Question 1
Dr. Andrew Lung, CFA, FRM, is Head of Factors Investing for RedRock Asset management. As part of RedRock Group, the Factors Investing team is responsible for proprietary factor investing and ESG-factor product innovation. Recently, the team is focusing on testing novel ESG factors risk premium by empirical data. There are some disputes between the team members. Which of the following statements regarding alpha, beta, factor risk premium, and related topics is correct?
A. Low beta assets have attraction and investors do not need much risk premium compensation because the payoff of these assets tends to be high during bad times.
B. The market risk premium in Single-factor-model CAPM is proportional to the market volatility because under CAPM investors have mean-variance utility and have homogenous expectations.
C. The small market capitalization stocks tend to have few deviations from the CAPM expected return because the information regarding small-cap stocks is less costly and is easily accessed by many investors.
D. The market, investors, and economists do believe that there will be a perfectly efficient market. Before approaching the pure form, the markets are near-efficient and if the market segments are more liquid, outsized profits may be easier to collect and obtain.
Answer: A
Question 2
Dr. Andrew Lung also serves as Senior Advisor to RedRock Retirement Solutions. The capital of the retirement fund is largely allocated to traditional asset classes such as public stocks, municipal bonds, and high- rated corporate bonds in the US market. In order to collect more excess returns, Dr. Lung suggests that some tactical strategies such as dynamic factors trading may produce exceeding yield. Which of the following suggestions regarding factors trading is correct?
A. During the economic turbulence, RedRock retirement can obtain a large positive premium from the volatility factor by writing put options.
B. Dr. Lung suggests that RedRock Retirement Solutions should give up the size strategy because, since the mid- 1980s, the size effect is not significant in the American market.
C. The analyst of RedRock Retirement Solutions recommends productivity factor, political factor, and demographic factor because he thinks that these factors are for long-term investors and can be captured by active trading.
D. For the value factor, during bad times, the growth firms have less flexibility to adjust and burden with more ineffective capital while value firms can quickly shift to more profitable activities.
Answer: B
Question 3
One of the fund managers of RedRock Asset management, Alex Ni, is a devout believer in the efficient market hypothesis ( EMH \text{EMH} EMH). Therefore, he manages three index funds to track three different indexes. Another active manager, Luiz Veiga, has no consensuses on the investment with Ni and always debates the market phenomena such as deviations from EMH \text{EMH} EMH with Ni. Which of the following statements regarding risk premium, deviations from EMH \text{EMH} EMH, and factors is correct?
A. The researchers who believe rational forms acknowledge that high expected returns result from investors’ cognitive or emotional biases that enable investors to underreact or overreact to pieces of information.
B. Under
EMH
\text{EMH}
EMH, the risk premium that investors obtain depends on market beta and market risk premium. If the average risk aversion of investors is
5
5
5, and market volatility is
10
%
10\%
10% per annum, the market risk premium will be
50
%
50\%
50% per annum.
C. Investors can use dynamic factors to gain factor risk premium such as volatility factor. The CBOE Volatility Index (
VIX
\text{VIX}
VIX) represents the level of market turbulence and most asset classes have a negative relation with
VIX
\text{VIX}
VIX.
D. The momentum strategy is a positive feedback strategy where investors will take more positions to the stocks with the skyrocketed price.
Answer: D
Question 4
A fund analyst decides to replace the traditional factor regression with style analysis. Which of the following statements is the characteristic of style analysis?
A. Style analysis can present how the factors exposures change and evolve under various market conditions, helping investors track the time-varying exposure.
B. A positive beta to Value Index Fund means that the portfolio has co-movement with performances of firms with low book-to-market value ratio.
C. Style analysis employs untradeable factor indices created by Fama and French such as SMB index and HML index. Due to violation of an appropriate benchmark, style analysis is not a sophisticated approach to analyze factor exposures and alpha.
D. Style analysis can only reflect the changes of factor loadings while it cannot reveal the time-varying alphas that the portfolio creates.
Answer: A
Question 5
Here is the information regarding a current active-managed portfolio and its former fund manager:
| Number of assets | 50 50 50 |
|---|---|
| Information coefficient of the fund manager | 0.25 0.25 0.25 |
| Residual risk (volatility)of the portfolio | 15 % 15\% 15% |
| Score | Expected to be standard normally distributed |
| How many average bets were be taken per annum | 55 55 55 |
Which of the following is accurate concerning portfolio construction?
A. We can expect at a
99
%
99\%
99% confidence level that the alpha will locate in the area between
−
9.68
%
-9.68\%
−9.68% to
9.68
%
9.68\%
9.68%.
B. The procedure that reexamines unduly large or small alphas and eliminates them is called scaling alpha outliers.
C. If the average number of bets of active managers is
30
30
30 times, the former fund manager is more diligent and must produce more active returns given both cost and benefit.
D. If transaction costs are zero, the manager will not revise the portfolio because the portfolio is always aligned with the benchmark.
Answer: A
Question 6
Four fund managers are debating the concept of dispersion. The concept of dispersion can help clients, fund managers, and supervisors monitor the current performance of various accounts. Whose comment regarding dispersion is correct?
