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CFA LEVEL – PORTFOLIO MANAGEMENT © 2019 AnalystPrep.com All rights reserved By AnalystPrep.com 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 CFA Level 1, Volume 4, Study Session 12, Reading 42 – Risk Management: An Introduction, LOS 42g: Describe methods for measuring and modifying risk exposures and factors to consider in choosing among the methods 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 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 The line that represents the combination of the optimal risky portfolio and the risk-free assets is known as the: A Capital allocation line B Indifference curve C Efficient frontier © 2019 AnalystPrep.com All rights reserved The correct answer is A The capital allocation line represents the combination of the optimal risky portfolio and the riskfree assets CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Risk and Return: Part I, LOS LOS 39h: Explain the selection of an optimal portfolio, given an investor’s utility (or risk aversion) and the capital allocation line 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) 0.108 = 2% + 0.8 × (11%) Discount rate = (Weight of debt × After tax cost of debt) + (Weight of equity + Cost of equity) 0.0928 = (0.4 × 0.07) + (0.6 × 0.108) 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 Which of the following return-generating models uses macroeconomic indicators such as GDP growth and inflation along with fundamental factors such as earnings and earnings growth to forecast future value? A Revenue model B Market model C Multifactor model © 2019 AnalystPrep.com All rights reserved The correct answer is C 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 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 The correct answer is C 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 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 B I & III only C I & II only © 2019 AnalystPrep.com All rights reserved The correct answer is A 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 CFA Level 1, Volume 4, Study Session 12, Reading 38 – Portfolio Management: An Overview, LOS 38e: Describe mutual funds and compare them with other pooled investment products A portfolio had the following annual rates of return: 2013 2014 2015 5% 12% -2% The portfolio’s manager states that the return for the period is 5% The manager is referring to the: A Holding period return B Arithmetic mean return C Geometric mean return The correct answer is B Holding period return = (1 + 0.05) × (1 + 0.12) × (1 - 0.02) - = 15.25% Arithmetic mean return = (5% + 12% - 2%) / = 5% Geometric mean return = √(1 + 0.05)(1 + 0.12)(1 − 0.02) − = 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 © 2019 AnalystPrep.com All rights reserved 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 correct answer is B 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: Stock A Stock B Variance of returns 1.5% 2.0% Correlation coefficient 0.4 What is the covariance between A and B? A 0.043 B 0.00012 C 0.0069 The correct answer is C 𝑟(𝐴.𝐵) = 0.4 ∗ √1.5 ∗ √2.0 = 0.4 ∗ 12.25 ∗ 14.14 = 0.0069 CFA Level 1, Volume 4, Study Session 12, Reading 39 – 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 © 2019 AnalystPrep.com All rights reserved 11 Four portfolios have the following expected returns and risk: Portfolio A B C D Expected return 5% 7% 9% 8% Standard deviation 12% 15% 15% 16% A risk-averse agent choosing from these portfolios would most likely select: A Portfolio A B Portfolio C C Portfolio D The correct answer is B 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 © 2019 AnalystPrep.com All rights reserved Stock A return 15% -10% -2% 22% Stock B return 12% 2% 15% 12% What is the covariance between A and B? A 45.91 B 42.21 C 43.21 The correct answer is A 𝐶𝑜𝑣(𝐴,𝐵) = 𝐴´ = 𝐵´ = ∑𝑛𝑖=1(𝐴𝑖 − 𝐴´)(𝐵𝑖 − 𝐵´) 𝑛−1 15 − 10 − + 22 = 6.25 12 + + 15 + 12 = 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) = 4−1 8.75 ∗ 1.75 + 16.25 ∗ 8.25 − 8.25 ∗ 4.75 + 15.75 ∗ 1.753 = 45.91 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 © 2019 AnalystPrep.com All rights reserved The correct answer is B 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 CFA Level 1, Volume 4, Study Session 12, Reading 38 – Portfolio Management: An Overview, LOS 38e: Describe mutual funds and compare them with other pooled investment products 