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Answer: The quadratic programming technique takes into account additional risk parameters compared to other major portfolio construction techniques but also requires more inputs, which leads to more noise.
## Explanation Let's analyze each option: **Option A: CORRECT** - Quadratic programming is a sophisticated portfolio optimization technique that considers multiple risk parameters including variances and covariances - It does require more inputs (expected returns, variances, covariances) which can introduce estimation error and noise - This accurately describes the trade-off between comprehensive risk control and input sensitivity **Option B: INCORRECT** - Screening techniques typically rank stocks by alpha or other metrics, but they can and often do apply risk control measures - Many screening approaches do use capitalization weighting or other risk control methods **Option C: INCORRECT** - Stratification technique involves splitting stocks into categories but maintains risk control by matching benchmark weights in each category, not by overweighting low-risk categories - The goal is to control risk by maintaining similar sector/industry exposures as the benchmark **Option D: INCORRECT** - Linear programming techniques can and do consider multiple risk dimensions beyond just pair-wise correlations - They can incorporate constraints on size, industry, volatility, beta, and other risk factors Quadratic programming is indeed the most comprehensive risk control technique among these options, though it suffers from the input sensitivity problem mentioned in Option A.
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The risk committee of an equity mutual fund is reviewing a portfolio construction technique proposed by a new portfolio manager who has recently been allocated capital to manage. The fund typically grants its portfolio managers flexibility in selecting and implementing appropriate portfolio construction procedures but requires that any methodology adopted fulfill key risk control objectives set by the firm. Which of the following is correct regarding a portfolio construction technique and its approach to risk control?
A
The quadratic programming technique takes into account additional risk parameters compared to other major portfolio construction techniques but also requires more inputs, which leads to more noise.
B
The screening technique ranks stocks by risk-adjusted alpha but it does not apply any additional risk control measures such as weighting the selected stocks by their relative capitalization.
C
The stratification technique splits the list of stocks into categories and maintains risk control by overweighting the categories with lower risks and underweighting the categories with higher risks.
D
The linear programming technique focuses on the pair-wise correlations of stocks rather than characterizing each stock along multiple dimensions of risk such as size, industry, volatility, or beta.