Question #1 of 35 Question ID: 1236101

Ashley Brown is an analyst that is trying to incorporate capital market expectations into her
forecasts of risk and return for equity markets. Brown's short-term (1 year) forecast for equity

returns appears inconsistent with her forecast for three-year returns. Brown's forecasts are
best described as being not:

A) intertemporally consistent.

B) spatially consistent.

C) cross-sectionally consistent

Explanation

Consistency over various time horizons is referred to as intertemporal consistency. Cross-

sectional consistency refers to consistency across asset classes.

(Study Session 4, Module 10.1, LOS 10.a)

Question #2 of 35 Question ID: 1231593

Which of the following is NOT a characteristic of econometrics as used in economic

forecasting? Econometrics:

A) provides a straightforward method of creating a model.

B) can provide precise quantitative forecasts of economic conditions.

C) is better at forecasting expansions than recessions.

Explanation

Econometric analysis can actually be di cult and time intensive to create.

(Study Session 4, Module 10.2, LOS 10.e)

Question #3 of 35 Question ID: 1236108

Suppose that the economy is expected to grow at its long-term trend rate, target in ation is
2%, the in ation index is expected to increase by 3%, and the central bank real neutral short-
term interest rate is 1%. The target nominal short-term interest rate should be closest to:

A) 6.0%
B) 4.5%

C) 3.5%

Explanation

Since the real neutral rate is 1% and target in ation is 2%, the adjustment will be made to
the nominal 3% short-term rate. Given that GDP is growing at its long-term trend, this will
not impact the adjustment using the Taylor Rule. With in ation at 3% and target in ation at
2%, the central bank will increase interest rates by one-half the di erence, resulting in a
nominal target rate of 3.5%.

(Study Session 4, Module 10.4, LOS 10.h)

Question #4 of 35 Question ID: 1231597

During an economic recession, which of the following items will increase?

A) In ation.

B) Interest rates.

C) Bond prices.

Explanation

Bond prices increase during a recession as in ationary decreases and interest rates decline
causing bond prices to increase since they are inversely related to the change in interest
rates.

(Study Session 4, Module 10.3, LOS 10.f)

Question #5 of 35 Question ID: 1231589

Which of the following is most representative of an exogenous economic shock?

A) Anticipated loose monetary policy by a country’s central bank leading to in ation

and to depreciation in the country’s currency.

B) Ongoing expansionary scal policy by the federal government leading to higher

in ation and interest rates.

C) A hurricane hitting the Gulf of Mexico resulting in the shut-down of many oil wells
and re neries and to higher oil prices.

Explanation
An exogenous shock is something that occurs outside the normal course of an economy,
such as a natural disaster or unanticipated government policy. The shock is unanticipated
and is not part of a trend as would be characterized by ongoing monetary or scal policy.

(Study Session 4, Module 10.2, LOS 10.c)

Question #6 of 35 Question ID: 1231602

Which asset would perform the worst during de ationary periods?

A) Real estate wholly owned.

B) Real estate nanced with debt.

C) Corporate bonds.

Explanation

De ation reduces the value of investments nanced with debt. In the case of real estate, if
the property is levered with debt, losses in its value lead to steeper declines in the investor's
equity position. As a result, investors ee in an attempt to preserve their equity and prices
fall further. Bond prices will rise during de ationary periods when in ation and interest
rates are declining.

(Study Session 4, Module 10.3, LOS 10.g)

Question #7 of 35 Question ID: 1233982

Calculate the short-term interest rate target given the following information.

Neutral rate 4.00%

In ation target 2.00%

Expected In ation 5.00%

GDP long-term
3.00%
trend

Expected GDP 1.00%

A) 4.5%.

B) 6.5%.

C) 9.5%.

Explanation
ntarget = 4.0% + 5.0% + [0.5 × (1% − 3%) + 0.5 × (5% − 2%)]

= 9.0% + [−1.0% + 1.5%] = 9.5%

The weak projected economic growth calls for cutting interest rates. If in ation were not a
consideration, the target interest rate would be 1% lower than the neutral rate. However,
the higher projected in ation overrides the growth concern and the nominal target rate is
higher than the nominal neutral rate of 4.0% + 5% = 9%.

(Study Session 4, Module 10.4, LOS 10.h)

Question #8 of 35 Question ID: 1231606

Which of the following would indicate the greatest stimulation of economic growth?

A) Tax receipts decline due to a new government policy.

B) Tax receipts increase due to changes in the economy.

C) Tax receipts increase due to a new government policy.

Explanation

Only changes in the de cit directed by government policy will in uence growth. A tax cut,
which would result in lower tax receipts over the short-term, would stimulate the economy.
Changes in the de cit that occur naturally over the course of the business cycle are not
stimulative or restrictive. In an expanding economy, de cits will decline because tax receipts
increase and disbursements to the unemployed decrease. The opposite occurs during a
recession.

(Study Session 4, Module 10.4, LOS 10.h)

Question #9 of 35 Question ID: 1231607

Which of the following regarding the use of monetary policy to stimulate growth or rein in

in ation in an economy is most accurate?

A) Both the direction of a change in interest rates and the level of interest rates are
important.

B) Neither the direction of a change in interest rates nor the level of interest rates are
important.

C) Only the direction of a change in interest rates is important.

Explanation
Both the direction of a change in interest rates and the level of interest rates are important.
If, for example, rates are increased to say 4% to combat in ation but this is still low
compared to the neutral rate of 6% in a country, then this rate may still be low enough to
allow growth and in ation to continue.

(Study Session 4, Module 10.4, LOS 10.h)

Question #10 of 35 Question ID: 1236106

An investment in high-yield bonds is likely to have the highest return in which of the following

phases of the business cycle?

A) Contraction

B) Early expansion

C) Initial recovery

Explanation

As a recovery begins, bond yields should bottom out and concerns about default should
diminish. Both factors will lead to high-yield bonds performing well. A contraction will lead
to concerns about default, and bond yields tend to rise in early expansion — both of these
factors will limit the return to high yield bonds.

(Study Session 4, Module 10.3, LOS 10.f)

Question #11 of 35 Question ID: 1236103

Which of the following is least likely to be considered an exogenous shock?

A) Discovery of a new natural resource to be used in production.

B) Strong economic recovery following a slow recession.

C) Political tensions arising between two neighboring countries.

Explanation

Normal business cycle activity is not considered exogenous since the activity is built into
asset prices. The other items are considered exogenous in that they arise outside of the
normal economic cycle.

(Study Session 4, Module 10.2, LOS 10.c)

Question #12 of 35 Question ID: 1231596

Which phase of the business cycle is characterized by rising stock prices but increased investor
nervousness?

A) Initial recovery.

B) Slowdown.

C) Late expansion.

Explanation

The late expansion phase of the business cycle is characterized by high con dence and
employment, increases in in ation, rising bond yields, and rising stock prices. Investor
nervousness increases risk during this period. The central bank also limits the growth of the
money supply.

(Study Session 4, Module 10.3, LOS 10.f)

Question #13 of 35 Question ID: 1231603

Which of the following is NOT an input to the Taylor rule?

A) The discount rate.

B) The neutral rate.

C) The expected GDP.

Explanation

The Taylor rule determines the target interest rate using the neutral rate, expected GDP
relative to its long-term trend, and expected in ation relative to its targeted amount.

(Study Session 4, Module 10.4, LOS 10.h)

Question #14 of 35 Question ID: 1236109

Suppose that currently, monetary policy is stimulative and scal policy is restrictive. Which of
the following most likely describes the shape of the yield curve?

A) Moderately steep

B) Inverted

C) Very steep

Explanation
Stimulative monetary policy will result in lower short-term rates. Restrictive scal policy will
slow economic activity, thus likely reducing rates in the future. The net result is a moderately
steep yield curve. If both were stimulative, the yield curve would rise sharply and be very
steep. An inverted yield curve is normally the result of restrictive monetary and scal policy.

(Study Session 4, Module 10.4, LOS 10.i)

Question #15 of 35 Question ID: 1231591

Which of the following is NOT a characteristic of economic indicators as used in economic

forecasting? Economic indicators:

A) have an e ectiveness that has been veri ed by academic research.

B) are di cult to understand and interpret.

C) can be adapted for speci c purposes.

Explanation

Economic indicators are actually easy to understand and interpret.

(Study Session 4, Module 10.2, LOS 10.e)

Question #16 of 35 Question ID: 1236102

To forecast equity returns, an analyst examines historical returns from several countries.
However, a few of the countries previously in the database were removed due to political
changes. The problem represented here is best described as:

A) nonstationary data.

B) ex post / ex ante dissonance.

C) survivorship bias.

Explanation

The removed countries experiencing political changes likely had low equity returns
compared to the remaining countries. Therefore, the database might bias the return on
equity markets as a result of including only the survivors. Ex post / ex ante dissonance
would not be the best answer since there is no ex post data for the countries removed.
Nonstationary data is an inappropriate answer because the data was not just potentially
di erent, but it was dropped from the database entirely.

(Study Session 4, Module 10.1, LOS 10.b)

Question #17 of 35 Question ID: 1231611

Which of the following would indicate that a country is less a ected by global events? The

country is:

A) small and has an undiversi ed economy.

B) small and has a diversi ed economy.

C) large and has a diversi ed economy.

Explanation

Larger countries with diverse economies are less a ected by events in other countries. Small
countries with undiversi ed economies are more susceptible to global events.

(Study Session 4, Module 10.4, LOS 10.j)

Question #18 of 35 Question ID: 1231595

During the initial recovery phase of the business cycle, which of the following items will be
increasing?

A) Bond yields.

B) Short-term interest rates.

C) Stock prices.

Explanation

Stock prices generally increase in the initial recovery phase of the business cycle as the
economy goes into an expansion. However, bond yields and short-term interest rates are
still very low.

(Study Session 4, Module 10.3, LOS 10.f)

Question #19 of 35 Question ID: 1236105

When using economic indicators, examining the number of indicators increasing versus

decreasing in a composite is most accurately referred to as a:

A) lagging indicator.

B) checklist assessment.

C) di usion index.
Explanation

Di usion indices provide a check on economic indicators by quantifying the number of

increasing components in the composite indicator versus decreasing. Lagging economic
indicators re ect recent past economic activity. Checklist assessments consider a wide range
of economic data to assess an economy's future position.

(Study Session 4, Module 10.2, LOS 10.e)

Question #20 of 35 Question ID: 1233981

Calculate the short-term interest rate target given the following information.

Neutral rate 4.00%

In ation target 2.00%

Expected In ation 4.00%

GDP long-term
3.00%
trend

Expected GDP 5.00%

A) 10%.

B) 8%.

C) 6%.

Explanation

ntarget = 4.0% + 4.0% + [0.5 × (5% − 3%) + 0.5 × (4% − 2%)]

= 8.0% + [1.0% + 1.0%] = 10.0%

The higher than targeted growth and higher than targeted in ation argue for a targeted
interest rate of 10%. This rate hike is intended to slow down the economy and in ation.

(Study Session 4, Module 10.4, LOS 10.h)

Xavier Fellows works in the research department of Multinational Inc., a large investment
bank. He is tasked with forecasting economic conditions to support the bank's money

managers and traders.

Fellows takes his work seriously and is considered to be an excellent forecaster. His economic

forecasts are updated monthly and sent to most of Multinational's analysts and money
managers. The analysts use Fellows' forecasts as the basis for their own research on speci c

securities or asset classes.

However, Fellows is concerned that his forecasts are not accurate enough. In an e ort to avoid

making mistakes, Fellows follows a detailed process to develop accurate and usable forecasts.
Fellows hopes that this process will help him avoid some of the common problems of
forecasts. Here is his system:

1. Establish a benchmark for market expectations. Multinational serves thousands of

clients with di erent investment goals and constraints, and Fellows knows analysts will

need the di erent benchmarks for a variety of di erent types of investors.

2. Look at the historical returns of a number of asset classes to act as a check on forecasts
for each asset class.

3. Assemble data on historical returns and valuations for all relevant asset classes,
considering potential biases, adjusting the numbers to account for di erent calculation

methods, and ensure that data de nitions match those used by the company that
collected the data.
4. Interpret the data. Fellows uses his years of experience to extrapolate that data into

growth and valuation assumptions for each asset class. This step is the most subjective.
5. Distill assumptions into top-down forecasts, detailing the assumptions and methods for

interpreting historical data in the event that individual analysts want to use data to
create their own industry-speci c forecasts.
6. Monitor performance. If Fellows' forecasts prove to be inaccurate, he works to improve

his models.

This month's forecast dwells heavily on in ation projections and their expected e ect on the

returns of di erent asset classes. Fellows projects a decline in in ation and predicts that bond
yields have bottomed out.

Question #21 - 23 of 35 Question ID: 1231599

Fellows skipped a step in his technique for producing forecasts. He forgot to:

A) assure that the underlying data is accurate.

B) identify where he obtained his data.

C) identify a valuation model used in his analysis.

Explanation

Fellows' plan mirrors the seven-step process for formulating capital-market expectations in
every aspect except one, identifying the valuation model used in the analysis. Assuring the
accuracy of data and identifying its source are important, but they would presumably fall
under steps three and ve of Fellows' process.

(Study Session 4, Module 10.1, LOS 10.a)

Question #22 - 23 of 35 Question ID: 1231600

Due to the decline in in ation and the low bond yields, Fellows should conclude that the
economy is most likely in what stage of the business cycle?

A) Slowdown.

B) Initial recovery.

C) Late expansion.

Explanation

In general, in ation rises in the latter stages of an expansion and falls during a recession
and the initial recovery. Bond yields peak during a slowdown and fall during a recession,
however, they bottom out during the initial recovery stage.

(Study Session 4, Module 10.3, LOS 10.f)

Question #23 - 23 of 35 Question ID: 1231601

Which of the following is least accurate regarding in ation?

A) Low in ation a ects the return on cash instruments.

B) Declining in ation results in declining economic growth and asset prices.

C) Highly levered rms are most a ected by declining in ation rates.

Explanation

Low in ation can be bene cial for equities if there are prospects for economic growth free
of central bank interference. Declining in ation usually results in declining economic growth
and asset prices. The rms most a ected are those that are highly levered because they are
most sensitive to changing interest rates. Low in ation does NOT a ect the return on cash
instruments.

(Study Session 4, Module 10.3, LOS 10.g)

Question #24 of 35 Question ID: 1231587

The use of appraisal data, relative to actual returns, results in:

A) correlations that are biased upwards and standard deviations that are biased
downwards.
B) correlations that are biased upwards and standard deviations that are biased
upwards.

C) correlations that are biased downwards and standard deviations that are biased
downwards.

Explanation

The use of appraisal data, relative to actual returns, results in correlations that are biased
downwards and standard deviations that are biased downwards. The reason is that price
uctuations are masked by the use of appraised data.

(Study Session 4, Module 10.1, LOS 10.b)

Question #25 of 35 Question ID: 1231609

Which of the following is consistent with a steeply upwardly sloping yield curve?

A) Monetary policy is restrictive and scal policy is restrictive.

B) Monetary policy is expansive while scal policy is restrictive.

C) Monetary policy is expansive and scal policy is expansive.

Explanation

When both scal and monetary policies are expansive, the yield curve is sharply, upwardly
sloping (i.e., short-term rates are lower than long-term rates), and the economy is likely to
expand in the future.

(Study Session 4, Module 10.4, LOS 10.i)

Question #26 of 35 Question ID: 1231608

Which of the following is consistent with a at yield curve?

A) Monetary policy is restrictive and scal policy is restrictive.

B) Monetary policy is expansive while scal policy is restrictive.

C) Monetary policy is restrictive while scal policy is expansive.

Explanation

If monetary policy is restrictive while scal policy is expansive, the yield curve will be at.

(Study Session 4, Module 10.4, LOS 10.i)

Question #27 of 35 Question ID: 1231586

Which of the following regarding the formulation of capital market expectations is least
accurate? An analyst should:

A) vary their assumptions when interpreting data and drawing conclusions.

B) investigate assets’ historical performance and their determinants.

C) consider the investor’s tax status, allowable asset classes, and time horizon.

Explanation

In the fth step of the formulation of capital market expectations, the analyst should use a
consistent set of assumptions when interpreting data and drawing conclusions.

(Study Session 4, Module 10.1, LOS 10.a)

Question #28 of 35 Question ID: 1231610

Which of the following is consistent with a likely weak economy in the future?

A) Monetary policy is restrictive while scal policy is expansive.

B) Monetary policy is expansive and scal policy is expansive.

C) Monetary policy is restrictive and scal policy is restrictive.

Explanation

When both scal and monetary policies are restrictive, the yield curve is downward sloping
(i.e., it is inverted as short-term rates are higher than long-term rates), and the economy is
likely to contract in the future.

(Study Session 4, Module 10.4, LOS 10.i)

Question #29 of 35 Question ID: 1231588

A return index that tracks the NASDAQ stock market index can be subject to:

A) survivorship bias and hence upward biased returns.

B) survivorship bias and hence downward biased returns.

C) back ll bias and hence upward biased returns.

Explanation
Survivorship bias can result when a return series is based on a stock index. It will be biased
upwards if the return calculation does not include rms that have been dropped from the
index due to delistings.

(Study Session 4, Module 10.1, LOS 10.b)

Question #30 of 35 Question ID: 1236110

Abaslovia, a developing country, has pegged its exchange rate to the currency of a developed
country. Which of the following is most likely concerning the relationship between the two
countries? Abaslovia will have an interest rate:

A) less than that of the developed country.

B) equal to that of the developed country.

C) greater than that of the developed country.

Explanation

Though the currency has been pegged, the developing country still has the risk of the peg
failing. The interest rate should re ect that risk, and thus Abaslovia's interest rate should be
higher than that of the developed country.

(Study Session 4, Module 10.4, LOS 10.j)

Question #31 of 35 Question ID: 1236107

Suppose that the consumer price index is expected to change from 124 to 118. The asset class

most likely to perform the best during such a period is:

A) real estate.

B) high quality bonds.

C) equity.

Explanation

The in ation index forecast suggests that de ation is expected. Nominal rate bonds should
perform the best under that scenario because the purchasing power of the coupon
payments would increase. Given the high-quality nature of the bonds, concerns about
default are unlikely to dominate this greater purchasing power bene t.

(Study Session 4, Module 10.3, LOS 10.g)

Question #32 of 35 Question ID: 1231592

Which of the following is NOT a characteristic of a checklist approach as used in economic

forecasting? A checklist approach:

A) does not allow for changes in the model over time.

B) requires subjective judgment.

C) may not be able to model complex relationships.

Explanation

A checklist approach actually allows for changes in the model over time.

(Study Session 4, Module 10.2, LOS 10.e)

Question #33 of 35 Question ID: 1231594

In the early expansion phase of the business cycle stock prices are:

A) stagnant as they are in the later stages of an expansion.