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 The correct answer is C Vega is the risk metric that measures the change in the derivative's price for a change in the volatility of the underlying asset CFA Level 1, Volume 4, Study Session 12, Reading 42 – Risk Management: An Introduction, LOS 42g: Describe methods for measuring and modifying risk exposures and factors to consider in choosing among the methods © 2019 AnalystPrep.com All rights reserved 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 The correct answer is B 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 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 © 2019 AnalystPrep.com All rights reserved The real after-tax return of the fund in Year is closest to: A.1.97% B.2.41% C.3.50% The correct answer is A The after-tax nominal net return is 3.5% [5% - (5% × 0.3)] The after-tax real return is (1+ 3.5%)/(1 + 1.5%) – = 1.97% Taxes are paid before incorporating the effects of inflation CFA Level 1, Volume 5, Study Session 12, Reading 39 – Portfolio Risk and return: part I, LOS 39a: calculate and interpret major return measures and describe their appropriate uses 31 Mark Taylor is an equity investor who has recently purchased the stock of a Kenyan enterprise The risk-free rate of return in Kenya is 4.5%, while the expected return on the market index is 7.2% The correlation of the stocks purchased with the market index has recently increased from 0.6 to 0.8, and the standard deviation of the stock and market index is 25.7% and 16.4% respectively The expected return on the Kenyan stock is closest to: A 5.88% B 7.88% C 13.53% The correct answer is B 0.8 × 0.257 = 1.2537 0.164 E(R) = 4.5% + 1.2537(7.2% – 4.5%) = 7.88% CFA Level 1, Volume 5, Study Session 12, Reading 39 – 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 © 2019 AnalystPrep.com All rights reserved 32 Maya Thomas is an independent equity investor who has undertaken an investment in a Brazilian coffee manufacturer’s stock The covariance of the manufacturer’s stock with the market index is 0.01577, and the market variance is 0.01360 Thomas can most likely anticipate earning a return on her equity investment that is: A less than the risk-free rate B less than the market return C greater than the market return The correct answer is C The beta of the stock is 1.1596 (0.01577/0.01360) A beta greater than 1.00 implies that the expected return on the stock is higher than the market return A positive beta indicates that the required return will be greater than the risk-free rate CFA Level 1, Volume 5, 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 33 Which of the following sections of an Investment Policy Statement (IPS) provides relevant information on specific types of assets that have been excluded from the portfolio? A Investment objectives B Investment constraints C Investment guidelines The correct answer is C The investment guidelines section of an IPS provides information about how the policy should be executed and on specific types of assets excluded from the investment, if any CFA Level 1, Volume 4, Study Session 12, Reading 41 – Basics of Portfolio Planning and Construction, LOS 41b: Describe the major components of an IPS © 2019 AnalystPrep.com All rights reserved 34 Which of the following least likely depicts the investor's ability to take risk? A Seventy percent of the investor’s home mortgage has already been paid B The investor has net assets of $470,000 and an investment horizon of 14 years C The investor is a Ph.D in Economics and understands the risk associated with the stock markets The correct answer is C Option C depicts the investor's willingness to take risk; not its ability to take risk Longer time horizons, greater net assets, having a secure job, and insurance of assets provide information regarding the investor's ability to take risk CFA Level 1, Volume 4, Study Session 12, Reading 41 – Basics of Portfolio Planning and Construction, LOS 41d: Distinguish between the willingness and the ability (capacity) to take risk in analyzing an investor’s financial risk tolerance 35 Distributed ledger technology (DLT) has the potential to accommodate “smart contracts.” Those smart contracts are most likely: A Computer programs that self-execute on the basis of pre-specified terms and conditions agreed to by the parties to a contract B A digital currency created in January 