A. Manager Ty: dispersion refers to the different performances of different client accounts managed by different fund managers. The peer comparison can encourage competition between managers.
B. Manager Ab: dispersion will not disappear even the holdings in each account are identical.
C. Manager Togashi: managers running separate accounts for multiple clients can control dispersion, but cannot
eliminate it.
D. Manager Hy: The dispersion of client-initiated constraints can also be controlled by the manager.
Answer: C
Question 7
Here is the information on Asset A in the Pluto Pension Plan’s sub-portfolio:
| Items | Number |
|---|---|
| Number of asset classes | 5 5 5 |
| Dollar Covariance of Asset A and portfolio | 0.0332 0.0332 0.0332 ($ millions) |
| Value of Asset A | 2 2 2 ($ millions) |
| Dollar Variance of the portfolio | 0.4556 0.4556 0.4556 ($ millions)2 |
| Value of the portfolio | 30 30 30 ($ millions) |
Which of the following is the best estimate of marginal VaR of Asset A at 95 % 95\% 95% confidence level?
A.
0.0809
0.0809
0.0809
B.
0.12
0.12
0.12
C.
0.004
0.004
0.004
D. cannot be estimated
Answer: A
Question 8
John Jinson, a student who majored in finance, finished a class focusing on portfolio risk measures. Jinson finished reading chapters in the textbook and made some notes. Here are some notes Jinson wrote down, Which notes is correct?
A. When calculating individual
VaR
\text{VaR}
VaR, we should consider the long or short position. A long position has a positive
VaR
\text{VaR}
VaR and a short position has a negative
VaR
\text{VaR}
VaR.
B. The step of calculating portfolio
VaR
\text{VaR}
VaR: calculate individual
VaR
\text{VaR}
VaR first and then calculate the undiversified
VaR
\text{VaR}
VaR using the correlation matrix between assets.
C. When calculating portfolio
VaR
\text{VaR}
VaR, time horizon and confidence level both are vital, We can use the square root rule to convert to a longer time horizon and remember the reliability factor is critical (
2.58
2.58
2.58 for
99
%
99\%
99% and
1.96
1.96
1.96 for
95
%
95\%
95%).
D. The portfolio VaR is equal to the undiversified
VaR
\text{VaR}
VaR when the correlation between two assets in the portfolio is one.
Answer: D
Question 9
John Jinson, a student who majored in finance, finished a class focusing on portfolio risk measures. After reviewing the knowledge and making some summaries, he did some numerical exercises to prepare for the exam next week regarding Portfolio VaR \text{VaR} VaR and VaR \text{VaR} VaR tools. When he completed the exercises, he added four more notes to his summaries, Which notes is correct?
A. If two assets are not linearly correlated, I can simply sum the individual
VaR
\text{VaR}
VaR up to calculate the portfolio
VaR
\text{VaR}
VaR.
B. There are two methods to compute incremental
VaR
\text{VaR}
VaR-full revaluation and using Marginal
VaR
\text{VaR}
VaR to estimate. The full revaluation method is more precise but more time-consuming.
C. I have learned
CVaR
\text{CVaR}
CVaR in the previous Credit Risk classes. We can use capital to cover the Component
VaR
\text{VaR}
VaR to absorb unexpected volatilitv.
D. In order to measure the impact of changes in positions on the risk of the portfolio, the individual
VaR
\text{VaR}
VaR is sufficient.
Answer: B
Question 10
One of the Portfolio VaR exercises that John Jinson finished provided the following information
| Asset A | Asset B | |
|---|---|---|
| Annual volatility | 10 % 10\% 10% | 15 % 15\% 15% |
| Weight | 60 % 60\% 60% | 40 % 40\% 40% |
| Correlation between Asset A and Asset B | 0.85 0.85 0.85 | |
| Portfolio Value (S) | 1 , 000 , 000 1,000,000 1,000,000 |
After calculating, John Jinson wrote down the answer of portfolio daily VaR \text{VaR} VaR in 99 % 99\% 99% confidence level: $ 268 , 449 268,449 268,449 assuming 252 252 252 days per year and zero daily return. Did John Jinson make the correct answer? If it was not the correct answer, what should the answer be?
A. John Jinson made the correct answer.
B. No, he did not. The correct answer should be $
16
,
910
16,910
16,910
C. No, he did not. The correct answer should be $
18
,
760
18,760
18,760
D. No, he did not. The correct answer should be $
189
,
845
189,845
189,845
Answer: B
Question 11
Daisy TU, an analyst of Pluto Pension Plan, is responsible for the market analysis of the Emerging stock market. In order to have a top-down portfolio view, Tu reads the annual report of the DB pension plan for the past three years. The basic information for the plan last year is as follows:
| Asset | Liability | |
|---|---|---|
| Annual return | 8 % 8\% 8% | 16 % 16\% 16% |
| Annual volatility | 12 % 12\% 12% | 15 % 15\% 15% |
| Value at the beginning of the year | $ 800 800 800 million | $ 750 750 750 million |
| Correlation between asset and liability | 0.57 0.57 0.57 | 0.57 0.57 0.57 |
Which of the following statements regarding the pension plan is correct?