B) rising at a faster rate than they are in the later stages of an expansion.

C) rising at a slower rate than they are in the later stages of an expansion.

Explanation

In the early expansion phase of the business cycle, stock prices are increasing. This is due to
the fact that sales are increasing but inputs costs will be fairly stable. Labor will not ask for
wage increases because unemployment is still high. Idle plant and equipment will be pushed
into service at little cost. Furthermore, rms usually emerge from recession leaner because
they have shed their wasteful projects and excessive spending. Later on in the expansion,
the growth in earnings and stock returns slows because input costs start to increase.
Interest rates will also increase during late expansion, which is a further negative for stock
valuation.

(Study Session 4, Module 10.3, LOS 10.f)

Question #34 of 35 Question ID: 1231590

Which of the following statements least likely represents a scenario from an exogenous shock?

A) Political unrest in the Middle East leading to an unexpected decrease in oil

production, increased oil prices, decreased consumer spending, increased
l d l d
B) A country defaults on its debt payments, thereby causing the country’s currency to
lose value and forcing the central bank to take measures to stabilize the banking
d h
C) OPEC not being able to agree on production levels leading to increased uncertainty
in global markets and increased oil prices.

Explanation

The OPEC meeting and probable outcomes could be anticipated and already factored into
current oil prices leading to the least severe outcome of the answer choices. Exogenous
shocks usually lead to economic slowdowns, as in the case of an oil shock leading to higher
prices, in ation, reduced consumer spending, increased unemployment, and a slowing
economy. A reduction in oil prices could be caused by a weak global economy with weak
demand for oil or an oversupply of oil in the global market. This would reduce the price of
oil and boost the economy, potentially overheating it in which causes high in ation and
increased interest rates that ultimately slow the economy down. In a nancial crisis the
result is usually characterized by banks becoming vulnerable and requiring action by the
central bank to stabilize the banking system and economy by increasing liquidity and
lowering interest rates.

(Study Session 4, Module 10.2, LOS 10.c)

Question #35 of 35 Question ID: 1236104

An analyst has accurately estimated a real growth rate of 3% in his discounted cash ow
model by examining the growth of the economy. Population growth is expected to be 1%,
labor force participation is expected to grow by 0.5% and capital expenditures are expected to

grow by 1%. Which of the following best describes the analyst's estimate of growth? The
analyst:

A) has not accounted for in ation in the forecast.

B) is forecasting unrealistic growth.

C) is anticipating technological progress.

Explanation

Total factor productivity, such as technological progress, can reasonably explain the
di erential between the inputs to economic growth and the analyst's growth rate in the
discounted cash ow model. (In ation is not a concern since the analyst is working with real
numbers.)

(Study Session 4, Module 10.2, LOS 10.d)

Question #1 of 45 Question ID: 1231635

Carla Smitz, CFA, is working with new, young clients Terry and Janice Dillard to develop their
investment policy statement (IPS). Smitz should most likely take into consideration:

A) both their human capital and risk tolerance.

B) their risk tolerance.

C) their human capital.

Explanation

If they do not have an IPS, the manager should consider everything that relates to their
complete nancial situation.

(Study Session 5, Module 12.2, LOS 12.b)

Question #2 of 45 Question ID: 1228822

In terms of vehicles for implementing passive and active mandates within asset classes, which of

the following investments would be the most passive approach?

A) Not managing the portfolio with regard to any benchmark.

B) Tilting the asset allocation toward a certain investment style index.

C) Investing in the global market portfolio.

Explanation

The most passive approach would include buying and holding a self-rebalancing, broad index
of risky assets, such as the global market portfolio. Tilting allocation toward a certain
investment style index is slightly more active given that it involves an active decision, but still
uses the passive implementation of indexing. The most active approach would include
unconstrained mandates where the portfolio is not restricted in degree of deviation from its
benchmark. Not managing the portfolio with regard to any benchmark sounds like no IPS or
SAA has ever been created and a likely ethics violation.

(Study Session 5, Module 12.5, LOS 12.i)

Question #3 of 45 Question ID: 1231632

Decision-reversal risk is likely to:

A) occur when a manager panics during a market crisis.

B) occur in large institutional portfolios with exposure to alternative investments.

C) create a skewed distribution of portfolio return.

Explanation

Decision-reversal risk is thoughtlessly reversing a previous investment decision at the worst

time. It commonly occurs when less knowledgeable investors get into complex positions they
do not understand, panic when things don't go well, and sell. Thoughtless selling when an asset
is down would likely reduce upside recovery and create negative (cut of the upside) skew in the
returns. It refers primarily to the client panicking and is presumably less common in more
knowledgeable institutional investors who have more access to investment information.

(Study Session 5, Module 12.1, LOS 12.a)

Question #4 of 45 Question ID: 1228815

Which of the following statements regarding the strategic asset allocation process
is least accurate?

A) The strategic asset allocation must be rebalanced periodically for changes in the
valuation of the various asset classes in the portfolio.

B) The strategic asset allocation review is typically performed once per year.

C) Strategic asset allocation, similar to tactical asset allocation, employs a short-run

capital market projection.

Explanation

Strategic asset allocation employs a long-term capital market projection.

(Study Session 5, Module 12.4, LOS 12.g)

Question #5 of 45 Question ID: 1231633

Which of the following statements regarding the portfolio management process is most accurate?

A) The investment advisor should consider the client’s entire conventional balance
sheet.

B) Client-speci c constraints are used to determine the appropriate asset classes for the
client’s strategic asset allocation.

C) The portfolio management process is the same for both individuals and institutional
investors.

Explanation
The general process of constructing, monitoring, and revising portfolios is the same for both
individuals and institutional investors.

The investment advisor should consider the client's entire economic (not conventional) balance
sheet. For individuals, the economic balance sheet would include human capital on the asset
side.

Capital market expectations are the macroeconomic circumstances used to determine the
appropriate asset classes for the client's strategic asset allocation based on risk and return in
relation to the client's investment policy statement (IPS).

(Study Session 5, Module 12.1, LOS 12.a)

Question #6 of 45 Question ID: 1228796

An organization has positive economic net worth. This implies that the:

A) organization’s accounting owner’s equity is also positive.

B) value of extended portfolio assets exceeds the value of extended portfolio liabilities.

C) value of economic assets exceeds the value of economic liabilities.

Explanation

A positive economic net worth implies that the value of the organization's economic assets
exceeds the value of economic liabilities.

Economic assets and liabilities includes the traditional accounting balance sheet assets and
liabilities as well as extended portfolio assets and liabilities that are not included on traditional
balance sheets. Therefore, extended portfolio assets and liabilities alone do not cover o
economic net worth.

Although it would be unusual in practice, the economic net worth could be positive in theory
even if the accounting owner's equity is negative.

(Study Session 5, Module 12.1, LOS 12.b)

Question #7 of 45 Question ID: 1228814

Strategic asset allocation is based upon:

A) long-term capital market expectations and risk/return preferences of the investor.

B) long-term capital market expectations and the investment policy statement.

C) short-term capital market expectations and the investment policy statement.

Explanation
Strategic asset allocation is based on long-term capital market expectations (which forms the
basis for the generation of the e cient frontier) and the investment policy statement (IPS) of
the investor. The IPS includes not only the risk/return objectives of the investor but also the
investor's constraints.

(Study Session 5, Module 12.4, LOS 12.g)

Question #8 of 45 Question ID: 1228794

An investor is expecting to retire sometime within the next two years. In a target date fund, what

should the recommended equity/bond allocation be for this investor?

A) 95% equity; 5% bonds.

B) 50% equity; 50% bonds.

C) 10% equity; 90% bonds.

Explanation

As an investor ages, the equity/bond mix generally shifts towards bonds as human-capital and
risk tolerance decrease. Given the extreme di erences in these allocations, 50/50 is far more
plausible in the absence of any other information.

(Study Session 5, Module 12.1, LOS 12.b)

Question #9 of 45 Question ID: 1228812

Strategic asset allocation re ects what systematic risk exposure?

A) Asset class systematic risk.

B) Investor’s desired systematic risk exposure.

C) Long-term systematic risk exposure.

Explanation

Strategic asset allocation re ects the investor's desired systematic risk exposure.

(Study Session 5, Module 12.4, LOS 12.g)

Question #10 of 45 Question ID: 1228808

Asset classes may share di erent sources of risk. An alternative approach to asset allocation is

the use of risk factors. Which of the following is least accurate regarding this approach?
A) Risk factors are often not directly investable.

B) Asset class characteristics are used to determine the di erent risk factors.

C) Asset classes often have overlapping risk factors.

Explanation

Risk factors describe the sources of risk for an asset class not the other way around. The
objective of risk factors is to determine the systematic sources of risk of all asset classes and
then construct an asset allocation around desirable exposures to these risk factors. Risk factors
are often not investable (i.e., in ation). Asset classes often have overlapping risk factors. For
example, credit and equities will have overlapping risk factors. Examples of risk factors include
volatility, liquidity, in ation, interest rates, duration, foreign exchange, and default risk.

(Study Session 5, Module 12.3, LOS 12.f)

Question #11 of 45 Question ID: 1228797

Which of the following investment objectives is most likely associated with asset-only asset

allocation approaches?

A) Funding liabilities when they come due.

B) Meeting speci c goals within a certain degree of con dence.

C) Maximizing expected return per unit of risk.

Explanation

The investment objective for an asset-only asset allocation is to maximize the expected return
per unit of risk (e.g., maximize the Sharpe ratio).

(Study Session 5, Module 12.2, LOS 12.c)

Question #12 of 45 Question ID: 1231634

Which investment objective is most appropriate for an endowment?

A) To ensure there are su cient assets to meet current and ongoing liabilities.

B) To ensure there are su cient assets for funding while adhering to constraints and
risk preferences.

C) To achieve a rate of return that exceeds the return required to fund current and
ongoing distributions.

Explanation
An endowment is primarily concerned with funding distributions. It does not have any pre-
determined liabilities per se (in contrast to a pension fund, for example). Adhering to
constraints and risk preferences (i.e. willingness) is much more characteristic of an objective for
an individual investor.

(Study Session 5, Module 12.1, LOS 12.a)

Question #13 of 45 Question ID: 1228823

Each of the following statements concerns either strategic asset allocation or tactical asset

allocation. Which of the following statements is least accurate?

A) Strategic asset allocation is typically a constant mix strategy.

B) Strategic asset allocation employs a long-run view of capital market conditions.

C) Tactical asset allocation employs a long-run view of capital market conditions.

Explanation

Tactical asset allocation is an attempt to take advantage of temporary capital market

ine ciencies and takes a short-run view of market conditions. Both of the other statements are
true.

(Study Session 5, Module 12.5, LOS 12.j)

Question #14 of 45 Question ID: 1228825

Tactical asset allocation analysis:

A) assumes that investor's risk tolerance decreases with wealth.

B) assumes lack of ine ciencies in the market.

C) is often based on deviant beliefs.

Explanation

Tactical asset analysis often operates on the assumption that the market overreacts to
information.

Tactical asset analysis is typically performed routinely as part of a continuing asset

management, attempts to take advantage of perceived ine ciencies in the relative prices of
securities in di erent asset classes, and assumes that investor's risk tolerance is una ected by
changes in wealth.

(Study Session 5, Module 12.5, LOS 12.j)

Question #15 of 45 Question ID: 1231631

Which of the following is not part of an e ective investment governance model?

A) Establishing client objectives.

B) Determining manager compensation.

C) The process of setting an asset allocation.

Explanation

Determining manager compensation is not directly one of the elements. The six elements are:

Establish long-term and short-term investment objectives.

Allocate the rights and responsibilities of all the involved parties.
Specify processes for creating an investment policy statement (IPS).
Specify processes for creating a strategic asset allocation.
Apply a reporting framework to monitor the investment program's stated goals and
objectives.
Include periodic review of the governance policies by an independent third party.

(Study Session 5, Module 12.1, LOS 12.a)

Question #16 of 45 Question ID: 1228810

Stokes Day Nursery is a nonpro t organization to provide day care for children from low-income
homes. The endowment that funds the nursery has a value of $8 million, and it is estimated that
the nursery will need $360,000 in the current year to fund its operations. The nursery's expenses

are expected to grow by 3% annually, in line with in ation. William Rose has been hired as a
consultant to review Stokes Day Nursery's portfolio. The asset allocation for the current portfolio

is shown below.

Asset Class Allocation (%) Expected Return

Cash 2% 3%

Intermediate-term Treasury bonds 35% 4.5%

High quality corporate bonds 33% 5.0%

U.S. equities 25% 8.5%

Int'l equities (developed markets) 5% 10.0%

Int'l equities (emerging markets) 0% 12.0%

Rose makes four suggestions regarding the current portfolio:

Suggestion 1: The allocation to cash should be higher.

The allocation to intermediate-term Treasury bonds

Suggestion 2:
should be lower.

Suggestion 3: The allocation to U.S. equities should be lower.

The allocation to emerging market international equities
Suggestion 4:
is appropriate.

Which of the suggestions should the board of directors for Stokes Day Nursery agree with?

A) Suggestions 2 and 4 only.

B) Suggestions 1 and 3 only.

C) Suggestions 1 and 2 only.

Explanation

The board should agree with Suggestion 1 – $360,000 is needed to fund the current year's
expenses, representing 4.5% of the portfolio. The cash allocation should be higher to make
sure the current year's expenses can be paid. The board should also agree with Suggestion 2 –
an endowment needs more growth to meet future needs as well as keep up with in ation. With
a spending rate of 4.5% and an in ation rate of 3.0%, the endowment requires a return of at
least 7.5%. The current allocation to bonds is too high. Given the growth needs of the
endowment and the return projections of the asset classes, the allocation should be higher for
U.S. equities and both emerging and developing market equities, therefore, the board should
not agree with Suggestions 3 and 4.

(Study Session 5, Module 12.4, LOS 12.g)

Question #17 of 45 Question ID: 1228802

Which of the following is NOT a desirable characteristic of an asset class used for describing the

returns on a portfolio?

A) It should be easy to construct a bogey portfolio for each class.

B) The asset classes used should explain a large part of the variability of portfolio
returns.

C) The residual from the regression model of returns should be heteroskedastic.

Explanation

The asset classes used should explain a large part of portfolio return variability, and it should
be easy to construct a bogey portfolio for each class. Heteroskedasticity refers to a non-
constant variance of the error terms in a regression, which makes the regression model
unreliable.

(Study Session 5, Module 12.3, LOS 12.e)

Question #18 of 45 Question ID: 1228821

What is the major di erence between dynamic asset allocation and static asset allocation?
Dynamic asset allocation:

A) considers more than one asset class while static asset allocation only considers one
asset class at a time.

B) considers asset and liability management simultaneously while static asset allocation
does not.

C) takes a multi-period view of the investment horizon while static asset allocation does
not.

Explanation

Dynamic asset allocation takes a multi-period view of the investment horizon while static asset
allocation does not. Dynamic asset allocation and static asset allocation both can be used for
asset only or asset-liability approaches to strategic asset allocation. Both dynamic and static
asset allocation approaches consider more than one asset class.

(Study Session 5, Module 12.5, LOS 12.i)

Question #19 of 45 Question ID: 1231639

With regard to asset allocation risk measures, which of the following statistical risk measures is
most likely associated with a de ned bene t plan utilizing an asset-only approach?

A) The standard deviation of the funding ratio.

B) The standard deviation of the overall portfolio.

C) The standard deviation of the surplus.

Explanation

For an asset-only approach, the relevant risk measure is the standard deviation of portfolio
returns, which incorporates asset class volatilities and asset class return correlations. This case
speci cally says an asset only approach is being used and that is not uncommon for DB plans.
Arguably a liability relative style is more appropriate, but the asset only approach can implicitly
deal with the liabilities by targeting a rate of return su cient to meet the liability payouts.

(Study Session 5, Module 12.3, LOS 12.d)

Question #20 of 45 Question ID: 1228813

Assignment of asset class weights for a portfolio based on long-term capital market expectations
is called:

A) tactical asset allocation.

B) strategic asset allocation.

C) portfolio optimization.

Explanation

Strategic asset allocation is the assignment of weights to di erent asset classes based on long-
term capital market expectations. Tactical asset allocation is based on short-term capital
market expectations.

(Study Session 5, Module 12.4, LOS 12.g)

Question #21 of 45 Question ID: 1228818

Bruce Calloway is interested in utilizing an appropriate asset allocation strategy for his portfolio.
His long-term view of the capital market conditions is that there will always be change and

opportunities to capture excess returns in the market. As a risk neutral investor, he is a

consistent risk taker and his risk tolerance on his portfolio can be expected to be constant based
on such market expectations. Which asset allocation strategy is the most appropriate strategy for

his portfolio?
A) The strategic asset allocation strategy is most appropriate since this strategy allows
the portfolio to be periodically rebalanced according to market conditions.

B) The tactical asset allocation strategy is most appropriate since this strategy assumes
the investor’s risk tolerance is constant and his capital market expectations are
bj f h
C) The dynamic strategic asset allocation strategy is most appropriate since this allows
the capability to quickly move in and out of di erent assets as market conditions
h
Explanation

The most appropriate asset allocation strategy is the tactical strategy. This strategy assumes
that the investor's risk tolerance is constant and his capital market expectations are subject to
frequent change. The tactical strategy assumes that investment allocation decisions are based
on current market conditions, but the risk tolerances do not change with changes in wealth
levels. For example, when the market conditions are bearish, the investor's view of risk does
not change with respect to capital commitments to stocks and will allocate a consistent level of
his portfolio to cash or bonds. In bull market or when markets rally, the investor's risk
tolerance will not change and would continue to allocate consistent amounts to stocks and
cash or bonds.

(Study Session 5, Module 12.5, LOS 12.i)

Question #22 of 45 Question ID: 1228798

Which of the following statements about the liability-relative and/or goals-based approaches is

correct?

A) Mean-variance optimization (MVO) is appropriate for both approaches.

B) Both approaches consider assets in the context of meeting liabilities.

C) Surplus optimization is an example of the goals-based approach.

Explanation

Both the liability-relative and goals-based approaches consider assets relative to liabilities. The
main di erence between the two approaches is that the liability-relative approaches focus on
institutional investor liabilities, while the goals-based approaches focus on individual investor
liabilities.

Surplus optimization is an example of the liability-relative approach.

MVO is appropriate for asset-only approaches by incorporating expected returns, volatility, and
correlations of asset classes.

(Study Session 5, Module 12.2, LOS 12.c)

Question #23 of 45 Question ID: 1228799

An investor mentions to her portfolio manager that her main goal is to maximize her portfolio's
Sharpe ratio while also considering her risk tolerance and constraints. Which of the following
asset allocation approaches is most appropriate for the investor?

A) Goals-based.

B) Asset-only.

