks. The Biogene Fund generally takes significant positions in stocks, commonly owning 4.5-5% of the outstanding shares. The fund's prospectus limits positions to a maximum of 5% of the shares outstanding. The performance of the Biogene Fund has been superior over the last few years, but for the last two quarters the fund has underperformed its benchmark by a wide margin. Connor is determined to improve his performance numbers going forward.
The Biogene prospectus allows Connor to use derivative instruments in his investment strategy. Connor frequently uses options to hedge his fund's exposure as he builds or liquidates positions in his portfolio since Biogene's large positions often take several weeks to acquire. For example, when he identifies a stock to buy, he often buys call options to gain exposure to the stock. As he buys the stock, he sells off the options or allows them to expire. Connor has noticed that the increased volume in the call options often drives the stock price higher for a few days. He has seen a similar negative effect on stock prices when he buys large amounts of put options.
The end of the quarter is just a few days away, and Connor is considering three transactions:
Transaction A: Buying Put Options on Stock A
The Biogene Fund owns 4,9% of the outstanding stock of Company A, but Connor believes the stock is fully valued and plans to sell the entire position. He anticipates that it will take approximately 45 trading days to liquidate the entire Biogene position in Stock A
The Biogene Fund owns 5% of the outstanding stock of Company B . Connor believes there is significant appreciation potential for Stock B, but the stock price has dropped in recent weeks. Connor is hoping that by taking an option position, there will be a carryover effect on ihe stock price before quarter end.
Transaction C: Selling the Biogene Fund's Entire Position in .Stock C
Connor believes that Stock C is still attractive, but he is selling the stock with the idea that he will repurchase the position next month. The motivation for the transaction is to capture a capital loss that will reduce the Biogene Fund's tax expense for the year.
Apple has an investment banking department that is active in initial public offerings (IPOs). George Arnold, CFA, is the senior manager of the IPO department. Arnold approached Connor about Stock D, a new IPO being offered by Apple. Stock D will open trading in two days. Apple had offered the IPO to all of its clients, but approximately 20% of the deal remained unsold. Having read the prospectus, Connor thinks Stock D would be a good fit for his fund, and he expects Stock D to improve his performance in both the short and long term. Connor is not aware of any information related to Stock D beyond that provided in the prospectus. Connor asked to purchase 5% of the IPO, but Arnold limited Biogene's share to 2%, explaining:
'With Biogene's reputation, any participation will make the unsold shares highly marketable. Further, we may need Biogene to acquire more Stock D shares at a later date if the price does not hold up.'
Connor is disappointed in being limited to 2% of the offering and suggests to Arnold in an e-mail that, given the 2% limitation, Biogene will not participate in the IPO . Arnold responded a few hours later with the following message:
'I have just spoken with Ms. D, the CFO of Stock D . Although it is too late to alter the prospectus, management believes they will receive a large contract from a foreign government that will boost next year's sales by 20% or more. I urge you to accept the 2%---you won't be sorry!'
After reviewing Arnold's e-mail, Connor agrees to the 2% offer.
Based upon Connor's acceptance of the 2% limitation after receiving the e-mail from Arnold:

Austin Clark, CFA, has been asked to analyze White Goods Corporation, a $9 billion company that owns a nationwide chain of stores selling appliances and other electronic goods. As part of his analysis of the White Goods Corporation, Clark's supervisor, David Horvath, asks Clark to forecast White Goods' 2009 sales using multiple regression analysis. The following model was developed:
sales = 20.1 + 0.001 GDP+ 1,000.6 TR + 0.1 CC -3.2 PC -40.3 UR
t-values: (1.1) (2.3) (1.75) (3.2) (-0.48) (-0.9)
Number of observations: 76
Standard error estimate: 15.67
Unadjusted R2: 0.96
Regression sum of squares: 412,522
Error sum of squares: 17,188
Independent Variable Descriptions
GDP = gross domestic product
TR = average coupon rate on 5-year U .S . Treasury securities
CC = most recent quarter end consumer confidence index value
PC = previous year's sales of personal computers
UR = most recent quarter end unemployment rate
Variable Estimates for 2009
GDP =8,000
TR = 0.05
CC =97
PC = 60,000
UR = 0.055

Sara Robinson and Marvin Gardner are considering an opportunity to start their own money management firm. Their conversation leads them to a discussion on establishing a portfolio management process and investment policy statements. Robinson makes the following statements:
Statement 1;
Our only real objective as portfolio managers is to maximize the returns to our clients.
Statement 2:
If we are managing only a fraction of a client's total wealth, it is the client's responsibility, not ours, to determine how their investments are allocated among asset classes.
Statement 3: When developing a client's strategic asset allocation, portfolio managers have to consider capital market expectations. In response, Gardner makes the following statements:
Statement 4: While return maximization is important for a given level of risk, we also need to consider the client's tolerance for risk.
Statement 5: We'll let our clients worry about the tax implications of their investments; our time is better spent on finding undervalued assets.
Statement 6: Since we expect our investor's objectives to be constantly changing, we will need to evaluate their investment policy statements on an annual basis at a minimum.
Robinson wants to focus on younger clientele with the expectation that the new firm will be able to retain the clients for a long time and create long-term profitable relationships. While Gardner felt it was important to develop long-term relationships, he wants to go after older, high-net-worth clients.
Are Statements 2 and 3 correct when considering asset allocation?

William Rogers, a fixed-income portfolio manager, needs to eliminate a large cash position in his portfolio. He would like to purchase some corporate bonds. Two bonds that he is evaluating are shown in Exhibit I. These two bonds are from the same issuer, and the current call price for the callable bond is 100. Assume that the issuer will call if the bond price exceeds the call price.
Rogers is also concerned about increases in interest rates and is considering the purchase of a putable bond. He ants to determine how assumed increases or decreases in interest rate volatility affect the value of the straight bonds and bonds with embedded options. After Rogers performs some analysis, he and his supervisor, Sigourney Walters, discuss the relative price movement between the two bonds in Exhibit 1 when interest rates change significantly
During the discussions, Rogers makes the following statements:
Statement 1: If the volatility of interest rates decreases, the value of the callable bond will increase.
Statement 2: The noncallable bond will not be affected by a change in the volatility or level of interest rates.
Statement 3: When interest rates decrease, the value of the noncallable bond increases by more than the callable bond.
Statement4: If the volatility of interest rates increases, the value of the putable bond will increase.

Rogers obtained the prices shown in Exhibit b using software that generates an interest rate lattice. He uses his software to generate the interest rate lattice shown in Exhibit 2.
Exhibit 2: Interest Rate Lattice (Annualized Interest Rates)