2009 by the mysterious Satoshi Nakamoto C Computer programs that follow trends and patterns of money invested by people with expert knowledge The correct answer is A DLT has the potential to accommodate “smart contracts,” which are computer programs that self-execute on the basis of pre-specified terms and conditions agreed to by the parties to a contract Examples of smart contract use are the automatic execution of contingent claims for derivatives and the instantaneous transfer of collateral in the event of default CFA Level 1, Volume 4, Study Session 12, Reading 43 – Fintech in Investment Management, LOS 43d: Describe Financial Applications of Distributed Ledger Technology © 2019 AnalystPrep.com All rights reserved 36 Which of the following is not a true statement about VaR? A A VaR measure does not tell the maximum loss B A VaR measure focuses on the right tail of the distribution C VaR is subject to the same model risk as the derivative pricing model The correct answer is B A VaR measure focuses on the left tail of the distribution However, a VaR measure does not tell the maximum loss A VaR measure can be used to gauge average extreme losses VaR is subject to the same model risk as the derivative pricing model CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Risk and Return: Part I, LOS 39g: describe and interpret the minimum-variance and efficient frontiers of risky assets and the global minimum-variance portfolio 37 The feedback step least likely assists in rebalancing the client’s portfolio due to change in: A Asset weightings B Security prices C Circumstances of the investment manager The correct answer is C The feedback step assists the portfolio manager in rebalancing the portfolio due to change in market conditions or the circumstances of the CLIENT, not the manager CFA Level 1, Volume 4, Study Session 12, Reading 42 – Risk Management: An Introduction, LOS 42b: describe features of a risk management framework 38 Which of the following is most likely to be an objective for a foundation? A Maintain the fund’s nominal value B Reduce the volatility of spending needs C Generate liquidity to meet spending needs © 2019 AnalystPrep.com All rights reserved The correct answer is C Two objectives of foundations include: • • Maintaining the real capital value of the fund Generating income (liquidity) to fund the objectives of the institution CFA Level 1, Volume 4, Study Session 12, Reading 39 – Risk Management: An Introduction, LOS 42b: describe features of a risk management framework 39 Sasha Gable is managing the portfolio of a pension fund, which is equally invested in equities and real estate The correlation between the two securities is 0.10 Details concerning expected annual returns and standard deviations are summarized in the exhibit below: Expected Annual Return (%) Expected Annual Standard Deviation (%) Equities 15.5 5.7 Real estate 22.1 13.8 Holding all else constant, if Gable decides to increase the weight of equities to 60% by selling real estate, the portfolio standard deviation will, in percentage terms: A Increase by 3.38% B Decrease by 12.18% C Decrease by 14.44% The correct answer is B The standard deviation of the current portfolio is 7.596% σport= (0.5)2(0.057)2 +(0.5)2(0.138)2 +2×(0.5)(0.5)(0.10)(0.057)(0.138) = 0.0772 The standard deviation of the new portfolio is 6.6374% σport,new= (0.6)2 (0.057)2 +(0.4)2 (0.138)2 +2×(0.6)(0.4)(0.10)(0.057)(0.138) = 0.0678 © 2019 AnalystPrep.com All rights reserved The standard deviation of the portfolio will decrease by 12.18% [(0.0678/0.0772) – 1] CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Risk and Return: Part I, LOS 39e: calculate and interpret portfolio standard deviation 40 Stock returns are usually negatively skewed This statement implies that: A The standard deviation will be overestimated B There is a higher than normal possibility for extreme returns C There is a high frequency of positive deviations from the mean The correct answer is A Negative skewness implies that there is a higher frequency of negative deviations from the mean, which has the effect of overestimating standard deviation Kurtosis measures whether there is higher than normal probabilities for extreme returns CFA Level 1, Volume 4, Study Session 12, Reading 40 – Portfolio Risk and Return: Part II, LOS 40c: explain systematic and nonsystematic risk, including why an investor