C) Liability-based.

Explanation

By looking to maximize her portfolio's Sharpe ratio, the investor is focusing on the portfolio
assets only. As a result, an asset-only approach is most appropriate. The asset-only approach
will consider both the investor's risk tolerance and constraints.

Both the liability-based and goals-based approaches consider assets in the context of liabilities.

(Study Session 5, Module 12.2, LOS 12.c)

Question #24 of 45 Question ID: 1228806

According to the modern portfolio theory, which risk is rewarded?

A) E cient risk.

B) Systematic risk.

C) Total risk.

Explanation

According to modern portfolio theory, only systematic risk is rewarded. Total risk (may be
measured by standard deviation) is comprised on systematic and unsystematic risk.

(Study Session 5, Module 12.3, LOS 12.f)

Question #25 of 45 Question ID: 1228804

Which of the following statements regarding the characteristics of asset classes is most correct?
Asset classes should:

A) be negatively correlated.

B) not be highly correlated.

C) have an index.

Explanation
Asset classes should not be highly correlated with each other is a desired characteristic.
Furthermore, asset classes should be mutually exclusive and collectively mutually exhaustive.

(Study Session 5, Module 12.3, LOS 12.e)

Question #26 of 45 Question ID: 1228809

Which of the following is least likely a characteristic of strategic asset allocation?

A) Investor constraints.

B) Short-term capital market expectations.

C) Investor risk and return objectives.

Explanation

Strategic asset allocation takes into account long-term capital market expectations and the
investor's investment policy statement (risk/return objectives and constraints).

(Study Session 5, Module 12.4, LOS 12.g)

Question #27 of 45 Question ID: 1228811

What does Strategic Asset Allocation allow managers to do with respect to systematic risk?

A) Monitor and control.

B) Reduce.

C) Identify and minimize.

Explanation

Strategic asset allocation re ects the investor's desired systematic risk exposure and allows the
manager to monitor and control risk – not to reduce or minimize it.

(Study Session 5, Module 12.4, LOS 12.g)

Question #28 of 45 Question ID: 1228800

Which of the following characteristics of asset classes is most desirable? Asset classes should:

A) be mutually exclusive.

B) be correlated with each other.

C) have an index.

Explanation

Desirable characteristics of asset classes are: they cannot be classi ed into more than one
asset class (be mutually exclusive), they should not be highly correlated with each other, the
assets within an asset class have similar descriptive as well as statistical characteristics,
su ciently liquid, and they cover the majority of all investable assets.

(Study Session 5, Module 12.3, LOS 12.e)

Question #29 of 45 Question ID: 1228829

Which of the following strategic rebalancing considerations encourages the use of a wider
rebalancing range?

A) Higher transaction costs.

B) Believing in price mean reversion.

C) More risk-averse investors.

Explanation

Higher transaction costs for an asset class imply wider rebalancing ranges. If investors believe
that current trends will continue, an argument can be made for using wider rebalancing
corridors. More risk-averse investors and beliefs in mean reversion both encourage tighter
rebalancing corridors.

(Study Session 5, Module 12.5, LOS 12.j)

Carl Allen and Cli Hanes are analysts for Tacticon Advisory (Tacticon). Allen and Hanes have
been assigned the task of documenting some of Tacticon's asset allocation techniques. After

receiving accolades in a recent trade magazine article featuring investment rms with innovative
trading strategies, their supervisor, Amos Ridley, decides it is time the rm began formally
documenting the rm's proprietary asset allocation process.

Ridley wants Allen and Hanes to record the speci cs of Tacticon's investment process for internal
use. He also wants them to compile a document explaining a variety of allocation techniques to

be used by the marketing sta and portfolio managers when working with prospects and clients.

At their rst meeting after receiving the assignment, a discussion of strategic and tactical
allocation commences. Allen and Hanes feel con dent about the distinction between the two, but
are less certain about the di erences between asset-liability management (ALM) versus asset-
only approaches to asset allocation.

Hanes states "ALM and asset-only approaches are used for strategic asset allocation. With ALM
an investor's optimal asset allocation is directly related to explicit liability modeling. On the other
hand, with asset-only strategies, liabilities only indirectly impact the return objective."

Allen replies, "I'm not so sure. I thought that tactical, asset-only approaches like immunization
and cash ow matching are more precise than ALM for controlling risk."

Question #30 - 31 of 45 Question ID: 1228827

Strategic asset allocation:

A) establishes a portfolio’s long-term asset class exposures by integrating each element

of investment policy with capital market expectations.

B) involves short-term variations from an investor’s normal asset mix.

C) sets a portfolio’s asset class exposures to unsystematic risk.

Explanation

Strategic asset allocation establishes a portfolio's long-term asset class exposures by

integrating each element of investment policy with capital market expectations. It a ords an
investor the ability to control systematic risk exposures by aligning their risk and return
objectives with the actual portfolio of investments. Tactical asset allocation involves
adjustments away from the strategic mix to take advantage of short-term projections of relative
asset class performance.

(Study Session 5, Module 12.5, LOS 12.j)

Question #31 - 31 of 45 Question ID: 1228828

Concerning the discussion between Hanes and Allen about ALM versus asset-only allocation
approaches:

A) only one is correct.

B) both are incorrect.

C) both are correct.

Explanation

Hanes is correct: ALM and asset-only approaches are used for strategic not tactical asset
allocation. With ALM an investor's optimal asset allocation is directly related to explicit liability
modeling. Allen is incorrect: with asset-only strategies, liabilities only indirectly impact the
return objective. Asset-only approaches are less precise than ALM for controlling risk.
Immunization and cash management are ALM approaches.

(Study Session 5, Module 12.5, LOS 12.j)

Question #32 of 45 Question ID: 1228805

Regarding the classi cation of sub-asset classes, which of the following statements is most
correct?

A) Correlations between sub-asset classes with a broader asset class are likely to be
high.

B) Increasing granularity in asset classes is important to the strategic asset allocation

process.

C) Correlations between broad asset classes are likely to be high.

Explanation

Sub-asset classes are divisions within a class such as value versus growth within the equity
class. They will not be as di erent from each other as the di erences between broad asset
classes (such as equity versus xed income). In other words sub-assets within a broad class are
relatively more highly correlated than broad asset classes are to each other. Broad asset
classes are most important in SAA, not creating lots of sub-asset classes which is what
increasing granularity means. More sub-asset classes can be useful in TAA or strategy
implementation.

(Study Session 5, Module 12.3, LOS 12.e)

Question #33 of 45 Question ID: 1228803

Which of the following would indicate that the asset classes used for describing the returns of a

portfolio are desirable?

A) High R-squared and easily measured manager asset proportions.

B) Low R-squared and easily measured manager asset proportions.

C) High R-squared and large con dence intervals.

Explanation

Desirable asset classes would explain a high proportion of portfolio returns and thus have a
high R-squared. The asset mix proportions for each manager should be easily measured.

(Study Session 5, Module 12.3, LOS 12.e)

Question #34 of 45 Question ID: 1228795

An economic balance sheet represents a current snapshot of an investor's complete economic
situation for investment purposes. As an investor's time horizon changes so do the extended
portfolio assets and liabilities. Which of the following statements is the most accurate description
regarding an economic balance sheet? Generally:

A) the nancial characteristics of target date funds most closely correspond with those
of an economic balance sheet.

B) the ratio of nancial capital to human capital decreases as an investor ages.

C) as an investor ages toward retirement the present value of their human capital
increases.

Explanation

Target date funds alter the allocation toward risk as the investment horizon shortens and the
required income generation increases. Within an economic balance sheet the extended
portfolio assets and liabilities vary such that the appropriate asset allocation must adapt in an
e ort to meet this dynamic. This is similar to how target date funds are designed. Human
capital decreases through time. The ratio of nancial capital to human capital ideally should
increase as an investor ages. The allocation toward risky assets is directly proportional to the
economic value of human capital.

(Study Session 5, Module 12.1, LOS 12.b)

Question #35 of 45 Question ID: 1231638

Mark Zedon, a nancial consultant prepares a strategic asset allocation for his client based on the
client's risk/return preferences. This approach to strategic asset allocation is called the:

A) asset only approach.

B) investment policy statement approach.

C) e cient frontier approach.

Explanation

Because the consultant only takes into account the investor's risk and return preferences, he is
using the asset only approach to strategic asset allocation.

(Study Session 5, Module 12.3, LOS 12.d)

Question #36 of 45 Question ID: 1231637

Which one of the following most closely matches an advantage of the asset-liability approach
over the asset only approach to strategic asset allocation?
A) Asset classes have di erent systematic risk exposures.

B) Liabilities and assets are highly correlated.

C) Liability funding is more accurately controlled.

Explanation

The asset-liability approach to strategic asset allocation is desirable because liabilities are more
accurately controlled.

(Study Session 5, Module 12.3, LOS 12.d)

Question #37 of 45 Question ID: 1228801

Which of the following would indicate that an asset class is useful for describing the returns of a
portfolio?

A) The error term is high.

B) The intercept term is signi cantly di erent from zero.

C) The R-squared of the model is high.

Explanation

A high R-squared would indicate that the model explains a good proportion of portfolio
returns.

(Study Session 5, Module 12.3, LOS 12.e)

Question #38 of 45 Question ID: 1228807

Regarding the use of risk factors when making asset allocation decisions, which of the following
statements is most correct?

A) Risk factors cannot be used as units of analysis in asset allocation.

B) Risk factors are as easy to invest in as an asset class.

C) Multifactor models can be used to isolate systematic risk exposures.

Explanation
Multifactor models can be used for asset allocation by creating factor portfolios, which isolate
systematic risk exposures (i.e., non-diversi able risks). Risk factors can be used as units of
analysis in asset allocation. But one problem is that it is not always easy to determine how to
invest in those identi ed risk factors. Some may be investable and others may not. Asset
classes are by de nition assets that are owned and investable, though the cost and ease of
investing varies.

(Study Session 5, Module 12.3, LOS 12.f)

Question #39 of 45 Question ID: 1228817

With respect to the global market portfolio, which of the following statements is least accurate?
The global market portfolio:

A) is the portfolio that minimizes unsystematic risk.

B) lies on the steepest sloping and feasible capital market line.

C) contains only asset classes that trade throughout the capital markets.

Explanation

The global market portfolio is the portfolio that is de ned at the tangency point of the capital
market line (CML) that joins the risk free asset and the e cient frontier (i.e., the feasible CML
that maximizes the Sharpe ratio) and is fully diversi ed thus it has minimized company speci c
unsystematic risk. It includes all assets – whether traded in the capital markets or not hence it
contains market risk (systematic risk) which theoretically cannot be further diversi ed. The
resulting weights are based on market capitalization.

(Study Session 5, Module 12.5, LOS 12.h)

Question #40 of 45 Question ID: 1228819

Deviation from the policy portfolio due to short-term capital market expectations is called:

A) strategic asset allocation.

B) targeted asset allocation.

C) tactical asset allocation.

Explanation

Tactical asset allocation is the deviation from the policy portfolio (Strategic asset allocation)
based on short-term capital market expectations.

(Study Session 5, Module 12.5, LOS 12.i)

Question #41 of 45 Question ID: 1228816

Within the context of mean-variance optimization, the global market portfolio is represented as a
portfolio:

A) with the lowest level of variance on the e cient frontier.

B) with the highest expected return on the e cient frontier.

C) that is on the line tangent to the e cient frontier.

Explanation

The location of the market portfolio on the e cient frontier is found by drawing a line from the
risk free asset that is tangent to the e cient frontier. The point of tangency is known as the
global market portfolio.

(Study Session 5, Module 12.5, LOS 12.h)

Question #42 of 45 Question ID: 1228820

Tactical asset allocation is a deviation from the strategic asset allocation for the purpose of:

A) aligning with investor’s risk preferences.

B) exceeding investor’s return objectives.

C) taking advantage of short-term capital market expectations.

Explanation

Tactical asset allocation deviates from Strategic asset allocation to take advantage of short-
term capital market expectations.

(Study Session 5, Module 12.5, LOS 12.i)

Question #43 of 45 Question ID: 1228830

Several investment decisions remain to be made following the selection of an appropriate

strategic asset allocation (SAA). These include the decision on how to rebalance the SAA back to
the target allocations. Which of the following statements is least accurate regarding a rebalancing
scheme? Rebalancing:

A) triggers include calendar month, relative deviations from targets, and absolute
deviations from target.

B) must consider both the cost and liquidity of the assets being rebalanced.
C) is required as part of a risk budget.

Explanation

Rebalancing is part of managing risk but not necessarily part of the risk budgeting approach to
portfolio management. Traditional rebalancing triggers include calendar (time), relative
deviations from targets, and absolute deviations from target. Rebalancing rules are heavily
dependent on the underlying liquidity of the assets and the associated cost of transacting.
Rebalancing rules can often include a level of discretion of the responsible party; sometimes
this decision is in uenced by the momentum of a particular asset class.

(Study Session 5, Module 12.5, LOS 12.j)

Question #44 of 45 Question ID: 1231636

James Mason is the Chief Operating O cer of the Homeless Mission Foundation (HMF), a
foundation with the purpose of providing food, clothing, and shelter for homeless individuals.
Mason is currently in the process of preparing a report to HMF's board recommending an asset
allocation for the foundation. This year, Mason estimates that HMF's operating budget will be
$2.75 million. In order to assist with preparation of his report, Mason has compiled the following
data.

The market value of the foundation is currently $50,000,000.

The cost for providing services to homeless individuals is expected to rise at a rate of 3.0%
per year.
The board would like to maintain a cash cushion equal to half of the estimated operating
budget in order to meet any unexpected expenses.
Management fees for the foundation are estimated to be 0.40%.
The board is willing to accept market risk in order to meet its long-term objectives, but the

board wants to accept shortfall risk (de ned as expected return minus two standard
deviations) of no more than 15%.

Mason must recommend one of three di erent portfolios to the board. Mason's choice of
portfolios is shown below:

Portfolio Portfolio Portfolio

Asset Class
A B C

Large cap U.S. stocks 24% 30% 20%

Small cap U.S. stocks 10% 5% 13%

International – Developed market

5% 13% 5%
equities

International – Emerging market

5% 5% 10%
equities

U.S. Corporate bonds 25% 20% 17%

U.S. Treasury bonds 20% 16% 21%

Real estate 5% 10% 10%

Cash 6% 3% 4%

TOTAL 100% 100% 100%

Expected Annual Total Return (%) 7.85% 9.20% 8.80%

Expected Standard Deviation (%) 11.15% 12.10% 12.20%

In his report, Mason is going to recommend a portfolio based on 3 criteria: liquidity needs, return
requirements, and shortfall risk. Which of the portfolios should Mason recommend?

A) Portfolio C.

B) Portfolio B.
C) Portfolio A.

Explanation

Liquidity requirements – Mason's notes stated that the portfolio needs to maintain cash equal
to 50% of the estimated operating budget. This means that cash in the portfolio needs to be
equal or greater than [(2.75)(0.5)]/50 = 2.75%. All of the portfolios meet the liquidity
requirement.

Return Requirements – Spending is equal to (2.75/50) = 5.5%. With in ation of 3.0% and
management fees of 0.40%, the return requirement is (1.055)(1.004)(1.03) -1 = 9.10%. Only
Portfolios B meets the return requirement.

Shortfall risk – The shortfall risk for each portfolio is as follows:

Portfolio A: 7.85% - (2 ×11.15%) = -14.45%

Portfolio B: 9.20% - (2 ×12.10%) = -15.00%

Portfolio C: 8.80% - (2 ×12.20%) = - 15.60%

Therefore, only Portfolios A and B meet the shortfall risk requirement.

Since Portfolio B is the only one to meet all three requirements, Portfolio B is the best
choice.

(Study Session 5, Module 12.3, LOS 12.d)

Question #45 of 45 Question ID: 1228824

Strategic asset allocation analysis:

A) is usually done more frequently than tactical asset allocation.

B) often results in constant mix strategies.

C) often results in a buy and hold strategy.

Explanation

This is often expressed as a percentage of total value invested in each asset class.

Strategic asset allocation analysis is usually done whenever the investor's circumstances
change signi cantly and is often done as frequently as yearly. It is based on long-run capital
market conditions, and requires transactions to rebalance the mix periodically.

(Study Session 5, Module 12.5, LOS 12.j)

Question #1 of 46 Question ID: 1228852

The following information is available regarding corner portfolios from an e cient frontier:

Exp. Asset Class Weights

Corner Expected Sharpe
Std.
Portfolio Return Ratio
Dev. 1 2 3 4 5

1 14.00% 18.00% 0.639 0.00% 0.00% 100.00% 0.00% 0.00%

2 13.66% 16.03% 0.696 0.00% 0.00% 86.36% 0% 14.00%

3 13.02% 13.58% 0.775 21.69% 0.00% 56.56% 0.00% 21.76%

4 12.79% 13.00% 0.792 21.48% 0.00% 52.01% 5.24% 21.27%

5 10.54% 8.14% 0.988 9.40% 51.30% 26.55% 0.00% 12.76%

6 8.70% 6.32% 0.981 0.00% 89.65% 4.67% 0.00% 5.68%

The following portfolios are under consideration by an investor:

Portfolio Expected Return

A 11.0%

B 13.5%

For an investor with a risk-aversion of 6, which portfolio would have the highest utility?

A) Portfolio B with a utility of 0.115.

B) Portfolio A with a utility of 0.092.

C) Portfolio A with a utility of 0.085.

Explanation
For portfolios A and B we rst need the approximate standard deviation.

Portfolio A with an expected return of 11% lies between corner portfolios 4 and 5. Let w
denote the weight of corner portfolio 5, we solve for w in the following equation:

11 = (10.54)(w) + (12.79)(1-w)

w = 0.80

Approximate standard deviation of portfolio A = (0.80)(8.14)+(0.20)(13) = 9.11.

Similarly, Portfolio B with an expected return of 13.50% lies between corner portfolios 2 and
3. Let w denote the weight of corner portfolio 2, we solve for w in the following equation:

13.50 = (13.66)(w) + (13.02)(1-w)

w = 0.75

Approximate standard deviation of portfolio B = (0.75)(16.03)+(0.25)(13.58) =

15.418.

RZ =6

UA = E(RA) – 0.5(RZ)(σ2A) = 0.11 – 0.5(6)(0.0911)2 = 0.085

UB = E(RB) – 0.5(RZ)(σ2B) = 0.135 – 0.5(6)(0.154)2 = 0.064

(Study Session 5, Module 13.5, LOS 13.f)

Question #2 of 46 Question ID: 1228838

Following information is a partial list of corner portfolios:

Asset class weights

Portfolio Exp. Return Std. Dev.
1 2 3

1 12.00% 10.50% 65.00% 0.00% 35.00%

2 16.50% 14.00% 15.00% 20.00% 50.00%

3 18.00% 20.00% 30.00% 20.00% 25.00%

4 23.00% 24.00% 15.00% 20.00% 55.00%

Which asset class is the most signi cant for an e cient portfolio with an expected return of

15% and the approximate standard deviation of this e cient portfolio?

