Schweser QBank 2017 portfolio management and wealth planning 11 evaluating portfolio performance

Evaluating Portfolio Performance

Test ID: 7427843

Question #1 of 169

Question ID: 465743

Which of the following is least likely to be utilized in macro performance evaluation?
ᅞ A) Beginning of period fund valuations.
ᅞ B) External cash flows into the fund.
ᅚ C) Pure sector allocation effects.
Explanation
Pure sector allocation effects result from micro performance evaluation. The inputs to macro performance evaluation include
policy allocations, benchmark portfolio returns, fund returns, fund valuations, and external cash flows.

Question #2 of 169

Question ID: 465821

An analyst has gathered the following information about the performance of an equity fund and the S&P 500 index over the same time
period.
Equity Fund

S&P 500

Return

13%

10.5%

Standard Deviation

22%

20%

Beta

1.21

1.00

Risk-free rate is 5.25%
The Treynor measure for the equity fund is:

ᅞ A) 0.570.
ᅚ B) 0.064.
ᅞ C) 0.048.
Explanation
(0.13 - 0.0525)/1.21 = 0.064.

Question #3 of 169

Question ID: 465861

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 different industries?
ᅞ A) Information ratio.
ᅞ B) Sharpe ratio.

ᅚ C) Treynor measure.
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 diversified 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.

Questions #4-6 of 169
The following table summarizes the performance attribution analysis for two fixed income managers of the Ashburton Fund for
the year ending December 31, 2005:

Ashley Asset

Thierry Asset

Bond Portfolio

Management

Management

Benchmark

0.48

0.48

0.48

0.64

0.64

0.64

Duration management

0.22

-0.11

0.00

Convexity management

-0.10

-0.10

0.00

Yield-curve change

0.08

0.23

0.00

Sector management

-0.12

1.23

0.00

Bond selection

0.18

-0.16

0.00

0.07

0.10

0.00

1.45

2.31

1.12

Interest rate effect expected
Interest rate effect unexpected

management

management
Trading Activity
management
Total Return

Ashley Asset Management states that its strategy is to outperform the index through active interest rate management and
bond selection.
Thierry Asset Management states its policy is to immunize against interest rate exposure and to earn positive contribution from
bond selection.


Question #4 of 169

Question ID: 465789

The two fund manager's active management process has yielded excess returns over the benchmark. How much of the
excess performance is attributable to interest rate management effects?

Ashley Asset Management

Thierry Asset Management

ᅚ A) 20 bps 2 bps
ᅞ B) 8 bps 23 bps
ᅞ C) 22 bps -11 bps
Explanation
The interest rate management effect is a combination of the impacts of 1) duration management 2) convexity management
and 3) Yield curve change management.

Question #5 of 169

Question ID: 465790

Given the data in the above table can the manager's positive performance be attributed primarily to their stated management
objectives?

Ashley Asset Management

Thierry Asset Management

ᅞ A) No No
ᅞ B) Yes Yes
ᅚ C) Yes No
Explanation
Ashley Asset Management exceeded the benchmark by 33bps. Interest rate management has added 20bps (22bps − 10bps +
8bps) and bond selection 18bps. This is a total of 38bps, which is more than 100% of their outperformance.
Thierry Asset Management exceeded the benchmark by 119bps. Immunization against interest rate exposure added 2bps and
bond selection reduced performance by 16bps an overall impact of -14bps. Clearly Thierry Asset Management did not add
contribution through their stated objective, most of it came from sector selection!

Question #6 of 169

Question ID: 465791

Which of the following statements about the interest rate effects on the performance of a fixed-income portfolio is least
accurate?
ᅞ A) The overall effect represents the performance of a passive default-free bond
portfolio.
ᅚ B) The expected return is the return from the on-the-run Treasury spot rate curve.
ᅞ C) The expected return is the return from implied forward rates.
Explanation
The expected return is the return implied by forward rates, not the on-the-run Treasury spot rate curve. Although the forward
rates are derived from the spot rates, a two-year spot rate is not the same as the expected forward rate in two years time.


Question #7 of 169

Question ID: 465687

What is the goal of performance appraisal?
ᅞ A) Identification of overall risk and return.
ᅞ B) Identification of the sources of differences between portfolio and benchmark risk and
return.
ᅚ C) Interpretation of performance attribution.
Explanation
Performance appraisal involves the interpretation of performance attribution. A judgment is made about manager's decisions
and skill, in an effort to differentiate between returns attributable to luck and those attributable to skill.

