Future Fellows - December 2010
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What is Bloom’s Taxonomy?

According to Wikipedia, Bloom’s Taxonomy is a classification of learning objectives within education. The taxonomy was first presented in 1956 through the publication The Taxonomy of Educational Objectives, The Classification of Educational Goals, Handbook I: Cognitive Domain, by Benjamin Bloom (editor), M. D. Englehart, E. J. Furst, W. H. Hill, and David Krathwohl. It is considered to be a foundational and essential building block within the education community.

There are six levels in the taxonomy, moving through the lowest order processes to the highest:

  • Knowledge—Exhibit memory of previously learned materials by recalling facts, terms, basic concepts, and answers.
  • Comprehension—Demonstrative understanding of facts and ideas by organizing, comparing, translating, interpreting, giving descriptions, and stating main ideas.
  • Application—Using new knowledge. Solve problems to new situations by applying acquired knowledge, facts, techniques, and rules in a different way.
  • Analysis—Examine and break information into parts by identifying motives or causes. Make inferences and find evidence to support generalizations.
  • Synthesis—Compile information together in a different way by combining elements in a new pattern or proposing alternative solutions.
  • Evaluation—Present and defend opinions by making judgments about information, validity of ideas, or quality of work based on a set of criteria.
(See http://en.wikipedia.org/wiki/Bloom’s_taxonomy for more information.) Examples of CAS exam questions at each level in the taxonomy follow. The questions were taken from 2010 Exam 8.
  1. Knowledge: Question 5a
    Describe the equity premium puzzle.

  2. Comprehension: Question 1a
    In a perfectly efficient market, one might conclude that randomly chosen stocks is as effective as rationally choosing a stock portfolio. Describe two reasons for active portfolio management.

  3. Application: Question 2a
    • The return of a risk free asset is 5%
    • An investment company offers a risky asset, with a Sharpe ratio of 0.2
    • An investor wants to hold a portfolio consisting of the risky asset and the risk-free asset
    Calculate the expected return of the portfolio if the investor wants the standard deviation of the portfolio to be 15%.

  4. Analysis: Question 9a
    Given the following information:
    • Value of a company’s assets today is $19,000,000
    • Value of a company’s equity to today is $5,000,000
    • Risk-free rate is 3% per annum
    • Debt of $15,000,000 to be repaid in one year
    • Instantaneous volatility of equity = 0.5
    • Volatility of assets = 0.25
    Explain what assumptions Merton makes that allows Merton’s model to be used in estimating default probabilities for companies.

  5. Synthesis: Question 12a
    An investor would like to enter into a forward contract whereby in two years the investor exchanges a fixed amount of US Dollars for one million Euros.

    Assume the current exchange rate is $1.50 per Euro and that the continuously compounded risk-free interest rates are 2% in Europe and 1% in the United States. The investor can borrow and invest at the risk-free rate.

    Determine an investment strategy which would give the investor the same cash flows as the forward contract.

  6. Evaluation: Question 13a
    When a known future cash outflow in a foreign currency is hedged by a company using a forward contract, there is no foreign exchange risk. When it is hedged using futures contracts, the marking-to-market process does leave a company exposed to some risk.

    Explain whether a company is better off using a futures contract or a forward contract in the following situation:

    The value of the foreign currency falls rapidly during the life of the contract.

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