A) Asset class 2, 12.85%.

B) Asset class 3, 12.85%.

C) Asset class 1, 15.00%.

Explanation
The expected return of 15% lies between corner portfolios 1 and 2 with expected returns of
12% and 16.50%. We solve for w in the following equation:

15 = w(12) + (1-w)(16.50)

w = 0.33

In other words, the e cient portfolio with an expected return of 15% has 33% weight of
corner portfolio 1 and 67% weight of corner portfolio 2. With respect to the asset classes,
the weights are then derived as follows:

Weight of asset class 1 = (0.33)(65%) + (0.67)(15%) = 31.50%

Weight of asset class 2 = (0.33)(0%) + (0.67)(20%) = 13.4%

Weight of asset class 3 = (0.33)(35%) + (0.67)(50%) = 45.05%

Asset class 3 has the highest weight and is the most signi cant.

Approximate standard deviation = (0.33)(10.50) + (0.67)(14) = 12.85%

(Study Session 5, Module 13.3, LOS 13.b)

Question #3 of 46 Question ID: 1228848

Consider an investor whose future wages are uncertain. The investor's human capital could be

modelled as a(n):

A) in ation-linked bond.

B) real return bond.

C) mix of in ation-linked bonds, equities, and corporate bonds.

Explanation

Investors with uncertain future wages are exposed to a variety of risks. As a result, their
human capital should be modelled as a combination of various risks, including a mix of
in ation-linked bonds, equities, and corporate bonds.

For investors who have jobs that are stable and increase with in ation, modelling their
human capital as in ation-linked bonds is appropriate.

(Study Session 5, Module 13.4, LOS 13.c)

Question #4 of 46 Question ID: 1228831

Any mean-variance e cient portfolio has the:

A) highest return among all other portfolios.

B) lowest standard deviation and the highest expected return.

C) lowest standard deviation for a given level of expected return.

Explanation

A mean-variance e cient portfolio has the lowest standard deviation for a given level of
expected return. Note that the lowest standard deviation portfolio and the highest return
portfolio are just two of the in nite number of e cient portfolios.

(Study Session 5, Module 13.1, LOS 13.a)

Question #5 of 46 Question ID: 1228842

Frances Bonner, a retired nurse, is a potential new client for Fullen Capital Management.

Bonner has told Fullen that in order to pay the living expenses not covered by her pension and

social security, she must generate $10,000 annually on her $500,000 investment portfolio. She

does not want to use principal to meet her living expenses. Fullen has four model portfolios
that Bonner could use for her portfolio.

Portfolio Expected Return Standard Deviation

A 4.5% 6%

B 5.5% 8%

C 6.5% 10%

Based on Roy's Safety-First Measure, Bonner should select:

A) Portfolio A.

B) Portfolio C.

C) Portfolio B.

Explanation

Bonner states that she requires $10,000 annually on a $500,000, which implies a minimum
return of $10,000/$500,000 = 0.02 = 2%

Roy's Safety First Measure is calculated as: SF = (RP – RMIN)/σP

SFA = (4.5 – 2)/6 = 0.4167

SFB = (5.5 – 2)/8 = 0.4375

SFC = (6.5 – 2)/10 = 0.4500

Since Portfolio C has the highest Roy's Safety First measure, Bonner should select Portfolio
C.

(Study Session 5, Module 13.3, LOS 13.i)

Question #6 of 46 Question ID: 1228849

An institutional investor has a signi cant allocation to private equity in its portfolio. Which of

the following approaches is least appropriate for addressing the liquidity risk of private equity

in a mean-variance optimization (MVO) context?

A) Include private equity as an asset class when running MVO but use the risk
characteristics of private equity instead of private equity as an asset class.

B) Only exclude private equity as an asset class when running MVO.

C) Include private equity as an asset class when running MVO using highly diversi ed
asset class inputs.

Explanation

Illiquid asset classes, including private equity, can either be included in or excluded from
MVO. If they are excluded from MVO, they should be used to meet separately set target
asset allocations. The other statements are correct.

(Study Session 5, Module 13.4, LOS 13.d)

Question #7 of 46 Question ID: 1228839

Daniel Roe and Loretta Morgan are both potential new clients of Grachek Investment Advisors.
A summary of Ellen Grachek's notes concerning the potential clients are as follows:

Roe stated that he wants to have a positive return on his $500,000 portfolio at all times,

and that his required before-tax return is 7%. On a risk aversion questionnaire, Roe

scored an 8, with 10 indicating the highest risk aversion.

Morgan indicated that her $1,000,000 portfolio must generate a 2% return each year in

order to meet her living expenses without making any withdrawals from the portfolio's
principal. On a risk aversion questionnaire, Morgan scored a 3, with 10 indicating the

highest risk aversion.

Grachek Investment Advisors has four model portfolios that they use for each client.
Characteristics for each portfolio are identi ed below:

Portfolio Expected Return Standard Deviation

A 5.5% 7%

B 6.0% 8%

C 6.5% 10%

D 8.0% 15%

After reviewing her notes and making some calculations, Grachek makes the following
statements regarding each client:

Based on a utility adjusted return of 2.54%, Portfolio B

Statement 1:
would be the best choice for Roe.
Using Roy's Safety-First Measure, Portfolio D generates
Statement 2: a score of 0.40, and would be the worst choice of the
four for Morgan's portfolio.

Regarding Gracket's statements:

A) Statement 1 is incorrect; Statement 2 is incorrect.

B) Statement 1 is incorrect; Statement 2 is correct.

C) Statement 1 is correct; Statement 2 is correct.

Explanation
Grachek's statement regarding Roe is based on utility-adjusted return.

Utility adjusted return = Up = Rp – 0.005(A)(σ2)

UA = 5.5% – 0.005 (8) (7%2) = 3.54%

UB = 6.0% – 0.005 (8) (8%2) = 3.44%

UC = 6.5% – 0.005 (8) (10%2) = 2.50%

UD = 8.0% – 0.005 (8) (15%2) = -1.00%.

Based on the calculations, Portfolio A would be the best choice for Roe with a utility-
adjusted return of 3.54%. Statement 1 is incorrect.

Grachek's statement regarding Morgan is based on Roy's Safety-First Measure. Morgan

indicated that she has a minimum 2% return.

Roy's Safety First Measure is calculated as: SF = (RP – RMIN)/σP

SFA = (5.5 – 2)/7 = 0.50

SFB = (6.0 – 2)/8 = 0.50

SFC = (6.5 – 2)/10 = 0.45

SFD = (8.0 – 2)/15 = 0.40

Based on the calculations, Portfolio D would be the worst choice for Morgan's portfolio.
Statement 2 is correct.

(Study Session 5, Module 13.3, LOS 13.b)

Question #8 of 46 Question ID: 1228836

The following information is available regarding corner portfolios from an e cient frontier.

Exp. Asset Class Weights

Corner Expected Sharpe
Std.
Portfolio Return Ratio
Dev. 1 2 3 4

1 9.90% 6.60% 1.197 0.00% 11.10% 88.90% 0.00%

2 10.06% 6.64% 1.214 0.00% 14.90% 85.10% 0.00%

3 12.10% 9.58% 1.054 55.22% 0.00% 44.78% 0.00%

4 14.23% 14.74% 0.830 100.00% 0.00% 0.00% 0.00%

An investor has a spending rate of 6%. If in ation is expected to be 4.50% annually and the

cost of earning investment returns is 0.5%, what would be the utility of the portfolio that will at
a minimum satisfy the investor's goals of capital preservation in real terms with a risk aversion
value of 4?

A) 0.099.

B) 0.120.

C) 0.078.

Explanation

r = (1+s)(1+i)(1+c) - 1 = (1.06)(1.045)(1.005) – 1 = 11.32%

This portfolio would lay between corner portfolios 2 and 3. Let w denote the weight of
corner portfolio 2, we solve for w in the following equation:

11.32 = (10.06)(w) + (12.10)(1-w)

w = 0.38

Approximate standard deviation of portfolio = (0.38)(6.64) + (0.62)(9.58) = 8.46%

RZ =4

U = E(R) – 0.5(RZ)(σ2) = 0.1132 – 0.5(4)(0.0846)2 = 0.099

(Study Session 5, Module 13.3, LOS 13.b)

Question #9 of 46 Question ID: 1228832

Je Graefe has a risk-aversion value of 6. He is evaluating three competing investments with

the following characteristics. Which investment would have the least utility for Graefe?

Portfolio Return Std. Dev.

A 18.0% 24.0%

B 13.5% 10.0%

C 9.5% 6.0%

A) B.

B) C.

C) A.

Explanation

RZ = 6

UA = E(RA) – 0.5(RZ)(σ2A) = 0.18 – 0.5(6)(0.24)2 = 0.007

UB = E(RC) – 0.5(RZ)( σ2C) = 0.135 – 0.5(6)(0.10)2 = 0.105

UC = E(RD) – 0.5(RZ)( σ2D) = 0.095 – 0.5(6)(0.06)2 = 0.084

Investment A has the least utility of 0.007.

(Study Session 5, Module 13.1, LOS 13.a)

Question #10 of 46 Question ID: 1228869

Which of the following statements regarding the goals-based approach to asset allocation is
correct?

A) The relevant risk measure for both individuals and institutions is the probability of
missing the goal.

B) Individuals are often concerned with single goals while institutions are often
concerned with multiple goals.

C) The return determination for individuals is based on minimum expectations while

for institutions, it is based on mathematical expectations.

Explanation
For institutions, "mathematical expectations" refers to the weighted expected return of the
portfolio components.

The relevant measure for institutions is volatility of return or surplus.

Individuals are often concerned with multiple goals while institutions are often concerned
with single goals.

(Study Session 5, Module 13.7, LOS 13.m)

Question #11 of 46 Question ID: 1228840

David Jalbert is considering three potential asset allocations. He wishes to earn a nominal
return no less than 2% as he has a low risk tolerance with a lamda of 7.

The following asset allocations are available:

Expected return Variance

Allocation 1 5% 0.0100

Allocation 2 7% 0.0143
Allocation 3 9% 0.0200

Based on the information provided, which of the following allocations should Jalbert choose?

A) Allocation 1.

B) Allocation 2.

C) Allocation 3.

Explanation
Step 1: Calculate the certainty-equivalent return

Allocation 1: 0.05 – (0.5 × 7 × 0.01) = 0.01500

Allocation 2: 0.07 – (0.5 × 7 × 0.0143) = 0.01995

Allocation 3: 0.09 – (0.5 × 7 × 0.02) = 0.02000

Jalbert would probably be indi erent between allocations 2 and 3 based on the certainty
equivalent return and prefers them both to allocation 1.

Step 2: Calculate the Roy's safety- rst criterion

Allocation 1: (0.05 – 0.02) / (0.0100)1/2 = 0.300

Allocation 2: (0.07 – 0.02) / (0.0143)1/2 = 0.418

Allocation 3: (0.09 – 0.02) / (0.0200)1/2 = 0.495

Allocation 3 has a higher probability of exceeding the threshold return than allocation 2, so
Jalbert should choose allocation 3.

(Study Session 5, Module 13.3, LOS 13.b)

Question #12 of 46 Question ID: 1228847

Which of the functions is least likely to be addressed with Monte Carlo simulation?

A) Transforming a data set with a non-normal distribution to a normal distribution

B) Rebalancing and taxes of a portfolio in a multi-period framework

C) Assisting individual investors in identifying risk tolerance levels

Explanation

Transforming data sets from non-normal distributions to normal distributions is not

addressed by Monte Carlo simulation. Multi-period analysis of rebalancing and taxes within
a portfolio is di cult to analyze mathematically but relatively straightforward using Monte
Carlo simulation. Monte Carlo simulation can be useful in illustrating the range and
likelihood of possible outcomes given various assumptions of how much risk to take on.
That provides the investor with more information to decide on a risk tolerance level with
which they are comfortable.

(Study Session 5, Module 13.4, LOS 13.g)

Question #13 of 46 Question ID: 1228854

Which of the following methods is the most appropriate way of incorporating client risk
preferences into asset allocations?

A) Specify additional constraints.

B) Specify a risk tolerance factor.

C) Specify a diversi cation objective.

Explanation

One way to incorporate investor risk preferences into an asset allocation decision is to
specify additional constraints, such as setting limits on allocations to risky asset classes or
setting a ceiling on portfolio risk.

Specifying a risk aversion factor (not risk tolerance factor) is another way to incorporate
investor risk preferences into an asset allocation decision.

There is no such thing as a "diversi cation objective" per se in the reading.

(Study Session 5, Module 13.5, LOS 13.f)

Question #14 of 46 Question ID: 1228850

An institutional portfolio contains the following asset classes: direct real estate, infrastructure,
and private equity. Which of the following statements is correct regarding the potential

inclusion of those asset classes in performing mean-variance optimization (MVO)?

A) Indexes that track such investments are typically not investable.

B) The risk-return characteristics of a speci c investment in those assets are typically

similar to the risk-return characteristics of the asset class.

C) There are numerous indexes available to accurately track such investments.

Explanation

Indexes that track less liquid asset classes (i.e. direct real estate, infrastructure, private
equity) are typically not investable as a passive alternative to active management. Therefore,
they are di cult to include in MVO.

There are very few indexes that accurately track infrastructure investments, which makes it
harder to nd data to use for estimating return, risk, and correlations for inclusion in MVO.

Speci c investments in less liquid assets are not fully diversi ed so they have both
systematic and unsystematic risks. In contrast, asset classes tend to be broader and more
diversi ed, thereby likely re ecting very little unsystematic risk. Therefore, the return-risk
characteristics of speci c illiquid assets and their corresponding asset classes are not
similar, which makes it di cult to include such asset classes in MVO.

(Study Session 5, Module 13.4, LOS 13.d)

Question #15 of 46 Question ID: 1228873

The highest percentage allocation to xed income for a 25-year old investor would be under
the:

A) 60/40 split.

B) 1/N rule, with 3 asset classes.

C) 120 minus age rule.

Explanation

Under a 60/40 split, the investor's allocation to xed income is permanently 40%, with a 60%
allocation to equities, regardless of age. This approach assumes there is no di erence in
asset allocation preferences between investors.

Under the 120 minus age rule, a 25 year old investor would have 120 – 25 = 95% allocation
to equities and 5% allocation to xed income.

Under the 1/N rule, the portfolio is equally weighted along each selected asset class. If xed
income is one of the 3 asset classes selected, then this approach caps the xed income
allocation at 1/3 = 0.33, or 33%.

(Study Session 5, Module 13.7, LOS 13.n)

Question #16 of 46 Question ID: 1228853

Corri Morgan is an investment advisor for Izaguirre Investment Management (IIM). Morgan is
reviewing the account for Brian and Nicole Herbster.

Brian and Nicole are both age 65, and have one daughter, Andrea, age 18. The Herbsters are
recently retired from Tucker Technology Inc., a large manufacturer of microprocessors for a

variety of applications. Andrea is an aspiring nance student and would like to attend a
prestigious university to pursue a degree in nance. The tuition at the University costs $40,000
per year, but Andrea's strong academic performance in high school allowed her to earn a
scholarship covering half of the tuition. The Herbsters have expressed a desire to fund the
amount of the college education not covered by the scholarship, as well as leave a large

inheritance to Andrea at their death. During their careers, the Herbsters earned relatively high
incomes, and were able to save approximately 10% of their income each year. With regard to
their portfolio, they say they prefer investments that have minimal volatility. Their current
investment portfolio is valued at $1.2 million.

The investment policy statement for the Herbsters is shown below:

The Herbster's income requirement is $6,000 monthly.

Return Objective
Total return requirement is $72,000 / $1,200,000 = 6%.

Ability to take on risk: average. Willingness to take risk:

Risk Tolerance
below average

Need cash each year for the next four years to fund
Liquidity
college education.

3 stages. Stage 1, funding daughter's college tuition.

Time Horizon Stage 2, retirement. Stage 3, after death – inheritance for
daughter.

Legal/Regulatory N/A

Taxes Little need to defer income.

Unique
Desire to fund daughter's college education.
Considerations

The Herbster's current portfolio is shown below:

Expected
Allocation Expected Expected
Asset/Fund Standard
(%) Return Yield
Deviation

Tucker Technology
32% 19.0% 0.5% 28%
Common Stock

Money Market Fund 2% 2.5% 2.5% 2%

Diversi ed Bond
30% 6.5% 5.5% 8%
Fund

Large capitalization 15% 9.5% 2.0% 16%

 equities

Emerging market
15% 16.0% 1.0% 26%
equities

Undeveloped
6% 19.0% 0% N/A
commercial land

After reviewing the notes on the Herbster's, Morgan reviews recommendations complied by
Todd Irons, a fellow portfolio manager with IIM. Irons' recommendations include the following:

Reduce the weighting in Tucker Technology common

Recommendation 1: stock – the large position exposes the portfolio to
unnecessary security speci c risk.

Increase the allocation to the Diversi ed Bond Fund

Recommendation 2:
in order to increase income and decrease volatility.

Increase the allocation to Large Capitalization

Recommendation 3:
Equities to provide growth.
Maintain the allocation to emerging market equities
Recommendation 4:
due to their high returns.
Maintain the allocation the undeveloped commercial
Recommendation 5: land due to its low correlation with other assets in
the portfolio.

After reviewing Irons' recommendations, Morgan should agree with:

A) Recommendations 1, 2 and 3 only.

B) Recommendations 1, 3 and 5 only.

C) Recommendations 1, 2 and 4 only.

Explanation

Morgan should agree with Recommendations 1, 2, and 3. The allocation to emerging market
equities is probably too high given the Herbster's preference for low volatility investments.
Also, the allocation to undeveloped commercial land would be a cash drain on the
Herbster's portfolio due to payments for taxes, etc. The Herbsters need income and liquidity
to meet ongoing portfolio disbursement requirements and the undeveloped commercial
land provides neither.

(Study Session 5, Module 13.5, LOS 13.f)

Question #17 of 46 Question ID: 1228871

Which of the following statements about an investor's goals-based asset allocation approach is
least correct?
A) The asset opportunity sets will consist of both taxable and tax-exempt
investments.

B) The investor’s di erent goals with speci ed probabilities of success will be

averaged, and a single module with the highest expected return will be used for
h ll
C) The goals-based asset allocation approach typically uses pre-established
subportfolios to meet client goals.

Explanation

The advantage of the goals-based asset allocation approach is that it is able to incorporate
di erent goals by an investor that could di er by amount, timing and urgency. Each goal is
evaluated separately by looking at modules (pre-established subportfolios) that provide the
minimum expected return needed to satisfy that goal. Goals are not averaged and multiple
modules are used, since each module will result in di erent minimum returns depending on
the level of speci ed probabilities of success.