A. The pension plan is under-funded at the end of the year while at the beginning of the year, it is fully funded.
B. When estimating the change of the surplus, the correlation between asset and liability should be taken into consideration.
C. The return of the surplus is
−
112
%
-112\%
−112% (based on the value at the beginning of the year).
D. If the pension plan experiences losses, the employees will be burdened with the losses and they may vote for a new fund manager.
Answer: A
Question 12
Portfolio risk budgeting and monitoring are highly related to the investment process. When analyzing al portfolio risk, the risk manager should take investment style, asset allocation, and the delegation of the fund managers into consideration. Which of the following statements is correct concerning portfolio risk budgeting and risk management?
A. The first step in the investment process is to delegate fund managers for various sub-sectors (i.e., someone focusing on small-cap and someone focusing on large-cap).
B. When evaluating the performance of different managers, RMUs should use the same risk measure either for passively managed funds or actively managed funds such as information ratio.
C. When a manager exceeds his or her risk budget, the manager should be investigated immediately and pass the portfolio to another manager due to his or her poor management.
D. Investment across different regions increases the complexity of the portfolio risk evaluation and risk management and a more centralized risk management system such as VaR will be recommended.
Answer: D
Question 13
Here is data of the past three-year historical performance of two well-diversified funds:
| Fund A | Fund B | |
|---|---|---|
| Annual return in 2019 | 12 % 12\% 12% | 8 % 8\% 8% |
| Annual return in 2020 | − 2 % -2\% −2% | 1 % 1\% 1% |
| Annual return in 2021 | 15 % 15\% 15% | 10 % 10\% 10% |
| Average volatility | 8.3 % 8.3\% 8.3% | 4.7 % 4.7\% 4.7% |
The Treasury bill rate is 3 % 3\% 3%. What is the Sharpe ratio of Fund A by using time weighted return as the return of fund A and is the performance evaluation result different if using the Treynor ratio?
A.
0.64
0.64
0.64 No difference
B.
0.64
0.64
0.64 Fund A will get a higher ranking
C.
0.61
0.61
0.61 Fund B will get a higher ranking
D.
0.61
0.61
0.61 No difference
Answer: D
Question 14
Frank Lim, FRM, CQF, is an option trader in Pluto Asset management. In his point of view, all problems can be solved from the perspective of option. Which of the following statements regarding modeling market timing by a call option is correct?
A. When modeling market timing by option, a dummy variable should be introduced.
B. If a fund manager has perfect forecasting ability, he will invest in Treasury bills if the market is in a poor condition while investing in the market portfolio if the market is in a good condition.
C. When modeling market timing ability by option, the strike price is the return of the market portfolio.
D. When modeling market timing ability by option, we assume that the fund manager has three options:
100
%
100\%
100% funds allocated to risk-free assets, 100% funds allocated to the market portfolio, or funds are equally-weighted allocated to risk-free assets and the market portfolio.
Answer: B
Question 15
After years of evolution along with the continuing growth of AUM, hedge funds, as an alternative investment class, have developed various strategies which focus on different assets and are with different credit risks and liquidity risks. Which of the following statements regarding hedge fund strategy is correct?
A. Trend-following strategies such as managed futures and global macro may have large deal risk due to the uncertainty in the macroeconomic and policy changes by government or compliance.
B. Capital structure strategy is a relative value strategy that focuses on the deviation from a normal term structure of the yield curve.
C. When entering a convertible arbitrage trade, the investor should purchase convertible securities and short an equal amount of corresponding stock.
D. If a hedge fund applies an equity market neutral strategy, the performance of the fund is independent of the market fluctuation but will be bothered by idiosyncratic risks
Answer: D
Question 16
Diversification is a vital method for risk mitigation. A high-net-worth individual allocates his funds to ten hedge funds with various strategies due to his beliefs in the benefits of diversification. Which of the following statements regarding the diversified investment in hedge funds is correct?
A. The investor makes a good choice because different strategies will behave in a more divergent manner.
B. The investor makes a good choice because as an alternative asset, the hedge fund will benefit more from diversification.
C. Spreading the funds when doing hedge funds investment is a bad choice because the fund size allocated in one hedge fund is positively related to the investor’s yield.
D. The investor makes a bad choice because the risk factors of hedge funds will display convergence in stress market conditions.
Answer: D
Question 17
Hedge funds, as an alternative investment, have different characteristics from traditional investment not only in yield but also in risk profile. Which of the following descriptions regarding risk profile and risk-sharing of hedge funds is correct?
A. Due to compensation and incentive structure, the agent-principal problem will negatively impact the long- term return for a hedge fund investor. The risk-sharing is asymmetric between investors and hedge fund
managers.
B. Hedge fund manager will not take an oversized risk because the management fee is based on the asset under management (AMU) which is the only part of the compensation scheme.
C. The hedge fund risk profile is stable because hedge funds will focus on the same strategy for years to obtain a long-term value premium.
D. The high return of hedge funds is quite attractive to high-net-worth individuals that after the 2000s, investors in hedge funds shifted from institutional investors to ultra HNW individuals.
Answer: A
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