2 1 CFA l1 portfolio management questions and answers pdf

With volatility in returns, the geometric mean return value will be less than arithmetic mean return values.. CFA Level 1, Volume 4, Study Session 12, Reading 40 – Portfolio Risk and Ret

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CFA LEVEL 1 –

PORTFOLIO MANAGEMENT

By AnalystPrep.com

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1 BCG Bank has a one month Value at Risk (VaR) of $400 million with the probability of 5%, which means:

A One month maximum loss of $400 million will occur 5% of the time

B Loss of $20 million will occur one month from now

C One month minimum loss of $400 million will occur 5% of the time

The correct answer is C

VaR does not provide maximum loss amount It is used as capital requirement measure at banks

LOS 42g: Describe methods for measuring and modifying risk exposures and factors to consider

in choosing among the methods

2 Overperiods in which returns display volatility, the arithmetic mean return value will be:

A Higher than the geometric mean return values

B Lower than the geometric mean return values

C The same as the geometric mean return values

The correct answer is A

With volatility in returns, the geometric mean return value will be less than arithmetic mean return values

39a: Calculate and interpret major return measures and describe their appropriate uses

3 The line that represents the combination of the optimal risky portfolio and the risk-free assets

is known as the:

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The capital allocation line represents the combination of the optimal risky portfolio and the free assets

LOS 39h: Explain the selection of an optimal portfolio, given an investor’s utility (or risk aversion) and the capital allocation line

4 Ben Carter, CFA, is an equity analyst and is assigned to discount the net present value (NPV)

of Indo Inc which has 40% of debt in its capital structure What discount rate should Carter use

if the after-tax cost of debt is 7%, the risk premium is 11%, the risk-free rate is 2%, and the Beta

of Indo is 0.8?

A 9.40%

B 9.28%

C 10.80%

The correct answer is B

Cost of equity = Risk free rate + Beta × (market risk - risk-free rate)

A Revenue model

B Market model

C Multifactor model

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A multi-factor model allows for many inputs or factors in determining the security return Multifactor models often use macroeconomic indicators such as GDP growth and inflation along with fundamental factors such as earnings, earning growth, etc

CFA Level 1, Volume 4, Study Session 12, Reading 40 – Portfolio Risk and Return: Part II, LOS 40d: explain return generating models (including the market model) and their uses

6 Data collected from such devices as smart phones, cameras, RFID chips, is referred as:

A Generated by individuals

B Generated by business processes

C Generated by sensors

Because the world has become increasingly connected, we can now obtain data from a wide range of devices, including smart phones, cameras, microphones, radio-frequency identification (RFID) readers, wireless sensors, and satellites that are now in use all over the world Sensor data are collected from such devices as smart phones, cameras, RFID chips, and satellites that are usually connected to computers via wireless networks

CFA Level 1, Volume 4, Study Session 12, Reading 43 – Fintech in Investment Management, LOS 53b: Describe Big Data, Artificial Intelligence and Machine Learning

7 Which of the following is/are the most likely similarity(ies) between exchange-traded funds

and closed-end funds?

I Both types of funds are passively managed to match a particular index

II In both types of funds, the market price of shares and the net asset value (NAV) can differ

significantly

III Both types of funds can be sold and purchased on the open market

A III only

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ETFs and closed-end funds are sold and purchased in the exchange market rather than from the fund itself ETFs are passively managed to match the index while closed-end funds are actively managed In closed-end funds, the market price of shares and the NAV differ significantly, whereas ETFs are designed to keep their share price close to the NAVs

LOS 38e: Describe mutual funds and compare them with other pooled investment products

8 A portfolio had the following annual rates of return:

A Holding period return

B Arithmetic mean return

C Geometric mean return

Holding period return = (1 + 0.05) × (1 + 0.12) × (1 - 0.02) - 1 = 15.25%

Arithmetic mean return = (5% + 12% - 2%) / 3 = 5%

Geometric mean return = 3√(1 + 0.05)(1 + 0.12)(1 − 0.02)− 1 = 4.84

CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Risk and Return: Part I, LOS

39a: Calculate and interpret major return measures and describe their appropriate uses

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9 The difference between the gross return and the net return of a portfolio most likely results

from:

A Accounting methods

B Fees

C Taxes and regulations

The net return of a portfolio equals its gross return minus management and administrative fees

CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Risk and Return: Part I, LOS 39a: Calculate and interpret major return measures and describe their appropriate uses

10 An analyst gathered this information about two stocks:

Variance of returns Correlation coefficient

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11 Four portfolios have the following expected returns and risk:

Portfolio Expected return Standard deviation

Portfolio A offers 0.416% or return for each standard deviation of risk

Portfolio B offers 0.467% or return for each standard deviation of risk

Portfolio C offers 0.600% or return for each standard deviation of risk

Portfolio D offers 0.500% or return for each standard deviation of risk

CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Risk and Return: Part I, LOS 39d: Explain risk aversion and its implications for portfolio selection

12 An analyst gathered this information about two stocks:

Time period Stock A return Stock B return

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What is the covariance between A and B?