The asset opportunity set for each module consists of both taxable and tax-exempt
investments.

(Study Session 5, Module 13.7, LOS 13.m)

Question #18 of 46 Question ID: 1228855

Which of the following statements regarding factor-based asset allocation is correct?

A) The size factor is the combined return from a short position in small stocks and
long position in large stocks.

B) The value-growth factor is the combined return from a short position in growth
stocks and a long position in value stocks.

C) The factors may be highly correlated with the market portfolio.

Explanation

The Fama-French model is an example of factor-based asset allocation. There are three
factors to consider:

A zero-dollar portfolio long in small stocks and short in large stocks (the size factor);
A zero-dollar portfolio long in value (high book-to-market) stocks and short growth
(low book-to-market) stocks (the value-growth factor);
The market portfolio

Because of the way the factors are formed, they are not correlated with each other or the
market portfolio, which improves the risk-return trade o from the optimal portfolios and
expands the e cient frontier.

(Study Session 5, Module 13.5, LOS 13.h)

Question #19 of 46 Question ID: 1228872

A 30-year old wealthy investor wants to maximize her allocation to commodity investments.
Which of the following approaches to asset allocation would best achieve her objective?

A) 120 minus age rule.

B) 1/N rule, with 10 asset classes.

C) Endowment model.

Explanation

The Endowment model (or Yale model) allows for higher allocation to alternative
investments, including commodities, real estate and private equity, than recommended
under mean-variance optimization (MVO). The investor should select managers with
signi cant exposure to these alternative asset classes. The model does not cap the
allocation to alternative investments.

The "120 minus age rule" considers only two asset classes: equities and xed income, with
the equity allocation percentage determined as 120 minus age, but it does not consider
alternative investments.

The "1/N rule" considers an equally weighted portfolio to each selected asset class. If
commodities is one of the 10 asset classes selected, then this approach caps the
commodities allocation at 1/10 = 0.10, or 10%, which may be insu cient for the investor.

(Study Session 5, Module 13.7, LOS 13.n)

Question #20 of 46 Question ID: 1228875

Which of the following factors would most likely result in a narrower rebalancing corridor?

A) Higher volatility of asset classes.

B) Higher transaction costs.

C) Higher investor risk tolerance.

Explanation

High asset class volatility would result in a narrower rebalancing corridor because higher
volatility increases the need for quicker rebalancing as the asset mix moves away from the
target allocation.

Higher investor risk tolerance allows for a wider rebalancing corridor because the investor is
now less concerned with deviations of the asset mix away from the target allocation.

Higher transaction costs allows for a wider rebalancing corridor because the asset mix
would have to change more to justify the higher cost of rebalancing.

(Study Session 5, Module 13.8, LOS 13.o)

Question #21 of 46 Question ID: 1228876

A portfolio manager expects that transaction costs will rise next year and that the correlation
of equities with the rest of the portfolio will rise. What is the net impact of those changes on

the portfolio's optimal rebalancing corridor width?

A) They will result in a wider corridor width.

B) They will result in an uncertain impact on corridor width.

C) They will result in a narrower corridor width.

Explanation

The rise in transaction costs and the rise in asset class correlation with the rest of the
portfolio will result in an overall wider optimal portfolio width.

Higher transaction costs allow for a wider corridor width because the asset mix would
have to change more to justify the higher cost of rebalancing.
Higher correlation of equities with the rest of the portfolio will lead to a wider corridor
because the portfolio will move more with the asset class and the allocations will tend
to stray more slowly from the target.

(Study Session 5, Module 13.8, LOS 13.o)

Question #22 of 46 Question ID: 1228863

The investment committee of a life insurance company recommends a strategic asset

allocation for the company based on the projected policy premium in ows and payouts along
with long-term capital market expectations. This approach to strategic asset allocation is

known as the:

A) static approach.

B) asset-liability approach.

C) investment policy statement approach.

Explanation

Because the committee takes into account the company's in ows and out ows (liabilities),
the approach is called the asset-liability approach to strategic asset allocation.

(Study Session 5, Module 13.6, LOS 13.l)

Question #23 of 46 Question ID: 1228866

A pension fund has pension assets that signi cantly exceed the value of pension liabilities. The

fund wants to minimize the risk that the pension plan will become underfunded. Which of the
following liability-relative approaches is most appropriate for the fund?

A) Surplus optimization.

B) Integrated asset-liability approach.

C) Two-portfolio (return-seeking) approach.

Explanation

The two-portfolio approach is most appropriate for the pension fund because it allows the
fund to create an asset portfolio that hedges its liabilities, while separately creating a
portfolio that manages the remaining assets using mean-variance optimization (MVO) under
a return-seeking approach. Should the funded status of the plan deteriorate in the future,
the manager could reduce allocation to the return-seeking portfolio and increase allocation
to the hedging portfolio.

Surplus optimization is an extension of MVO that manages the portfolio surplus against the
surplus volatility.

An integrated asset-liability approach jointly optimizes assets and liabilities, typically against
future changes in multiple factors.

(Study Session 5, Module 13.6, LOS 13.k)

Question #24 of 46 Question ID: 1228864

A bank is most likely to use which of the following approaches to liability-relative asset
allocation?

A) Two-portfolio approach.

B) Surplus e cient frontier approach.

C) Integrated asset-liability approach.

Explanation

Banks (along with insurance companies and hedge funds with short positions) make
decisions about the composition of their liabilities jointly with their asset allocation
decisions, which makes the integrated approach most appropriate.

Surplus optimization and the two-portfolio approach are distinct in that the composition of
the liabilities is already in place when the asset allocations decisions are made, so the two
decisions are made independently.

(Study Session 5, Module 13.6, LOS 13.l)

Question #25 of 46 Question ID: 1228859

Mean-variance optimization (MVO) outputs using factor exposures di er from using asset
class exposures that re ect the same underlying assets in that:

A) one approach will typically be superior to the other, depending on the space in
which the investor operates.

B) their e cient frontiers di er from each other.

C) the choice of exposures re ects how an investor forms capital market

expectations.

Explanation

The choice of whether to use factor exposures or asset class exposures depends on the way
investors form capital market expectations.

When factor exposures and asset class exposures re ect the same exposures (i.e.
underlying assets), the MVO results indicate that neither approach is superior to the other.
As a result, their e cient frontiers will not be signi cantly di erent.

(Study Session 5, Module 13.5, LOS 13.h)

Question #26 of 46 Question ID: 1228867

A risk manager at HIJ Bank is worried that an increase in interest rates will negatively impact
the bank's surplus, while an increase in risk volatility may negatively impact some of its
liabilities. Which liability-relative asset allocation approach would be most appropriate for the

bank?

A) Integrated asset-liability approach.

B) Surplus optimization.

C) Two-portfolio approach.

Explanation
Because the bank wants to look at both sides of the balance sheet through stress testing
against future changes in multiple factors (interest rates and risk volatility), an integrated
asset-liability approach is most appropriate. That approach will allow the bank to determine
the optimal asset and liability mix to meet its objectives.

Surplus optimization is an extension of mean-variance optimization (MVO) that manages the

portfolio surplus against the surplus volatility.

The two-portfolio approach segments the portfolio assets to hedge liabilities, and separately
manages the remaining portfolio using MVO.

(Study Session 5, Module 13.6, LOS 13.l)

Question #27 of 46 Question ID: 1228846

Which of the following asset classes is least likely to require a liquidity return premium?

A) Commodities.

B) Direct real estate.

C) Infrastructure.

Explanation

Commodities are not generally thought of as a less liquid asset class requiring a liquidity
return premium to compensate the investor for the additional liquidity risk. On the other
hand, asset classes such as direct real estate and infrastructure would be considered less
liquid and would require a liquidity return premium.

(Study Session 5, Module 13.4, LOS 13.d)

Question #28 of 46 Question ID: 1228837

The following information is available regarding corner portfolios from an e cient frontier.

Corner Expected Exp. Std. Asset Class Weights

Portfolio Return Dev. 1 2 3 4

1 6.90% 4.60% 0.00% 12.00% 88.00% 0.00%

2 10.00% 8.64% 0.00% 15.00% 45.00% 40.00%

3 13.00% 12.50% 55.00% 0.00% 45.00% 0.00%

A foundation has a spending rate of 8%. If in ation is expected to be 3.50% annually and the
cost of earning investment returns is 0.5%, which of the following represents the correct
weight of one of the asset classes that will at a minimum satisfy the investor's goals of capital
preservation in real terms to an investor with a risk aversion value of 4?

A) Asset class 3 with weight of 39.00%.

B) Asset class 1 with a weight of 42.90%.

C) Asset class 2 with weight of 50.00%.

Explanation

Foundations normally use the multiplicative approach and include the expense rate in the
return calculation.

r = (1+s)(1+i)(1+c) – 1 = (1.08)(1.035)(1.005) – 1 = 12.34%

This portfolio would lie between corner portfolios 2 and 3. Let w denote the weight of corner
portfolio 2, we solve for w in the following equation:

12.34 = (10.0)(w) + (13.00)(1-w)

w = 0.22

With respect to the asset classes, the weights are then derived as follows:

Weight of asset class 1 = (0.22)(0%) + (0.78)(55%) = 42.90%

Weight of asset class 2 = (0.22)(15%) + (0.78)(0%) = 3.30%

Weight of asset class 3 = (0.22)(45%) + (0.78)(45%) = 45.00%

Weight of asset class 4 = (0.22)(40%) + (0.78)(0%) = 8.80%

(Study Session 5, Module 13.3, LOS 13.b)

Question #29 of 46 Question ID: 1228856

A portfolio is comprised of 70% Canadian equities and 30% Canadian bonds and has a
standard deviation of 15%. The beta of Canadian equities is 1.2, while the beta of Canadian
bonds is 0.65. What is the absolute contribution of total risk (ACTR) of Canadian equities?

A) 10.5%.

B) 18.0%.

C) 12.6%.

Explanation

The percentage contribution of total portfolio risk by Canadian equities = ACTR / total
portfolio risk.

The ACTRCanadian equities = (weightCanadian equities) × (MCTRCanadian equities), where MCTR is

the marginal contribution to total risk. MCTRCanadian equities = betaCanadian equities × total
portfolio risk.

Therefore, the % contribution of total portfolio risk by Canadian equities = betaCanadian

equities × total portfolio risk × weightCanadian equities = 1.2 × 0.70 × 15% = 12.6%

(Study Session 5, Module 13.5, LOS 13.e)

Question #30 of 46 Question ID: 1228860

Which of the following statements regarding liabilities in the context of the asset allocation
decision is correct?

A) The pension liability associated with a de ned pension plan is an example of a

xed liability.

B) A university endowment contribution is an example of a legal liability.

C) A small pension liability in relation to the size of the sponsoring organization

should be ignored.

Explanation

A small liability in relation to the size of the sponsoring organization can usually be ignored
as its e ect on the optimal asset allocation is minimal.

The pension liability associated with a de ned pension plan is an example of

a contingent liability because the cash ows depend on uncertain future events.

University endowment contributions are an example of quasi-legal liabilities, which are not
legal obligations, but are cash out ows expected to occur in the future and are essential to
the mission of the institution.

(Study Session 5, Module 13.6, LOS 13.j)

Question #31 of 46 Question ID: 1228865

A pension plan wants to account for liability characteristics in its asset allocation decisions
with respect to higher than expected payouts in the future. Which of the following liability

characteristics best describes the plan's concerns?

A) Legal liabilities

B) Longevity risk

C) Quasi-legal liabilities

Explanation

Longevity risk is the risk that a pension plan would have to make higher than expected
payouts in the future, which is typically due to higher life expectancy of pension plan
members.

Legal liabilities are liabilities de ned through legal agreements, which would include a
pension plan's the obligation to make pension payments. However, the focus of the
question is on higher than expected payouts in the future so although "legal liabilities" is a
correct answer, it is not the best answer.

Quasi-legal liabilities refers to expected future cash out ows that are not due to legal
obligations. A pension plan's obligations are clearly legal liabilities, not quasi-legal liabilities.

(Study Session 5, Module 13.6, LOS 13.j)

Question #32 of 46 Question ID: 1228851

Which of the following statements regarding risk and risk budgeting is correct?

A) An optimal risk budget minimizes the total amount of portfolio risk that is
allocated to the portfolio’s constituent parts.

B) Active risk is most relevant in an asset allocation implementation setting.

C) For risk budgeting purposes, risk can be de ned as total risk, active risk, or mis t
risk.

Explanation

Overall market risk is relevant in an asset allocation setting and active risk is relevant in an
asset allocation implementation setting.

An optimal risk budget allocates risk e ciently in that it attempts to maximize the return per
unit of risk taken.

For risk budgeting purposes, risk can be de ned as total risk, active risk, or residual risk.

(Study Session 5, Module 13.5, LOS 13.e)

Question #33 of 46 Question ID: 1228835

Which of the following does NOT accurately re ect a statement describing the resampled
e cient frontier?

A) At each level of return the most e cient of the simulated e cient portfolios is at
the center of a distribution.

B) A portfolio may be considered statistically equivalent if the manager’s portfolio is

within a 90% con dence interval of the most e cient portfolio.

C) A single portfolio with speci c asset class weights at each level of return.

Explanation

A single portfolio with speci c asset class weights at each level of return describes
traditional mean variance optimization. The other answer choices describe the resampled
e cient frontier where Monte Carlo simulation is used to create an e cient frontier at each
return level and run thousands of times resulting in an e cient frontier that is the result of
an averaging process. The e cient frontier becomes a blur rather than a single sharp curve.
At each level of return, the most e cient of the simulated e cient portfolios is at the center
of the distribution.

(Study Session 5, Module 13.2, LOS 13.a)

Question #34 of 46 Question ID: 1228843

Aaron Manning wishes to minimize the risk of his portfolio returns as measured by standard
deviation while meeting a minimum expected return objective. The risk-free rate is 2%. The
following asset allocations are available:

Expected return Standard deviation of returns

Allocation 1 10% 12%

Allocation 2 7% 10%

Allocation 3 11% 15%

Based on the information provided, which of the following allocations should Manning
choose?

A) Allocation 2

B) Allocation 1

C) Allocation 3
Explanation

Calculate the Sharpe ratio for each allocation:

Allocation 1: (10% - 2%) / 12% = 0.67

Allocation 2: (7% - 2%) / 10% = 0.50

Allocation 3: (11% - 2%) / 15% = 0.60

Allocation 1 has the highest Sharpe ratio, therefore it is the optimal risk allocation that
Manning should choose.

(Study Session 5, Module 13.3, LOS 13.i)

Question #35 of 46 Question ID: 1228833

Dan Laske is evaluating three portfolios for investment of his retirement funds. Laske has a
risk aversion value of 5. Which portfolio would be best for him?

Portfolio Return Std. Dev.

A 15.0% 17.0%

B 10.6% 10.0%

C 8.8% 8.0%

A) C.

B) B.

C) A.

Explanation

RZ =5

UA = E(RA) – 0.5(RZ)(σ2A) = 0.15 – 0.5(5)(0.17)2 = 0.078

UB = E(RC) – 0.5(RZ)( σ2C) = 0.106 – 0.5(5)(0.10)2 = 0.081

UC = E(RD) – 0.5(RZ)( σ2D) = 0.088 – 0.5(5)(0.08)2 = 0.072

Portfolio B has the highest utility.

(Study Session 5, Module 13.1, LOS 13.a)

Question #36 of 46 Question ID: 1228868

Taylor Robinson, age 60, recently retired from her position as director of public giving for
United Electric Power, a large public utility company. Robinson has accumulated $2,000,000 in
her 401(k) portfolio for retirement. Robinson estimates that she will need $50,000 after-tax in
today's dollars to live comfortably. In ation is expected to be 2.5% annually. With her
background in public giving, Robinson has two favorite charities and would like to make non-
tax deductible gifts of $10,000 to each of them annually, indexed for in ation. In her will,
Robinson has speci ed that at her death, a gift fund will be established for each charity. Given
this objective, one of Robinson's primary goals is to maintain the principal in her retirement
fund in order to have a $1,000,000 gift account for each charity. Robinson recently met with
her nancial advisor, Brian Mitchell, CFA. During their meeting Robinson stated, "If I wanted to

gamble with my investments, I would play blackjack. At least then I would have fun losing
money." Mitchell presented Robinson with three di erent model portfolios.

Portfolio Portfolio Portfolio

Asset Class
A B C

Large cap U.S. stocks 5% 15% 25%

Small cap U.S. stocks 5% 15%

International – Developed
10% 5% 10%
market equities

International – Emerging market

15% 5%
equities

U.S. Corporate bonds 10% 50% 30%

U.S. Treasury bonds 5% 20%

Hedge fund of funds 10% 5%

Venture capital 15%

Cash 25% 10% 10%

Total expected after-tax return 5.8% 5.5% 6.0%

Current yield 1.4% 1.6% 1.8%

Which of the portfolios would be most appropriate for Robinson?

A) Portfolio C.

B) Portfolio B.

C) Portfolio A.

Explanation
Based on the information given, it would appear that Portfolio C would be the best choice.
Robinson needs $50,000 per year to meet her living expenses with an additional $20,000 per
year given to charity. This implies a real required return of $70,000/$2,000,000 = 3.5% after
taxes. Factoring in in ation = 3.5 + 2.5 = 6.00% or (1.035)(1.025) – 1 = 6.09%. Robinson's
statement about not wanting to gamble with her investments implies a low risk tolerance.
Portfolio C provides a return of at least the required 6.0%, and has a respectable income
component given the other choices. It also appears to be well diversi ed among a variety of
asset classes. The small allocation to a fund of hedge funds provides an asset with low
correlation that should reduce risk. Portfolio B is too conservative and does not meet
Robinson's return requirement. Portfolio A looks like a good choice because its return is
close to the required return, but it has a high allocation to cash. If we take a closer look at
the allocation of the portfolio, it would seem the 15% venture capital allocation is likely
driving Portfolio A's return. Since Portfolio A falls short of the required return and has a high
cash allocation and 15% allocated to venture capital, Portfolio A would not be the best
choice.

(Study Session 5, Module 13.7, LOS 13.m)

Question #37 of 46 Question ID: 1228862

Which of the following statements regarding the two-portfolio (or the hedging/return-seeking)
approach to liability-relative asset allocation is correct?

A) The asset allocation decisions regarding the two portfolios are made in
conjunction with each other.

B) The hedging portfolio could be constructed using cash ow matching.

C) If the funding ratio is greater than 1, then it becomes di cult to create a hedging
portfolio that completely hedges the liabilities.

Explanation

The hedging portfolio could be constructed using various techniques such as cash ow
matching, duration matching, and immunization.

