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Answer: Quadratic programming allows for risk control through parameter estimation but generally requires many more inputs estimated from market data than other portfolio construction techniques require.
The correct answer is A. Quadratic programming is a portfolio construction technique that allows for risk control through parameter estimation. It requires a significant number of inputs, including volatilities and pair-wise correlations between all assets in a portfolio. This process is powerful but can be sensitive to the quality of the data used for estimation, as imperfect data can introduce noise and lead to poor calibration. The other options are incorrect for the following reasons: B is incorrect because the screening technique aims for risk control by including a sufficient number of stocks that meet specific screening criteria and by avoiding concentration in any particular stock. However, it does not necessarily ensure an even distribution of stocks across sectors and may overlook entire sectors or classes of stocks that do not meet the screening criteria, making risk control in this process incomplete. C is incorrect because stratification involves categorizing stocks, such as by economic sectors, and implementing risk control by ensuring that the weighting in each sector matches the benchmark weighting. It does not permit the overweighting or underweighting of specific categories. D is incorrect because linear programming does not necessarily select the portfolio with the lowest level of active risk. Instead, it seeks to enhance stratification by introducing additional dimensions of risk control and ensuring that the portfolio closely matches the benchmark across all these dimensions. This question tests the understanding of different portfolio construction techniques and their respective capabilities for risk control.
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The equity mutual fund's risk audit committee is currently evaluating a portfolio construction strategy recommended by a newly appointed portfolio manager entrusted with capital management. Although the fund grants its managers the autonomy to select and employ appropriate portfolio construction techniques, it is imperative that the chosen method aligns with the key risk management objectives set by the company. Which of the following portfolio construction methods accurately reflects its ability to manage risk in the context of portfolio construction?
A
Quadratic programming allows for risk control through parameter estimation but generally requires many more inputs estimated from market data than other portfolio construction techniques require.
B
The screening technique provides superior risk control by concentrating stocks in selected sectors based on expected alpha.
C
When using the stratification technique, risk control is implemented by overweighting the categories with lower risks and underweighting the categories with higher risks.
D
When using the linear programming technique, risk is controlled by selecting the portfolio with the lowest level of active risk.