𝐵´ =12 + 2 + 15 + 124 = 10.25

𝐶𝑜𝑣(𝐴,𝐵)

=(15 − 6.25)(12 − 10.25) + (−10 − 6.25)(2 − 10.25) + (−2 − 6.25)(15 − 10.25) + (22 − 6.25)(12 − 10.25)

4 − 18.75 ∗ 1.75 + 16.25 ∗ 8.25 − 8.25 ∗ 4.75 + 15.75 ∗ 1.753

CFA Level 1, Volume 4, Study Session 12, Reading 439 – Portfolio Risk and Return: Part I, LOS

39c: Calculate and interpret the mean, variance, and covariance (or correlation) of asset returns

based on historical data

13 Which of the following is least likely a characteristic of open-ended mutual funds?

A Open-end funds accept new investment money and issue additional shares to existing or

new investors Therefore, the number of outstanding shares changes after every new

investment

B In open-end funds, new shares are created and sold at a premium or a discount to net

assets values depending on the demand for the shares

C An open-end structure makes it easy to grow in size but creates pressure on the portfolio

manager to manage the cash inflows and outflows

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In open-end funds, new shares are issued at the net asset value of the fund at the time of investment An open-end fund is a collective investment scheme which can issue and redeem shares at any time An investor will generally purchase shares in the fund directly from the fund itself rather than from the existing shareholders

It contrasts with a closed-end fund, which typically issues all the shares it will issue at the outset, with such shares usually being tradable between investors thereafter

14 Which of the following is the first-order risk measure of the change in the option price for a change in the volatility of the underlying asset?

A Gamma

B Rho

C Vega

Vega is the risk metric that measures the change in the derivative's price for a change in the volatility of the underlying asset

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15 As mandated by regulators worldwide, the global investment industry has undertaken major steps in stress testing and risk assessment that involve the analysis of vast amounts of

quantitative and qualitative risk data Which of the following statements is most accurate?

A There is decreasing interest in monitoring risk in real time because of the advances in artificial intelligence (AI)

B Required data include information on the liquidity of the firm, its balance sheet

positions and credit exposures

C Big Data cannot help identify weakening market conditions and adverse trends in

advance

Required data include information on the liquidity of the firm and its trading partners, balance sheet positions, credit exposures, risk-weighted assets, and risk parameters Stress tests may also take qualitative information into consideration, such as capital planning procedures,

expected business plan changes, business model sustainability, and operational risk

Option A is incorrect There is increasing interest in monitoring risk in real time To do so, relevant data must be taken by a firm, mapped to known risks, and identified as it moves

within the firm Data may be aggregated for reporting purposes or used as inputs to risk

models

Option C is incorrect Big Data may provide insights into real-time and changing market

circumstances to help identify weakening market conditions and adverse trends in advance, allowing managers to employ risk management techniques and hedging practices sooner to help preserve asset value

CFA Level 1, Volume 4, Study Session 12, Reading 43 – Fintech in Investment Management, LOS 53b: Describe Big Data, Artificial Intelligence and Machine Learning

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16 Stock A’s expected return is 5%, and its standard deviation is 12% Stock B’s expected return

is 12%, and its standard deviation is 17% What is the standard deviation of a portfolio composed of 40% stock A and 60% stock B given that the correlation between the two stocks is 0.5?

39e: Calculate and interpret portfolio standard deviation

17 Given the CAPM model, Company A is expected to return 10% to its investors The expected return of the market is 8%, and the risk-free rate is 3% Company A’s beta is closest to:

A 0.88

B 1.40

C 0.71

The Capital Asset Pricing Model (CAPM) provides a linear relationship between expected return for an asset and the beta, or systematic risk, of the asset The

E(RA) = Rf + βA∗ E(Rm− Rf)

10 = 3 + βA∗ E(8 − 3)

βA = 1.4

CFA Level 1, Volume 4, Study Session 12, Reading 40 – Portfolio Risk and Return: Part II, LOS 40g: calculate and interpret the expected return of an asset using the CAPM

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18 Which of these investors is more likely to have a low tolerance for investment risks?