If the funding ratio is less than 1, then it becomes di cult to create a hedging portfolio that
completely hedges the liabilities.

The two-portfolio approach has the distinctive feature that the composition of the liabilities
is already in place when the asset allocation decisions are made, so the two decisions are
made independently.

(Study Session 5, Module 13.6, LOS 13.k)

Question #38 of 46 Question ID: 1228844

Melissa Brown, an analyst with Mollette Capital Advisors, is reviewing the client pro le of
Karrie Jones. Mollette manages all of Jones' investment assets; however, since Brown is new to
the rm, she has never met Jones. She does know, however, that Jones' asset allocation is
appropriate given her age and investment policy statement. The allocation of Jones' portfolio
is shown below:

Asset Class Allocation (%)

Cash 5%

Intermediate-term Treasury bonds 0%

High quality corporate bonds 5%

U.S. equities 60%

International equities 30%

Given Jones' asset allocation, which of the following conclusions about Jones is most accurate?

A) Jones has a large amount of nancial capital.

B) Jones’ human capital makes up the bulk of her portfolio.

C) Jones has a low risk tolerance.

Explanation

With only 10% in xed assets and the rest in equities, Jones has a very aggressive portfolio.
At a young age, an aggressive portfolio like this makes sense as the individual will have a
high allocation to human capital (future stream of income from working). At this stage, the
allocation to human capital will be much larger than the allocation to nancial capital
(investment portfolio), therefore, the investment portfolio should be invested in riskier, high
return assets. Note that Jones likely has a high risk tolerance given the aggressive portfolio.

(Study Session 5, Module 13.4, LOS 13.c)

Question #39 of 46 Question ID: 1228874

In context of portfolio rebalancing, if the correlation of the asset class with the rest of the
portfolio is lower, then the optimal corridor of the asset class will be:

A) narrower.

B) wider.

C) unchanged.

Explanation
The lower the correlation of the asset class with the rest of the portfolio, the narrower the
corridor, because the portfolio will not "move" as closely with the asset class so the
allocations are more likely to diverge from the target allocation. Therefore, the corridor
needs to be narrowed in order to control the risk.

(Study Session 5, Module 13.8, LOS 13.o)

Question #40 of 46 Question ID: 1228861

Todd Zattau is the chief nancial o cer for the Crandall Steel Company, a mature U.S. steel

processing company. The company provides a traditional de ned bene t pension plan to all of
its employees. The plan covers 5,000 employees and the average age of workers who will
eventually collect bene ts is 52. Approximately 45% of the plan's participants are now retired
and are receiving bene ts. Zattau has hired Kara Rittenhouse, a nancial advisor to help him
construct an IPS for the plan as well as recommend revisions to the plan's current investment
allocation.

Zattau's progress on the IPS so far is shown below:

The discount rate applied to liabilities is 6.5%. Desired

Return Objective
level of returns is 7.2%.

Risk Tolerance ?

Liquidity ?

Company is a going concern, and new employees are still

being added to the de ned bene t plan, so the actual
time horizon of the plan is in nite. However, the high
Time Horizon
percentage of retired participants and older workforce
reduces the e ective time horizon of the plan
considerably.

Legal/Regulatory Plan is subject to ERISA requirements.

Taxes None

Unique
Plan is currently underfunded by 4%.
Considerations

The current investment allocation for the plan is shown below:

Asset Class Allocation (%) Expected Return

Cash 3% 3.0%

Intermediate-term Treasury bonds 25% 5.0%

High quality corporate bonds 32% 5.5%

U.S. equities 10% 8.5%

International equities 10% 10.0%

Venture Capital 15% 19.0%

Based on the information provided, what is the risk tolerance for the Crandall Steel Pension
plan, and what should Rittenhouse recommend for the plan's allocation to cash and U.S.
equities respectively?

Risk Tolerance Cash Allocation U.S. Equities Allocation

A) Below Average Higher Higher

B) Above Average Adequate Higher

C) Below Average Lower Lower

Explanation

Given the older average age of the workforce, the high percentage of retired lives, and the
fact that the plan is slightly underfunded, the risk tolerance of the plan is below average.
Since the percentage of retired employees is so large the plan is likely to have high liquidity
needs. Only having 3% in cash is not likely to give the plan the liquidity it needs (the fact that
the plan is underfunded is a clue here), so the allocation to cash should be higher. The plan
has an actuarial required return of 6.5%. Although the plan needs to rely heavily on xed
income instruments given the average age of its workforce and large percentage of retired
lives, relying entirely on xed income will not generate the long term returns that the plan
needs since it is a going concern. The plan should increase its allocation to U.S. equities,
perhaps by reducing the allocation to venture capital since U.S. equities is a less risky asset
class, but still exceeds the plan's required return requirement.

(Study Session 5, Module 13.6, LOS 13.k)

Question #41 of 46 Question ID: 1228845

Andrew Tyson, age 31, has an existing investment portfolio consisting of investment grade
bonds and large cap stocks. He also owns an apartment unit in the city and has a stable and

promising career as an engineer. By including his apartment and his human capital in his
investment portfolio, his capacity to bear risk would most likely:

A) increase.

B) decrease.

C) remain unchanged.

Explanation

Because human capital and residential real estate are two large, but often overlooked
components of an investor's total investment portfolio, including them in the analysis along
with traditional investments would increase the investor's capacity to bear risk.

(Study Session 5, Module 13.4, LOS 13.c)

Question #42 of 46 Question ID: 1228834

Which of the following statements regarding mean variance optimization (MVO) is least
accurate?

A) An individual with average risk tolerance will have a lamda of about 4.

B) Short positions are permitted.

C) All asset weights add up to 100%.

Explanation

A common constraint in MVO is the non-negativity constraint, which means that all weights
in the portfolio are positive and between 0 and 100% (there are no short positions).

The most common constraint in MVO is known as the budget or utility constraint, which
means the asset weights must add up to 100%.

Lamda is based on an investor's willingness and capacity to take on risk. In practice,

investors are assumed to have a lamda between 1 and 10, with an average level of 4.

(Study Session 5, Module 13.1, LOS 13.a)

Question #43 of 46 Question ID: 1228858

Which of the following statements about using investment factors in constructing asset
allocations is correct?

A) The factors are constructed to have high correlation with each other.

B) The use of investment factors is consistent with factor return models.

C) The investment factors are market-neutral, long/short portfolios.

Explanation

The use of investment factors is consistent with factor return models, including the three-
factor Fama-French model (where the factors are size, value and market).

The investment factors are zero-dollar, long/short portfolios that are long the outperforming
attribute and short the underperforming attribute.

The investment factors are constructed to have low correlation with each other and with the
market portfolio, which results in superior risk-return tradeo .

(Study Session 5, Module 13.5, LOS 13.h)

Question #44 of 46 Question ID: 1228857

A portfolio is comprised of three asset classes: 65% equities, 30% bonds and 5% cash. The
ratio of excess returns to the marginal contribution to total risk (MCTR) is equal to the
portfolio's Sharpe ratio. That implies that:

A) The MCTRequities is equal to the absolute contribution of total risk, or ACTRequities.

B) The 65%/30%/5% allocation is optimal from a risk-budgeting perspective.

C) The sum of the MCTRs of equities and bonds is equal to total portfolio risk.

Explanation

Since the ratio of excess return to MCTRequities is equal to the portfolio Sharpe ratio
(portfolio excess return / portfolio standard deviation), it implies that the current asset
allocation is appropriate.

The statement that MCTRequities is equal to ACTRequities is incorrect, since ACTRequities =

betaequities × MCTRequities.

It is the sum of the ACTRs (of equities and bonds only, since cash has zero ACTR) that is
equal to total portfolio risk, or standard deviation.

(Study Session 5, Module 13.5, LOS 13.e)

Question #45 of 46 Question ID: 1228841

Shad Reed is on the Board of Trustees for the Wesley Ridge World Hunger Organization. The
primary role of the organization is to oversee a large endowment fund that was originally
established in 1995 as the Wesley Ridge U.S. Hunger Fund to provide food to low income

children in the United States. Recently, the original donor for the endowment has died and
provided the fund another $200 million in his will and broadened the scope of the fund to
provide food for hungry children all over the world. With the new addition, the endowment's
assets are currently valued at $600 million. When the fund was originally established, the
spending rate was 5%; however, with the broader scope, the payout has increased to 6%. Also,
since funds are going to be distributed to other countries, the board has determined that
approximately 25% of the foundation's annual payout will be in the foreign currencies of other
countries. The fund's investment policy statement which has been revised by the board is
shown below:

Accounting for in ation of 2.5% and the new spending

Return Objective rate of 6%, the return requirement for the plan is 8.5%. A
total return approach is appropriate.

Above average, although risk tolerance has declined due

Risk Tolerance
to higher spending needs.

The endowment has minimal operating expenditures –

Liquidity
liquidity requirements are low.

Time Horizon Long-term

Legal/Regulatory N/A

Taxes N/A

Unique
N/A
Considerations

The board has consulted with an investment advisor to discuss changes to the endowment's
current asset allocation which is shown below:

Allocation Expected Expected Standard

Asset Class
(%) Return Deviation

Cash 2% 3.0% 2%

Intermediate-term U.S.
28% 5.5% 7%
Treasury bonds

Foreign Government
8% 6.5% 10%
Bonds

U.S. equities 50% 9.5% 18%

International equities 7% 11.0% 23%

Venture Capital 5% 19.0% 38%

Which of the following sets of recommendations would be most appropriate for the

endowment fund?

A) Increase the allocation to cash, decrease the allocation to U.S. equities, decrease
the allocation to international equities, and increase the allocation to venture
i l
B) Increase the allocation to foreign government bonds, increase the allocation to
international equities, keep the allocation to cash the same, and keep the
ll i i l h
C) Decrease the allocation to U.S. Equities, decrease the allocation to international
equities, increase the allocation to foreign government bonds, and increase the
ll d b d
Explanation

Since liquidity needs are low, the allocation to cash is appropriate. Since payments are going
to be made in foreign currencies, it makes sense to increase the allocation to both foreign
bonds and international equities. Especially if these asset classes have low correlation with
other assets in the portfolio, increasing their weight in the portfolio could reduce risk,
although their higher standard deviations suggest only moderate increases. Since the fund
has a long time horizon and above average risk tolerance, the allocation to venture capital is
ne given its above average returns and likely low correlation with other assets in the
portfolio.

(Study Session 5, Module 13.3, LOS 13.i)

Question #46 of 46 Question ID: 1228870

Which of the following heuristic and other approaches to asset allocation is most
closely associated with the assumption of a lack of informationally e cient markets?

A) 60/40 stock/bond heuristic

B) Norway model

C) Endowment model

Explanation

The endowment model has large allocations to alternative assets as well as support for
active management. The endowment model also seeks to earn illiquidity premiums. Those
three factors suggest that there is the assumption of a lack of informationally e cient
markets.

The Norway model's asset allocation emphasizes publicly traded securities, which re ects a
belief in the market's informational e ciency.

(Study Session 5, Module 13.7, LOS 13.n)

Question #1 of 17 Question ID: 1229025

An equity manager is using a segmentation approach in managing an institutional

investment portfolio. She invests mainly in large companies with a stable demand for their

products and domiciled in developed countries. Her main concern is that she has
overestimated the diversi cation bene t. Which segmentation approach is the equity
manager most likely utilizing?

A) Size and style

B) Geography

C) Economic activity

Explanation

One major weakness of segmentation by geography is that by targeting large companies

domiciled in developed countries, the actual exposure to a speci c geographic market may
be lower than expected (i.e. the diversi cation bene t is overestimated). Many large
companies in developed countries already have an international focus as opposed to
focusing on their domicile.

There is insu cient information provided to suggest that the equity manager is
segmenting in regards of style; admittedly, by targeting large companies, she is
segmenting by company size only.

There is insu cient information provided to suggest that the equity manager is
segmenting by economic activity. Targeting companies with a stable demand for their
products does not make it clear that the equity manager is using a production-oriented or
a market-oriented approach.

(Study Session 9, Module 22.1, LOS 22.b)

Question #2 of 17 Question ID: 1229023

A portfolio manager is considering investing in a startup rm with a price-to-earnings (P/E)

ratio of 42. The manager notes that the market P/E ratio is currently 25. Which of the

following equity investment style boxes would best categorize this company?

A) Small-cap growth.

B) Small-cap value.

C) Large-cap growth.

Explanation
Given the startup nature of this company, it most likely has a small market capitalization.
Also, given the company's high P/E ratio relative to market, it is likely more growth focused
than value focused. Therefore, this company would be best categorized as small-cap
growth.

(Study Session 9, Module 22.1, LOS 22.b)

Question #3 of 17 Question ID: 1229021

An investment advisor is considering the addition of equity securities to one of his client's
portfolios. According to the client's investment policy statement, the client exhibits a low

tolerance for risk and prefers stable portfolio income. Which type of equity security would

be most appropriate given this client's investment considerations?

A) Large-cap consumer staples company.

B) Small-cap technology company.

C) Mid-cap oil-producing company.

Explanation

Investing in companies that pay regular dividends, such as large, well-established rms,
would be most suitable for this client's conservative risk and return objectives. Small
technology rms are most likely focused on growth opportunities, so they would be more
appropriate for an aggressive portfolio. Commodity-producing companies may o er a
hedge against in ation, but this investment is less suitable for a conservative portfolio
than a large-cap consumer staples company.

(Study Session 9, Module 22.1, LOS 22.a)

Question #4 of 17 Question ID: 1229033

Which of the following statements regarding active management is correct?

A) It is more likely to have greater tax e ciency than passive management.

B) It is more likely to have a benchmark that is liquid.

C) It is more likely to bene t portfolios investing in companies in large-cap and/or

developed markets.

Explanation
Active management usually requires benchmarks with underlying stocks that are liquid to
avoid excessive trading costs.

Companies in large-cap and/or developed markets are usually well-covered by analysts so

all publicly available information would be imputed in stock prices, thereby most likely
limiting the usefulness of active management.

Compared to passive management, active management is more likely to have higher

turnover and more short-term capital gains. Higher turnover and short-term capital gains
are generally less tax e cient.

(Study Session 9, Module 22.2, LOS 22.e)

Question #5 of 17 Question ID: 1229029

An investor who seeks to actively in uence speci c companies is least likely to:

A) lend securities.

B) start a proxy voting.

C) be an activist investor.

Explanation

When shares are loaned out, voting rights are transferred to the stock borrower. Being
unable to vote reduces the investor's ability to in uence the company. Activist investors by
de nition seek to in uence the companies they invest in, and launching a proxy ght is
one way they may do so.

(Study Session 9, Module 22.2, LOS 22.d)

Question #6 of 17 Question ID: 1229031

Shareholder engagement involves the active interaction in company a airs by investors.

Which of the following issues is least likely to be discussed when shareholders engage with

companies?

A) Succession planning of the board of directors

B) Hiring policies for senior management

C) Internal controls

Explanation
Although the remuneration and compensation structures of senior management are likely
to be discussed with shareholders, the actual hiring policies are much less likely to be
discussed.

The discussion of internal controls falls within the issue of corporate governance and is a
highly likely issue to be discussed with shareholders.

The discussion of succession planning falls within the issue of the composition of the
board of directors and is a highly likely issue to be discussed with shareholders.

(Study Session 9, Module 22.2, LOS 22.d)

Question #7 of 17 Question ID: 1235082

Which of the following trading costs results when an order is not lled?

A) Price impact costs.

B) Delay costs.

C) Market impact costs.

Explanation

When an order is not lled, delay or slippage costs result. These costs can be substantial if
information regarding the security is released while the order sits un lled.

(Study Session 9, Module 22.2, LOS 22.c)

Question #8 of 17 Question ID: 1229024

A portfolio manager is planning to invest in an emerging market's small-cap index. Which of

the following equity universe segmentation approaches does this market index combine?

A) Geographic and economic activity segmentation.

B) Size/style and geographic segmentation.

C) Size/style and economic activity segmentation.

Explanation

An index that tracks small-cap companies from emerging markets combines size and style
segmentation with geographic segmentation. Economic activity segmentation groups
companies into sectors or industries.

(Study Session 9, Module 22.1, LOS 22.b)

Question #9 of 17 Question ID: 1229030

Which of the following equity investment portfolios would most likely be passively managed?

A) Emerging markets small-cap value portfolio.

B) World large-cap growth portfolio.

C) USA consumer defensive sector portfolio.

Explanation

An appropriate equity portfolio benchmark should contain a broad range of underlying

securities with su cient liquidity. These factors will enhance the potential for benchmark
outperformance while keeping trading costs at a reasonable level. For these reasons,
country and sector-speci c equity funds (e.g., consumer defensive companies) tend to be
more passively managed.

(Study Session 9, Module 22.2, LOS 22.e)

Question #10 of 17 Question ID: 1229019

Which of the following statements regarding using equities as an in ation hedge is most

accurate? They have been a good in ation hedge:

A) but only in the U.S for a short time span.

B) in many countries over a long time span.

C) in many countries over a short time span.

Explanation

Using data for 17 countries for 106 years, equities have had consistently positive real
returns (i.e., their nominal return has been higher than that of in ation).

(Study Session 9, Module 22.1, LOS 22.a)

Question #11 of 17 Question ID: 1229032

Ryan Wanne is an equity analyst who is preparing an educational presentation within the
rm on shareholder engagement. Which of the following statements regarding the
advantages of shareholder engagement should he include in the presentation?
A) Index fund managers who are regularly involved in shareholder engagement
have seen a clear improving trend of performance results.

B) Successful shareholder engagement bene ts all shareholders and not just the
subset of shareholders who engage.

C) Shareholder engagement that has pressured companies to adhere to

environmental, social, and governance (ESG) criteria have consistently resulted in
hi h
Explanation

Successful shareholder engagement bene ts all shareholders, including "free riders". Free
riders do not engage but reap the same bene t from any increase in the stock price.

ESG considerations are di cult to quantify so the empirical evidence to link increased
returns to shareholder engagement regarding ESG is inconclusive (so it cannot
conclusively be considered an advantage).

Index fund managers are passive in nature so their main goal is to track a benchmark and
to do so at minimal cost. Therefore, the investment of time and resources in shareholder
engagement by such managers will likely increase their costs and lower their returns.

(Study Session 9, Module 22.2, LOS 22.d)

Question #12 of 17 Question ID: 1229028

Active management may demand or provide liquidity to equity markets. Which of the
following active investment strategies would most likely demand liquidity from the market?

A) Buy-and-hold strategies.

B) Deep value strategies.

C) Momentum strategies.

Explanation

Momentum strategies tend to demand liquidity from the market by buying shares in an
increasing market and selling shares in a decreasing market. Strategies that invest in
undervalued securities are more like contrarian strategies that provide market liquidity.
Buy-and-hold strategies are passive in nature and don't speci cally demand or supply
liquidity.