should not expect to receive additional return for bearing nonsystematic risk 41 At the beginning of the year 2010, an investor deposited $25,000 in his investment account He generated an investment gain of $4,000 during the same year, which resulted in an ending account balance of $29,000 In 2011, the investor withdrew $12,000 from his account at year end At the beginning of the year 2012, the investor deposited a further $5,000 In 2013, no further transactions were made, and the value of the investment account at the end of the year was $20,000 The IRR of the investment account is closest to: A 3.44% B 11.88% C 20.11% © 2019 AnalystPrep.com All rights reserved The correct answer is A The IRR is calculated by entering the following amounts into the financial calculator: CF0 = - 25,000 CF1 = 12,000 CF2 = - 5,000 CF3 = 20,000 IRR = 3.44% CFA Level 1, Volume 4, Study Session 12, Reading 40 – Portfolio Risk and Return: Part II, LOS 40a: describe the implications of combining a risk-free asset with a portfolio of risky assets 42 The table below illustrates expected annual risk and beta data concerning three textile manufacturers (A, B and C) Textile Manufacturer Expected Annual Standard Deviation (%) A 25.5 Beta 1.8 B 31.8 0.6 C 19.4 1.2 Out of the three manufacturers, the highest total risk is equal to: A 0.065 B 0.101 C 0.318 The correct answer is B Total risk is equal to total variance The manufacturer with the highest total variance is B, and this variance is equal to 0.101 = 0.3182 © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 4, Study Session 12, Reading 41 – Basics of Portfolio Planning and Construction, LOS 41c: describe risk and return objectives and how they may be developed for a client 43 An investor currently owns a portfolio with an expected annual return and standard deviation of 12% and 18% respectively The investor is considering adding a new stock in his current portfolio The standard deviation of the stock is 22%, and its correlation with the current portfolio is 0.35 Considering 5% a risk-free rate, the risk-adjusted return of the stock from adding to the investor’s current portfolio is closest to: A 7.99% B 12.15% C 25.67% The correct answer is A Risk-Adjusted Return = 0.05 + [0.22(0.35)/0.18] × [0.12 – 0.05] = 7.99% CFA Level 1, Volume 1, Study Session 12, Reading 41 – Basics of Portfolio Planning and Construction, LOS 41f: explain the specification of asset classes in relation to asset allocation 44 A portfolio consists of 30 assets with the correlation being 0.75 among all pairs of assets The portfolio variance is 0.0625 The risk of such a portfolio will be closest to: A 4.84% B 15.63% C 22.62% The correct answer is C Portfolio risk = √([ 0.0675 30 − + × 0.75 × 0.0675) = 22.62% 30 30 © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 1, Study Session 12, Reading 40 – Portfolio Risk and Return: Part II, LOS 40e: calculate and interpret beta 45 A portfolio manager forms an investment portfolio with two asset classes, and 2, held in the proportions 60% and 40% respectively The expected annual returns and standard deviations of the asset classes are summarized in the table below Asset Class Expected Annual Return (%) Expected Annual Standard Deviation (%) 13.5 15.2 20.8 24.0 If the portfolio standard deviation is 14.5%, the correlation between the two asset classes should be closest to: A 0.20 B 0.73 C 1.00 The correct answer is A 0.1452 = (0.152)2(0.6)2 + (0.24)2(0.4)2 + 2(0.152)(0.24)(0.6)(0.4)p1,2 p1,2 = 0.199399 or 0.20 CFA Level 1, Volume 1, Study Session 12, Reading 40 – Portfolio Risk and Return: Part II, LOS 40c: explain systematic and nonsystematic risk, including why an investor should not expect to receive additional return for bearing nonsystematic risk © 2019 AnalystPrep.com All rights reserved 46 One difference between a defined contribution (DC) and defined benefit (DB) plan is that in the case of the latter: A Future benefits are undefined B Investment risk exposure is low C Employees are required to contribute a portion of their wages each period The correct answer is B With respect to DB plans, investment risk exposure is minimal This is because the responsibility of ensuring that assets invested are sufficient to generate the promised payments upon employee retirement falls on the employer However, in the case of DC plans, the responsibility of ensuring that enough funds are available