A Calton University

B Newtown Car Insurance Inc

C UNN Defined Benefit Pension Plan

Insurance companies need to be relatively conservative and need a higher level of liquidity than the two other options Insurance companies receive premiums from the insurance policies they write They need to invest these premiums to ensure there are sufficient funds available to pay for insurance claims when these arise As such, their investments are also often conservative in nature and cognizant of the investment time frame over which claims may arise

LOS 38b: Describe types of investors and distinctive characteristics and needs of each

19 Portfolio ABC has a beta of 1.6 and generated a return of 21% If the risk-free rate is 2% and the market premium is 10%, Jensen’s alpha for this portfolio is closest to:

A 5.0%

B 6.2%

C 3.0%

Jensen’s alpha is based on systematic risk The daily returns of the portfolio are regressed against the daily returns of the market in order to compute a measure of this systematic risk in the same manner as the CAPM

αABC= 21 − (2 + 1.6 ∗ 10)

α = 3

CFA Level 1, Volume 4, Study Session 12, Reading 40 – Portfolio Risk and Return: Part II, LOS 40h: Describe and demonstrate applications of the CAPM and the SML

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20 An analyst has recently read a research paper developed at a renowned university which says that the prices of derivatives are also sensitive to the changes in interest rates If the analyst

is interested in measuring such changes, then the best metric he should use is:

A Rho

B Gamma

C Delta

Rho measures the changes in the prices of derivatives given the changes in interest rates

21 An investor is interested in knowing the real return his portfolio has earned over a certain period Assuming that the nominal return of his portfolio is 18%, the CPI is 6%, and the tax rate

is 38.9%, then the real return of the portfolio is closest to:

A 19.08%

B 11.32%

C 6.92%

Real rate of return = (1 + Nominal rate) / (1 + Inflation) - 1 = (1.18 / 1.06) - 1 = 11.32%

CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Risk and Return: Part I, LOS 39a: Calculate and interpret major return measures and describe their appropriate uses

22 Two stocks in different industries will create a perfectly diversified portfolio if the correlation coefficient is:

A -1

B 0

C 1

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Two stocks in different industries will create a perfectly diversified portfolio if the correlation coefficient is -1 In such circumstances, one stock’s loss is proportionally matched by the other stock’s gain

CFA Level 1, Volume 4, Study Session 12, Reading 40 – Portfolio Risk and Return: Part I, LOS 41f: Describe the effect on a portfolio’s risk of investing in assets that are less than perfectly correlated

23 Which of the following is not considered a constraint when preparing an investment policy

statement?

A Legal and regulatory factors

B Liquidity needs

C Risk tolerance

The constraints when preparing an investment policy statement are: liquidity needs, time horizon, taxes, legal and regulatory factors, and unique needs and preferences Risk tolerance is included in the investment objectives of the policy statement, not in the constraints

concerns, legal and regulatory factors, and unique circumstances and their implications for the choice of portfolio assets

24 Which of the following pooled investment share prices is most likely to be significantly

different from its net asset value (NAV) per share?

A Share price from an open-end fund

B Share price from a closed-end fund

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Share price from a closed-end fund cannot be arbitraged, so it is most likely to be significantly

different from its net asset value (NAV) per share

25 An open-ended fund that invests in short-term debt securities such as U.S Treasury bills

and commercial paper is most likely a:

A Fixed income fund

B Money market fund

C Fund-of-funds

Money market funds invest in short-term debt securities such as U.S Treasury bills and commercial paper Fixed income funds also invest in debt securities, but usually longer-term securities

26 According to CAPM, risk-neutral investors are more likely to invest in:

A The least risky portfolio on the efficient frontier of risky securities

B The riskiest portfolio on the efficient frontier of risky securities

C The market portfolio leveraged by the risk-free asset

According to CAPM, risk-neutral investors are more likely to invest in the market portfolio leveraged by the risk-free asset

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CFA Level 1, Volume 4, Study Session 12, Reading 41 – Portfolio Risk and Return: Part II, LOS 42f: Explain the capital asset pricing model (CAPM), including its assumptions, and the security market line (SML)

27 The beta of a fund is 1.4 If the expected return on T-bills is 3% and the standard deviation of

the market is 9%, then the covariance between the market portfolio and the fund is closest to:

A 0.0063

B 0.0113

C 0.1260

The beta for the fund is equal to the covariance of the fund and the market divided by the variance of the market

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