(Study Session 9, Module 22.2, LOS 22.c)

Question #13 of 17 Question ID: 1229026

A wealth manager is researching the potential sources of income from owning and

managing an equity portfolio. Which of the following actions are required if the manager

wishes to generate income from a dividend capture strategy? The manager should:

A) buy-and-hold equities for a short period of time.

B) sell put options on equities.

C) transfer equities to another investor.

Explanation

With a dividend capture strategy, an investor buys a stock right before its ex-dividend date
and holds that stock through the ex-dividend date. After the dividend is received (i.e.,
captured), the manager immediately sells the stock. Transferring equities between
investors is a form of securities lending. Selling put options on equities while
simultaneously depositing money into a separate account is a cash-covered put.

(Study Session 9, Module 22.2, LOS 22.c)

Question #14 of 17 Question ID: 1229034

Which of the following statements regarding passive and/or active management is correct?

A) Both passive and active management are likely to be subject to reputation risk.

B) Both passive and active management are likely to be subject to key person risk.

C) Passive management makes use of narrower and more limited benchmarks.

Explanation

Narrow and limited benchmarks do not allow the manager much room to deviate and are
likely to support a more passive management approach.

It is active managers who are much more likely than passive managers to face reputation
risk (i.e. violations of rules, regulations, client agreement, or moral principles) in seeking to
outperform a benchmark and add value. In contrast, passive managers who are merely
seeking to match a benchmark are much less likely to face reputation risk.

Key person risk results from individuals who are essential to the success of the fund
leaving the investment rm. It is a clear risk for active management and much less of a
concern for passive management since passive managers are generally much more easily
replaceable.

(Study Session 9, Module 22.2, LOS 22.e)

Question #15 of 17 Question ID: 1229020

Which of the following is least accurate regarding using equities as an in ation hedge?

A) The e ectiveness of an individual stock as a hedge depends on its product

market.

B) The historical record is impressive as to their e ectiveness.

C) Their ability to hedge is una ected by taxes.

Explanation

Because corporate income and capital gains tax rates are not indexed to in ation, in ation
can reduce the stock investor's return, unless this e ect was priced into the stock when
the investor bought it. Equities have had consistently positive real returns in 17 countries
from 1900-2005. The more competition in a rm's product market, the less e ective their
stock will be as a hedge.

(Study Session 9, Module 22.1, LOS 22.a)

Question #16 of 17 Question ID: 1229022

An investment analyst is addressing environmental, social, and governance (ESG) concerns

for clients. Her goal is to recommend suitable investments by excluding companies from the

equity investment universe that fail to meet client ESG standards. Which of the following

screening techniques should be applied by the investment analyst?

A) Thematic investing.

B) Negative screening.

C) Positive screening.

Explanation

Negative screening (i.e., exclusionary screening) excludes companies or sectors that do

not meet client standards. Positive screening (i.e., best-in-class screening) seeks to
uncover companies or sectors that rank most favorably with clients. Thematic investing
screens equities based on a speci c theme.

(Study Session 9, Module 22.1, LOS 22.a)

Question #17 of 17 Question ID: 1229027

An investment analyst is evaluating portfolio costs related to buying and selling equity
securities. Which of the following costs is an example of an implicit trading cost?
A) Stock exchange fees.

B) Price impact from trading.

C) Broker commissions.

Explanation

Trading costs can be explicit or implicit. Explicit costs include broker commissions, stock
exchange fees, and taxes. Implicit costs include bid-ask spreads, price impact from the
transaction, and delay costs from not completing an entire trade due to illiquidity. Price
impact measures the e ect on market prices from making a trade.

(Study Session 9, Module 22.2, LOS 22.c)

Question #1 of 31 Question ID: 1229049

Chandler Gough, CFA, is constructing a passively managed equity portfolio containing a

large number of stocks. His primary objective is to minimize tracking error and his
secondary objective is to minimize transaction costs. Which of the following

construction approaches is most appropriate for Gough?

A) Full replication

B) Strati ed sampling

C) Optimization

Explanation

Optimization uses the tools of modern portfolio theory to address the problem of
minimizing tracking error, which is Gough's primary objective. However, if there are
changing historical relationships, then there is the need to maintain the optimization
as the data change and that may be costly due to transaction costs. Therefore,
optimization may or may not meet his secondary objective.

Full replication closely matches the index return so it minimizes tracking error, which
meets his primary objective. However, because there are a large number of stocks, full
replication will definitely be costly due to transaction costs and that will not meet his
secondary objective.

Stratified sampling has higher tracking error due to the large number of stocks and
therefore, the need for a larger sample. That does not meet his primary objective.
However, the use of a sample means that the transaction costs are lower than for full
replication.

(Study Session 9, Module 23.2, LOS 23.d)

Question #2 of 31 Question ID: 1229040

The use of free-float weighting for a market-cap weighted portfolio most likely has the

largest positive effect on which characteristic of indexes?

A) Rules-based.

B) Investable.

C) Transparent.

Explanation
Free-float weighting calculates market caps excluding closely held shares not available
to market participants for trading and therefore improves the investability of the
index.

(Study Session 9, Module 23.1, LOS 23.a)

Question #3 of 31 Question ID: 1229050

Which fund most likely has the lowest tracking error relative to its benchmark?

Fund Alpha: Fees = 0.11%; cash allocation = 4.2%

Fund Beta: Fees = 0.02%; cash allocation = 1.6%

Fund Gamma: Fees = 0.06%; cash allocation = 2.1%

A) Fund Gamma.

B) Fund Alpha.

C) Fund Beta.

Explanation

Lower fees and a smaller cash allocation result in lower tracking error, all else equal.

(Study Session 9, Module 23.3, LOS 23.e)

Question #4 of 31 Question ID: 1229052

Which of the following statements is most accurate?

A) Passive investors typically have little or no access to corporate boards and

management.

B) The cost of voting proxies for passive investors typically outweighs the
bene ts, so portfolio managers of passive funds don’t usually exercise the
i h h i
C) Corporate governance issues are important to passive investors.

Explanation
Investor activism and engagement between larger shareholders and corporate boards
and management is a key function of active portfolio management. Passive investors
can't sell shares if they are unhappy with the management and leadership of a
company, so corporate governance matters to them as well. Even passive portfolio
managers have a fiduciary duty to vote proxies, so whether the costs outweigh the
benefits or not, they can't ignore that responsibility. They do often use proxy-voting
services to reduce the cost of researching the issues.

(Study Session 9, Module 23.3, LOS 23.f)

Question #5 of 31 Question ID: 1229039

Three market-cap weighted indexes have the following Herfindahl-Hirschman indexes

(HHI):

HHI for Index XX = 0.01.

HHI for Index YY = 0.05.

HHI for Index ZZ = 0.10.

Which of these market-cap weighted portfolios has the same concentration risk as an

equally weighted portfolio of 100 stocks?

A) Index YY.

B) Index XX.

C) Index ZZ.

Explanation

The inverse of the HHI measures a portfolio's concentration risk, and that inverse can
be interpreted as the effective number of stocks in a portfolio. The effective number
of stocks for index XX is 1 / 0.01 = 100. In other words, if you had an equal weighted
portfolio of 100 stocks, its HHI would also be 0.01.

(Study Session 9, Module 23.1, LOS 23.a)

Question #6 of 31 Question ID: 1237356

The use of the derivatives-based approach to passive investing:

A) eliminates the need to rebalance portfolios.

B) makes it easy to quickly adjust a portfolio’s factor exposures at a low cost.

C) involves the application of standardized contracts with virtually no default

risk.

Explanation

Futures, options, and swaps can be used to quickly adjust exposures at a much
smaller cost than full replication or other indexing options. Because these contracts
are OTC, they retain counterparty and therefore default risk potential. Derivatives-
based strategies require periodic rebalancing to maintain alignment with their
indexing goals and factor exposures, so periodic rebalancing is a continual part of the
process.

(Study Session 9, Module 23.2, LOS 23.c)

Question #7 of 31 Question ID: 1237352

Investors actively consider market and risk exposures of their portfolio when selecting

an index for benchmarking purposes. Which statement below is most accurate relative
to this process?

A) Multi-factor models of returns use multiple risk factors to measure risk

factor exposures.

B) Choosing between broad market and sector-based exposure is the primary

decision for market exposure.

C) Investment exposure hinges only on an investor’s risk and return objectives.

Explanation

Multi-factor models of returns use multiple risk factors such as firm size, style and
prior returns to measure risk factor exposures. Investors need to consider risk and
return preferences and portfolio constraints when selecting portfolio exposures.
Market exposure choices include a broad market exposure, sector-level exposure,
domestic versus foreign market exposure, and type of economy (i.e., developed,
emerging, or frontier).

(Study Session 9, Module 23.1, LOS 23.a)

Question #8 of 31 Question ID: 1229053

Which of the following statements regarding the tracking error of an indexed equity
fund (when compared to its benchmark index) is most accurate?

A) The same trades made by both the fund and index within the same day will
not impact tracking error.

B) Tracking error increases as the sample size increases.

C) The existence of a bid-ask spread increases tracking error.

Explanation

The bid-ask spread is essentially a trading commission paid to brokers to execute

trades for the portfolio. There are no trading commissions to be considered for the
benchmark, therefore, trading commissions increase tracking error.

Tracking error initially declines as sample size increases because the manager first
purchases the most liquid, lowest transaction cost stocks. But after a point, as less
liquid stocks with higher transaction costs are added to increase the sample size,
tracking error increases. Therefore, the statement is not wholly accurate.

Performance of the benchmark index is based on close of day pricing while the index
fund itself may make security transactions during the day at prices other than closing
prices. The potential for large price differences may significantly contribute to tracking
error.

(Study Session 9, Module 23.3, LOS 23.e)

Question #9 of 31 Question ID: 1237353

Which of the following statements is correct relative to index construction?

A) Price-weighted indexes bias results to companies with the highest share

values.

B) Fundamentally-weighted indexes give the highest weight to rms with the

highest P/E multiples.

C) Market-cap weighted indexes bias results to companies with the highest

share values.

Explanation

Price-weighted indices weight constituent stocks by their price (share value) while
market-cap weighted stocks weight stocks based on market-cap (i.e., price times
shares outstanding. Fundamentally weighted indices weight based upon fundamental
factors such as sales, net income, or dividends paid.

(Study Session 9, Module 23.1, LOS 23.a)

Question #10 of 31 Question ID: 1229035

Which of the following indices would be biased towards small cap stocks?

A) A value-weighted index.

B) An equal-weighted index.

C) A price-weighted index.

Explanation

The equal-weighted index is biased towards small-cap companies because they will
have the same weight as large-cap firms even though they have less liquidity. Many
equal-weighted indices also have more small companies in them than large firms,
creating a further bias towards small companies. Value-weighted indices are biased
towards large cap stocks and price-weighted indices are biased towards high priced
stocks.

(Study Session 9, Module 23.1, LOS 23.a)

Question #11 of 31 Question ID: 1229044

Which of the following statements regarding passive factor-based strategies is most

accurate?

A) They usually have lower fees than market-cap-weighted strategies.

B) They usually use a single benchmark.

C) They usually have moderate fees because they do not require regular
monitoring.

Explanation

Factor-based strategies have moderate fees (i.e. fees are less than those for active
management) because they are rules based and that restricts the fees. They usually
use multiple benchmarks, including a factor-based one and a market-cap weighted
one. They also have higher management fees and trading commissions than market-
cap-weighted strategies.

(Study Session 9, Module 23.1, LOS 23.b)

Question #12 of 31 Question ID: 1237360

Which of the following most likely contributes to tracking error in passively managed

equity portfolios?

A) Trades based on closing prices.

B) Management fees.

C) Commission-free trading.

Explanation

Indices are based on closing prices. Therefore, it is best to use end-of-day pricing. It is
the use of intraday trading that can cause tracking error because the intraday volatility
does not compare one-to-one with closing price trading. Management fees and
trading commissions both increase the potential for tracking error.

(Study Session 9, Module 23.3, LOS 23.e)

Question #13 of 31 Question ID: 1229038

Which of the following statements regarding a free float-adjusted market capitalization

index is least accurate?

A) A free oat-adjusted market capitalization index assumes the investor has

bought all the publicly available shares of each company in the index.

B) The major value-weighted indices in the world have not been adjusted for
free oat.

C) The oat adjusted index is considered the best index type by many investors,
because it is representative and can be mimicked with minimal tracking risk.

Explanation

The major value-weighted indices in the world have been adjusted for free float.

(Study Session 9, Module 23.1, LOS 23.a)

Question #14 of 31 Question ID: 1229047

If an optimization approach to portfolio construction yields a portfolio that is not mean-

variance efficient relative to the benchmark, the most appropriate solution to this

problem is to:

A) switch to full replication.

B) add a constraint that portfolio volatility is equal to benchmark volatility.

C) re-estimate the key inputs to the model: returns, variances, and covariances.

Explanation

One drawback of the optimization approach is that it can create portfolios that are not
mean-variance efficient relative to the benchmark. The solution is to add a constraint
that total portfolio variance is equal to the volatility of the benchmark.

(Study Session 9, Module 23.2, LOS 23.d)

Question #15 of 31 Question ID: 1237354

Which investment methodology best describes factor-weighted portfolios?

A) Passively managed style.

B) Hybrid investment style.

C) Actively managed style.

Explanation

Factor-weighted portfolios are passively managed with active elements. Thus, they are
classified as a hybrid investment style.

(Study Session 9, Module 23.1, LOS 23.b)

Question #16 of 31 Question ID: 1237357

For an investment manager planning to use a stratified sampling approach to construct

a passive portfolio. Which statement below is most appropriate regarding each subset

(strata) within this approach?

A) Assets within each strata are determined by variance.

B) A higher number of criteria used in organizing the strata will result in higher
tracking error.

C) Each strata must contain a mutually exclusive subset of the constituent

universe.

Explanation

The strata can be organized by granular exposures, but they must be mutually
exclusive and exhaustive groupings. Once strata are established, constituent assets
for the index are selected randomly without further qualifiers. A higher level of criteria
for strata construction will reduce tracking error as the benchmark is replicated on a
more granular level.

(Study Session 9, Module 23.2, LOS 23.d)

Question #17 of 31 Question ID: 1237355

A large institutional asset manager deploys factor-weighted portfolio allocations across

it client accounts. Which statement most accurately describes the factor-weighting

approach?

A) The combination of using both factor-based and market-cap-weighted

indices for benchmarking typically reduces tracking error.

B) Risk-oriented factor-weighted strategies make estimates of forward-looking

risk exposures.

C) Factor-based strategies typically have higher fees than purely passive

strategies.

Explanation

Factor-based strategies have higher fees than purely passive strategies because there
are additional trading costs associated with a factor-based approach. A risk-oriented
approach focuses on minimizing portfolio variance, which is an historically focused
approach. There is no effort to forecast future volatility, which is one drawback to this
method. When more than one benchmark is used, tracking error will increase since
there are multiple points of comparison.

(Study Session 9, Module 23.1, LOS 23.b)

Question #18 of 31 Question ID: 1229055

Two groups of portfolio managers are planning shareholder activist actions on behalf of

their clients. The active managers hold stocks that they feel are most likely to

outperform their relevant benchmarks. The passive managers hold stocks that are
intended to match the performance of their relevant benchmarks. Some of the stocks

always been in the passive managers' benchmarks and will remain there indefinitely.

Which of the following statements is most accurate?

A) If the actions of the activist and passive managers are unsuccessful, they can
simply react by selling their shares.

B) The passive managers may have a greater obligation than active managers
to engage in activist actions.

C) The active managers are more likely than the passive managers to vote
proxy shares in the best interests of their investors.

Explanation

If a stock is always included in the benchmark and the passive managers are tracking
that benchmark, then the passive managers are essentially permanent shareholders.
In such a case, the passive managers may have a greater obligation than active
managers to engage in activist actions because the latter can easily sell their shares if
desired.

For passive managers who are trying to match the performance of a benchmark, it is
not as easy to sell the underlying shares in the portfolio compared to active managers
who are trying to outperform the benchmark.

Both active and passive managers have a fiduciary duty to vote proxy shares in the
best interests of their investors. The active managers will usually do so directly. Due to
the expense and time, however, most passive investors will usually do so indirectly
through proxy-voting services. In both cases, however, the duty to vote proxy shares
for their investors has been performed.

(Study Session 9, Module 23.3, LOS 23.f)

Question #19 of 31 Question ID: 1237358

You are using an optimization approach to construct a passively managed equity

portfolio for a large institutional client. Which statement below is the most accurate?

A) The goal of optimization is to maximize a desired result while minimizing

tracking error.
B) It is important to not have any style tilt when optimizing a portfolio.

C) Minimizing tracking error will also minimize variance per unit of return.

Explanation

Optimization seeks to maximize desired results (e.g., returns) while minimizing

undesirable characteristics (e.g., variance). This process may result in a style tilt if the
underlying index has a style tilt. It is important to note that minimizing tracking error
will not always be mean-variance efficient.

(Study Session 9, Module 23.2, LOS 23.d)

Question #20 of 31 Question ID: 1229041

Passive factor-based investing is also referred to in the industry as:

A) smart beta.

B) attribution trading.

C) strati ed investing.

Explanation

Portfolio returns can be explained by factor models, so one way to replicate the
return/risk characteristics of an index is to create a portfolio with the same exposures
to a set of risk factors as the index. This strategy is often referred to as a passive
factor-based strategy (also known as smart beta).

(Study Session 9, Module 23.1, LOS 23.b)

Question #21 of 31 Question ID: 1229048

A portfolio manager has a new client who would like to invest passively in equities and

desires low costs and high liquidity. Which of the following investments/approaches
would be most appropriate for the client?

A) Equity index derivatives

B) Exchange-traded funds (ETFs)

C) Separately managed equity index-based portfolios

Explanation
Equity index derivatives (options, futures, swaps) have the advantage of high liquidity
since they trade in liquid markets. As well, the transaction costs are relatively low (i.e.
only a relatively small premium is paid for options, no explicit transaction costs for
futures).

ETFs have higher transaction costs from commissions and bid-ask spreads as well as
illiquidity in some ETF secondary markets.

Separately managed equity index-based portfolios hold all of the constituent stocks in
the index or a representative sample. They require regularly updated data on the
index, sophisticated trading and accounting systems, and compliance systems, all of
which would significantly increases costs.

(Study Session 9, Module 23.2, LOS 23.c)

Question #22 of 31 Question ID: 1229054

Which of the following statements regarding cash drag for an equity index fund and/or

its relevant benchmark is correct?

A) Cash drag can have a positive e ect on the value of the fund.

B) Using derivatives strategies has no impact on cash drag on the fund.

C) Both the fund and the benchmark are subject to cash drag.