to meet employee retirement needs lies on the employees themselves Future benefits are predefined in the case of DB plans Employees will need to contribute a portion of their wages each period in the case of DC plans CFA Level 1, Volume 1, Study Session 12, Reading 42 – Risk Management: An Introduction, LOS 42c: define risk governance and describe elements of effective risk governance 47 What are the implications for investors using the Markowitz efficient frontier for making investment decisions? A The slope of the efficient frontier is concave B Investors are rewarded with increasing increases in returns for assuming more risk C Portfolios to the right of the global minimum variance portfolio are the most efficient The correct answer is A The Markowitz efficient frontier contains all the risky assets that rational, risk-averse investors will choose The slope of the minimum variance frontier is concave, which implies that investors seeking portfolios above the global minimum variance portfolio obtain decreasing increases in returns as they assume more risk Portfolios to the left of the global minimum variance portfolio (located along the efficient frontier) are the most efficient In other words, © 2019 AnalystPrep.com All rights reserved portfolios falling to the right of the minimum-variance frontier give a lower return for the same level of risk, which is undesirable CFA Level 1, Volume 1, 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 48 An investor has purchased shares of a large-cap equity stock The covariance of the stock with the market index is 0.0320, while the standard deviation of the stock and the market index is 22.5% and 15.7% respectively The return of the large-cap equity stock most likely follows a trend which: A Follows the general market B Resembles the general market C Moves opposite to the general market The correct answer is A The beta of the equity stock is + 1.30 [0.0320/(0.1572)] A positive beta indicates that the return of the equity stock follows the general market trend CFA Level 1, Volume 1, Study Session 12, Reading 41 – Basics of Portfolio Planning and Construction, LOS 41e: describe the investment constraints of liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances and their implications for the choice of portfolio assets 49 The advance in technology made the financial record keeping more efficient New technology, such as distributed ledger technology (DTL): A Provides secure ways to track ownership of financial assets on a peer-to-peer (P2P) basis B Increases the need for financial intermediaries C All of the above © 2019 AnalystPrep.com All rights reserved The correct answer is A New technology, such as DLT, may provide secure ways to track ownership of financial assets on a peer-to-peer (P2P) basis By allowing P2P interactions—in which individuals or firms transact directly with each other without mediation by a third party—DLT reduces the need for financial intermediaries CFA Level 1, Volume 1, Study Session 12, Reading 43 – Fintech in Investment Management, LOS 43d: describe Financial Applications to Distributed Ledger Technology 50 Which of the following investors most likely has a portfolio perspective in his investment strategy? I) Investor A has been investing in the shares of Max Mart for the last 10 years He always earns above-market returns because he regularly evaluates the risk and return of his single asset portfolio II) Investor B holds a Ph.D in Economics and, due to his sound knowledge of different sectors of the economy, he keeps shares from different firms from different sectors and evaluates the combined risks and returns of these assets in a portfolio III) Investor C is a new investor who recently started investing in some large-cap stocks His investment strategy involves evaluating the risks and returns of his portfolio shares in isolation A Investor A only B Investor B only C Investors B & C The correct answer is B Investor B has a portfolio perspective as he evaluates the combined risks and returns of each asset in his portfolio Investor A invests in a single stock, so there is no portfolio perspective in his strategy Investor C evaluates each share of his portfolio in isolation Therefore, he does not have portfolio perspective CFA Level 1, Volume 4, Study Session 12, Reading 39 – Portfolio Management: An Overview, LOS 39a: Describe the portfolio approach to investing © 2019 AnalystPrep.com All rights reserved 51 Which of the following statements concerning risk assembling activities is most likely an example of risk budgeting? A The portfolio must not include more than 55% of equities and 45% of real assets B The beta of the portfolio must not be above 0.85 C The portfolio must invest 50% of its funds in value stocks and 50% in fixed assets with maturities longer than 3-years The correct answer is B In risk budgeting, the risk is allocated or restricted by some risk measures like beta or VaR instead of limiting the risk by allocating the amount of money spent CFA Level 1, Volume 4, Study Session 12, Reading 40 – Risk Management: An Introduction, LOS 40e: describe risk budgeting and its role in risk governance 52 Two portfolios have the following characteristics: Portfolio Return Beta A 8% 0.7 B 7% 1.1 Given a market return of 10% and a risk-free rate of 4%, calculate Jensen's Alpha for both portfolios and comment which portfolio has performed better A -0.2% and -3.6% respectively - Portfolio A has performed better than B B -0.2% and -10.6% respectively - Portfolio B has performed better than A C 8.2% and 10.6% respectively - Portfolio B has performed better than A The correct answer is A Jensen's Alpha is calculated as follows: Jensen's Alpha = Rp - [Rf + Bp(Rm - Rf)] Porfolio A’s Jensen's Alpha = 8% - [4% + 0.7(10% - 4%)] Porfolio B’s Jensen's Alpha = 7% - [4% + 1.1(10% - 4%)] © 2019 AnalystPrep.com All rights reserved Jensen's Alpha is -0.2% and -3.6% for A and B respectively A higher Alpha indicates that a portfolio has performed better CFA Level 1, Volume 4, Study Session 12, Reading 42 – Portfolio Risk and Return: Part II, LOS 42h: Describe and demonstrate applications of the CAPM and the SML 53 Shares of Fition Corp are trading at $67 today, while analysts expect the price of the shares to reach $72 in year, and pay a dividend of $1.5 Given a required rate of return of 14%, Shares of Fition Corp are most likely: A Underpriced by $2.53 B Overpriced by $2.53 C Underpriced by $3.84 The correct answer is B Price = $72/1.14 + $1.5/1.14 = $64.47 Since the current value of the stock is $67, the stock is overpriced by $2.53 CFA Level 1, Volume 4, Study Session 12, Reading 42 – Portfolio Risk and Return: Part II, LOS 42g: Calculate and interpret the expected return of an asset using the CAPM 54 Which of the following are most likely components of an Investment Policy Statement (IPS)? I Duties and responsibilities of the investment manager II Procedures to update the IPS III Investment expertise of the investment manager A I & II only B I & III only C I, II & III The correct answer is A An IPS does not carry information regarding investment areas or the investment focus of the management firm, as this information is provided in the firm's investment brochure © 2019 AnalystPrep.com All rights reserved CFA Level 1, Volume 4, Study Session 12, Reading 43 – Basics of Portfolio Planning and Construction, LOS 43b: Describe the major components of an IPS 55 The expected return of a portfolio is 17%, and the return on risk-free assets is 8% The beta of the portfolio is 1.2, and the standard deviation of the portfolio is 5.5% Assuming that an investor invests 115% of his savings in this portfolio, his expected return is closest to: A 18.35% B 19.55% C 12.50% The correct answer is A Since the weight of the market portfolio is more than 100%, the investor is borrowing 15% of funds at the risk-free rate and investing 115% in the market portfolio E[r] = (-15%) × (8%) + (115%) × (17%) = 18.35% CFA Level 1, Volume 4, Study Session 12, Reading 42 – Portfolio Risk and Return: Part II, LOS 42a: Describe the implications of combining a risk-free asset with a portfolio of risky assets 56 The standard deviation of an asset's return is 10%, and the standard deviation of markets return is 14% If the correlation of returns with the market index is 0.7, then the beta of the asset is closest to: A 0.5 B 0.1 C 1.8 The correct answer is A Asset’s beta = Correlation with markets return × (Standard deviation of the asset / Standard deviation of market returns) = 0.7 × 10% / 14% = 0.5 CFA Level 1, Volume 4, Study Session 12, Reading 42 – Portfolio Risk and Return: Part II, LOS 42e: Calculate and interpret beta © 2019 AnalystPrep.com All rights reserved ... ∑
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