Explanation

When markets are falling, it is better to hold cash and therefore, cash drag actually
benefits the fund.

The benchmark is assumed to be fully invested, therefore, it is not subject to cash

drag.

The use of futures contracts is an example of a derivatives strategy that can be used
to provide equity exposure to a portfolio. That will avoid or reduce cash drag
compared to if the portfolio were simply invested in cash.

(Study Session 9, Module 23.3, LOS 23.e)

Question #23 of 31 Question ID: 1237359

When constructing passively managed equity portfolios, which type of index

construction is preferred when the universe is comprised of a relatively small number of

liquid stocks?
A) Full replication.

B) Strati ed sampling.

C) Optimization.

Explanation

When the universe is small and liquid, the best option is full replication. Fund
managers should switch to either stratified sampling or optimization techniques when
the investment universe is large and heterogeneous.

(Study Session 9, Module 23.2, LOS 23.d)

Question #24 of 31 Question ID: 1229046

Which portfolio construction method is most likely to be used when tracking an index

with a large number of constituent stocks for relatively small clients?

A) Strati ed sampling.

B) Full replication.

C) Optimization.

Explanation

Full replication is more difficult and less effective the larger the number of constituent
stocks, and smaller clients are less able to afford the costs of optimization.

(Study Session 9, Module 23.2, LOS 23.d)

Question #25 of 31 Question ID: 1229037

Which of the predominant weighting schemes used in the construction of equity share
indices assumes that the investor holds each company in the index according to its
relative weight in the index?

A) The price-weighted index.

B) The free oat-adjusted market capitalization index.

C) The market capitalization-weighted index.

Explanation
The market capitalization-weighted index, also known as the value-weighted index,
assumes that the investor holds each company in the index according to its relative
weight in the index. The price-weighted index assumes that the investor holds one
share of each stock in the index.

(Study Session 9, Module 23.1, LOS 23.a)

Question #26 of 31 Question ID: 1229051

Which type of analysis is most useful in identifying sources of tracking error?

A) Optimization.

B) Strati ed sampling.

C) Attribution analysis.

Explanation

The manager of a passively managed equity portfolio needs to understand the

sources of return versus the index in order to effectively and efficiently manage a
portfolio that replicates its performance. A key tool is attribution analysis, which can
help the manager identify the sources of tracking error.

(Study Session 9, Module 23.3, LOS 23.f)

Question #27 of 31 Question ID: 1237351

When selecting an index as a benchmark for a passively managed equity portfolio, an

investor should seek an index that is:

A) rebalanced annually.

B) organized around granular risk exposures.

C) rules-based and investable.

Explanation

It is important that indices are constructed with an objective, rules-based process and
that the underlying securities are investable. The focus of an index could be granular
or holistic. Indices should be periodically rebalanced but there is not set mandate for
the timing of the rebalancing action.

(Study Session 9, Module 23.1, LOS 23.a)

Question #28 of 31 Question ID: 1229045

The strategy of using derivatives to shift a portfolio back to the risk exposure that

matches the index as a result of short-term deviations is best referred to as:

A) a risk overlay.

B) a rebalancing overlay.

C) a completion overlay.

Explanation

Completion overlays using derivatives can move the portfolio back to the risk
exposure of the index if it deviates in the short-term, for example, by adjusting the
portfolio's beta to match the index beta.

(Study Session 9, Module 23.2, LOS 23.c)

Question #29 of 31 Question ID: 1229036

The fact that firms with greater market capitalization have a greater impact on the index

than firms with lower market capitalization creates a primary bias in what type of index?

A) Price-weighted index.

B) Equal-weighted index.

C) Value-weighted index.

Explanation

Value-weighted indices' primary bias is toward large firms that may be mature and/or
overvalued. This bias is a result of these large firms having a greater impact on the
index than firms with lower market capitalization.

(Study Session 9, Module 23.1, LOS 23.a)

Question #30 of 31 Question ID: 1229043

Bernice Betts is an analyst who is analyzing common equity risk factors in context of

passive factor-based strategies. She is currently examining stocks with recent above-
average returns. Which risk factor is Betts most likely examining?

A) Yield factor

B) Momentum factor

C) Quality factor

Explanation

The momentum factor focuses on trying to earn additional return from stocks that
have recently had above-average price increases.

The quality factor focuses on stocks that have consistent earnings and dividend
growth, a high cash flow to earnings ratio, or a low debt-to-equity ratio.

The yield factor focuses on dividend yield in comparison to other stocks and seeks
stocks with high dividend yields to provide higher excess returns in low interest rate
environments.

(Study Session 9, Module 23.1, LOS 23.b)

Question #31 of 31 Question ID: 1229042

Management fees and trading commissions are most likely to be lowest for:

A) passive factor-based investing.

B) active investing.

C) market-cap weighted passive investing.

Explanation

Management fees and trading commissions are highest for active investing and lowest
for market-cap weighted passive investing.

(Study Session 9, Module 23.1, LOS 23.b)

Question #1 of 11 Question ID: 1234001

Joanne Sparta is a 48-year old, successful physician who earns in excess of $500,000 per
year. She has also been successful speculating on small business startups, which has added

an average of $200,000 to her annual income over the last 10 years. Sparta travels
extensively. She likes to consider herself someone who lives in the fast lane and possesses
re ned tastes in both the arts and entertainment. Sparta's annual expenses, including travel
and entertainment, average $375,000. Sparta has no foreseeable liquidity needs, legal,
regulatory, or tax concerns, and has no unique circumstances. Which of the following most
appropriately describes Sparta's ability and willingness to bear risk? Sparta is:

A) both willing and able to accept risk.

B) willing, but unable to accept risk.

C) neither able or willing to accept risk.

Explanation

Based on the information provided, Sparta's fast life style, speculative activities, and
relatively large income in excess of expenses, indicates both a willingness and ability to
accept risk.

(Study Session 12, Module 28.3, LOS 28.e)

Question #2 of 11 Question ID: 1233998

Which of the following statements regarding situational pro ling is least accurate?

A) When properly used, situational pro ling will provide a great degree of insight
into an investor's preferences, economic situation, goals, and desires.

B) With situational pro ling, the source of an investor's wealth is considered an

indicator of the investor's risk tolerance.

C) Situational pro ling considers an individual's preferences, economic resources,

goals, and desires.

Explanation

Due to the extensive number of possible individual situations, situational pro ling must be
applied cautiously. It should be applied as only an initial step in developing an
understanding of an individual's preferences, economic situation, goals, and desires.

(Study Session 12, Module 28.1, LOS 28.a)

Question #3 of 11 Question ID: 1234000

Which of the following statements regarding institutional and individual investors is

CORRECT?

A) Time horizon factors are typically more crucial to individuals than institutions.

B) Portfolio growth is not important when an individual client is faced with

substantial income requirements.

C) Institutions and not individual investors should focus on total return.

Explanation

Institutions as well as individuals should consider a total return perspective. Spending

objectives usually represent an income component while growth objectives represent a
capital gains component. Even though a client may have a signi cant current income
requirement, attention to portfolio growth is also required. The same is true with respect
to in ation. One of the distinguishing factors between individual and institutional
investors is time horizon. Institutional investors may have in nite lives, but individuals do
not.

(Study Session 12, Module 28.1, LOS 28.a)

Question #4 of 11 Question ID: 1234003

When planning for retirement, an individual investor may wish to use a Monte Carlo

approach over a deterministic approach because:

A) Monte Carlo approaches provide a better analysis of outcome ranges than the
single wealth gure estimate generated by deterministic approaches.

B) deterministic approaches use inappropriate inputs.

C) Monte Carlo approaches are simpler and quicker to implement.

Explanation

Monte Carlo approaches generate ranges of outcomes that can be associated with
probabilities of their occurrences. Although slightly more involved in implementation, and
sometimes taking longer to generate, Monte Carlo generated ranges and or probabilities
may better indicate to the client realistic retirement opportunities.

(Study Session 12, Module 28.4, LOS 28.g)

Question #5 of 11 Question ID: 1234004

Deterministic approaches di er from Monte Carlo approaches in that deterministic

approaches:

A) generate single numbers whereas Monte Carlo approaches generate a range of

outcomes.

B) generate ranges of outcomes whereas Monte Carlo approaches generate single

numbers.

C) use probability forecasts whereas Monte Carlo approaches use best estimates.

Explanation

Monte Carlo approaches rely on probabilistic inputs to generate a range of outcomes that
may provide better information than any method that generates a single number, like
deterministic approaches.

(Study Session 12, Module 28.4, LOS 28.g)

Question #6 of 11 Question ID: 1234002

Which measure of risk is determined in the most objective manner?

A) Ability to take risk.

B) Tolerance for risk.

C) Willingness to take risk.

Explanation

Ability to take risk is determined objectively, while willingness to take risk is a far more
subjective, emotional matter. Risk tolerance is a combination of ability and willingness so
it is not as objective as ability alone.

(Study Session 12, Module 28.3, LOS 28.e)

Question #7 of 11 Question ID: 1234007

With respect to the constraints portion of an investor's investment policy statement, issues

relating to on-going expenses, emergency reserves, alterations in on-going expenses, and

transactions costs are all examples of:
A) liquidity preferences.

B) unique circumstances.

C) time horizon issues.

Explanation

The issues listed in the stem of the question are concerned with the investor's liquidity
requirement.

(Study Session 12, Module 28.6, LOS 28.j)

Question #8 of 11 Question ID: 1233999

Which of the following statements regarding the investment policy statement is least
accurate? An individual's investment policy statement:

A) di ers from an institution's in that time horizon plays a more prominent role.

B) di ers from an institution's in that taxes play a more prominent role.

C) is exactly the same as that of an institution's.

Explanation

An individual's investment policy statement di ers from an institution's in that time

horizon, taxes, and unique circumstances play a more prominent role. The overall process
is the same.

(Study Session 12, Module 28.1, LOS 28.a)

Question #9 of 11 Question ID: 1234005

Which of the following statements about Monte Carlo simulation is CORRECT? Monte Carlo
simulation:

A) is best when it uses only historical data.

B) typically produces approximately 100 trials.

C) forecasts a more accurate risk/return tradeo than a deterministic approach.

Explanation
History provides a view of only one possible path among the many that might occur in the
future. It is di cult to estimate expected returns using historical gures because of the
volatility factor. Monte Carlo analysis produces probability distribution by tabulating the
outcomes of a large number (often 10,000) of simulated trials.

(Study Session 12, Module 28.4, LOS 28.g)

Question #10 of 11 Question ID: 1234006

Which of the following statements distinguishes the ability to take risk from the willingness
to take risk? The:

A) willingness to take risk is connected with primary goals and objectives.

B) ability to take risk is more qualitative in nature whereas the willingness to take
risk can be measured in a quantitative nature.

C) ability to take risk is more amenable to quantitative measures whereas the

willingness to take risk is more qualitative in nature.

Explanation

The ability to take risk is usually associated with speci c goals and time horizons and is
more quantitative than willingness to take risk. Willingness to take risk is more subjective
from the investor's perspective and is therefore more qualitative in nature.

(Study Session 12, Module 28.6, LOS 28.j)

Question #11 of 11 Question ID: 1235083

An investor hires a portfolio manager and stipulates a maximum value at risk for the

portfolio. This is an example of the use of the value at risk framework to:

A) build portfolios.

B) measure performance.

C) set risk limits.

Explanation

The investor has used the value at risk framework to set risk limits for the portfolio.

(Study Session 12, Module 28.7, LOS 28.l)

Question #1 of 12 Question ID: 1235092

Which of the following is the most appropriate method of calculating the manager's active
return? The manager's active return is the:

A) portfolio return minus the benchmark return.

B) portfolio return minus the market return.

C) market return minus the benchmark return.

Explanation

The manager's active return is the portfolio return minus the benchmark return, where
the benchmark is appropriate to the manager's style.

(Study Session 15, Module 35.3, LOS 35.k)

Question #2 of 12 Question ID: 1235087

What is the goal of performance appraisal?

A) Interpretation of performance attribution.

B) Identi cation of overall risk and return.

C) Identi cation of the sources of di erences between portfolio and benchmark

risk and return.

Explanation

Performance appraisal involves the interpretation of performance attribution. A judgment

is made about manager's decisions and skill, in an e ort to di erentiate between returns
attributable to luck and those attributable to skill.

(Study Session 15, Module 35.1, LOS 35.a)

Question #3 of 12 Question ID: 1235097

Which of the following statements regarding the Sharpe ratio is most accurate?

A) The denominator of the Sharpe ratio is standard deviation which is comprised

partly of systematic risk called beta.
B) The measure of risk used in the denominator of the Sharpe ratio is standard
deviation also known as unsystematic risk.

C) Beta is not a component of the Sharpe ratio.

Explanation

The equation for the Sharpe ratio = (RP − RF) / σP.

The Sharpe ratio contains standard deviation in the denominator of the equation which is
total risk and is comprised of both systematic risk called beta and unsystematic risk thus
the Sharpe ratio does contain a component of beta.

(Study Session 15, Module 35.4, LOS 35.o)

Question #4 of 12 Question ID: 1235090

Fund Sponsors often use the median account in a particular universe of account returns as

an appropriate benchmark. This form of benchmark has a number of drawbacks. Which of

the following is NOT a drawback that would be associated with using the median account as

a benchmark?

A) It is not measurable as its value cannot be determined on a reasonably frequent

basis.

B) As the median manager is unknown, the measure is ambiguous.

C) It is virtually impossible to identify the median manager in advance.

Explanation

There are seven properties of a valid benchmark. With regard to the median account
approach, its value is measurable. This is probably the only criteria that the median
manager approach satis es. The other statements are true of the median account.

(Study Session 15, Module 35.3, LOS 35.j)

Question #5 of 12 Question ID: 1235091

Which of the following best characterizes manager universes as a benchmark? Manager

universes:

A) are not a valid benchmark because they are not investable.

B) are not a valid benchmark because they are not measurable.

C) are a valid benchmark because they are measurable.

Explanation

Manager universes are not a valid benchmark because they are not investable, are not
speci ed in advance, and are not unambiguous. It is also impossible to determine if they
are appropriate due to the ambiguity of the median manager. Furthermore, the
performance records of poor managers are dropped from manager universes so there is
an upward bias (i.e., survivorship bias) where the median manager's return is in ated. The
only property of a valid benchmark that manager universes ful ll is that they are
measurable.

(Study Session 15, Module 35.3, LOS 35.j)

Question #6 of 12 Question ID: 1235094

The Treynor measure is correctly de ned as a measure of a fund's:

A) excess earned compared to its systematic risk.

B) return earned compared to its unsystematic risk.

C) return earned compared to its systematic risk.

Explanation

The Treynor measure is de ned as a fund's excess return (fund's return minus the risk-
free rate) divided by its systematic risk (beta).

(Study Session 15, Module 35.4, LOS 35.o)

Question #7 of 12 Question ID: 1235096

If the AM Growth Fund is considered to be well-diversi ed, which measure would be more

appropriate in evaluating its risk/return performance?

A) The Treynor measure.

B) The M2 measure.

C) The Sharpe ratio.

Explanation
If the AM Growth Fund is well diversi ed, the appropriate risk measure would be beta, or
the systematic risk component of total risk. Therefore, the Treynor measure would be
appropriate in this case.

(Study Session 15, Module 35.4, LOS 35.o)

Question #8 of 12 Question ID: 1235089

Which of the following is NOT regarded to be an essential characteristic of a valid

benchmark?

A) Re ective of past investment opinion.

B) Speci ed in advance.

C) Appropriate to the manager’s investment approach and style.

Explanation

The benchmark has seven characteristics. All of the above are included with the exception
of "re ective of past investment opinion", it should be re ective of current investment
opinion, and the manager should have current knowledge and expertise of the securities
in the benchmark.

(Study Session 15, Module 35.3, LOS 35.j)

Question #9 of 12 Question ID: 1235093

In the Sortino ratio, the excess return is divided by the:

A) standard deviation using only the returns below a minimum level.

B) standard deviation.

C) maximum drawdown.

Explanation
The Sortino ratio examines the downside risk of returns. It is calculated as the portfolio
return minus the minimum acceptable return (MAR) divided by a standard deviation that
only uses returns below the MAR. It is similar to the target semivariance. Both remaining
responses refer to other measures of risk-adjusted performance. The Sharpe ratio divides
the excess return above the risk-free rate by the standard deviation. An example of a risk-
adjusted return on invested capital (RAROC) measure would be to divide the portfolio's
expected return by the VAR. The RoMAD (return over maximum drawdown) is the average
portfolio return divided by the maximum drawdown. Drawdown refers to the percentage
di erence between the highest and lowest portfolio values during a period.

(Study Session 15, Module 35.4, LOS 35.n)

Question #10 of 12 Question ID: 1235088

In global performance evaluation, performance attribution seeks to:

A) identify the sources of di erence between portfolio and benchmark return.

B) measure the risk and return of the portfolio.

C) di erentiate whether returns come from a manager’s luck or skill.

Explanation

Performance attribution seeks to identify the sources of di erence between portfolio and
benchmark return. Note that performance measurement involves the calculation of risk
and return, while performance appraisal seeks to identify whether returns are a result of a
manager's luck or skill.

(Study Session 15, Module 35.1, LOS 35.c)

Question #11 of 12 Question ID: 1235095

Which of the following statements about risk/return investment manager performance

measures is least accurate?

A) The Treynor measure includes company-speci c risk as part of its performance

measurement.

B) When measuring the performance of an equity fund, if the Sharpe ratio is 0.55,
and the Treynor measure is 0.47, the di erence is attributable to unsystematic
k
C) The Sharpe measure includes company-speci c risk as part of its performance
measurement.

Explanation
The Treynor measure does not include company-speci c risk, it uses beta in the
denominator, which only measures systematic risk. Note that the Sharpe measure uses
standard deviation in its denominator, which is a measure of total risk.

(Study Session 15, Module 35.4, LOS 35.o)

Question #12 of 12 Question ID: 1235098

Which of the following measures would be the most appropriate one to use when

comparing the results of two portfolios in which each portfolio contains many stocks from a

broad selection of di erent industries?

A) Treynor measure.

B) Sharpe ratio.

C) Information ratio.

Explanation

The equations for the 3 measures are as follows:

Treynor measure = (RP − RF) / βP

Sharpe ratio = (RP − RF) / σP

Information ratio = (RP − RB) / (σP − B)

Since both portfolios are well diversi ed most of their risk comes from systematic risk or
beta and is tied to the general level of overall risk in the market. In this case the best
measure to use would be the Treynor measure since this uses beta or systematic risk as
the measure of risk. The Sharpe ratio uses standard deviation as the measure of risk in the
denominator and the information ratio is best to use when comparing a portfolio to a
benchmark.

(Study Session 15, Module 35.4, LOS 35.o)