Question #8 of 169

Question ID: 465820

Robert Meznar is currently employed as a senior software architect in a large established software company. He is 38 years
old, and his current salary is $80,000 after tax. Meznar recently sold his stock (acquired through stock options) in an Internet
start up company. The entire proceeds of $2 million is held in treasury securities.
Meznar is currently married with 3 children. He is concerned with the potential educational expenses of his children and wants
to set aside $500,000 for his favorite charitable organization. The family needs $150,000 to maintain its current lifestyle. The
expected inflation rate is 6% and Meznar pays a 20% tax rate on his investment income. Meznar does some investment
research on his own, is confident, careful and methodical, and tries to avoid extreme volatility. However, he has a strong
preference for good, brand name companies.
John Snow, CFA, of Capital Associates has been forwarded the file of Meznar to suggest an appropriate portfolio. Snow relies
heavily on the following forecasts, furnished by the firm, for long term returns for different asset classes. He has already
developed three possible portfolios for Meznar.

Asset Class

Return

U.S. Stock

Standard
Deviation

X

Y

Z

12.0%

16%

40%

30%

25%

Non U.S. Stocks

14.0

24%

0

15

25%

U.S. Corporate bonds

7.0

10%

60

15

0

Municipal Bonds

5.0

8%

0

20

25

REIT

14

14%

0

20

25

Assume the expected standard deviation of X, Y, and Z are 10.74%, 19%, and 22% respectively. If the risk free rate is 5%,
what are the Sharpe ratio measures of portfolio X, Y and Z?
Y

Z

ᅞ A) 0.83

0.55

0.46

ᅚ B) 0.37

0.29

0.28

ᅞ C) 3.46

1.52

1.09

X


Explanation
Sharpe Ratio = (Expected Return - Risk Free Rate)/ Standard Deviation
Portfolio X: Sharpe Ratio = (0.09 - 0.05) / 0.1074 = 0.372
Portfolio Y: Sharpe Ratio = (0.105 - 0.05) / 0.19 = 0.289
Portfolio Z: Sharpe Ratio = (0.1125 - 0.05) / 0.22 = 0.284

Question #9 of 169

Question ID: 465811

The Sharpe Ratio is correctly defined as a measure of a fund's:
ᅚ A) excess return earned compared to its total risk.
ᅞ B) excess return earned compared to its systematic risk.
ᅞ C) return earned compared to its total risk.
Explanation
The Sharpe ratio is defined as a fund's excess return (fund's return minus the risk-free rate) divided by the total risk (standard
deviation).

Question #10 of 169

Question ID: 465723

Custom security-based benchmarks reflect the manager's investment universe, weighted to reflect a particular approach.
Which of the following is NOT an advantage of this type of benchmark?
ᅞ A) Allows fund sponsors to effectively allocate risk across investment
management teams.
ᅚ B) It is cheap to construct and easy to maintain.
ᅞ C) It meets all the required benchmark properties and all of the benchmark validity
criteria.
Explanation
A major disadvantage of custom security-based benchmarks is that they can be expensive to construct and maintain. The
other statements are regarded to be advantages of using custom security-based benchmarks.

Question #11 of 169

Question ID: 465697

For a global portfolio, the money-weighted returns for the four quarters of last year are: 3%, -2%, 5%, and 2.5%. The

corresponding time-weighted returns are: 2.5%, -1%, 4%, and 3.5%. What would an investor report as the annual rate of
return on the portfolio?
ᅚ A) 9.23%.
ᅞ B) 8.64%.
ᅞ C) 9.0%.


Explanation
For reporting purposes, time weighted return is reported. Annual return = 1.025 × 0.99 × 1.04 × 1.035 − 1 = 0.0923 or 9.23%.

Questions #12-13 of 169
An analyst has gathered the following asset allocations and returns, including an appropriate benchmark, covering the past
twelve months for the Triad Fund.
Fund and Benchmark Weights

Fund and Benchmark Returns

Asset Class

Fund

Benchmark

Fund

Benchmark

Stock

0.65

0.50

17.00

13.80

Bonds

0.25

0.40

8.10

8.30

Cash

0.10

0.10

3.85

4.05

Question #12 of 169

Question ID: 465753

The value added to the Triad Fund returns attributable to the pure sector allocation effect is:
ᅚ A) 0.83%.
ᅞ B) 0.54%.
ᅞ C) 0.16%.
Explanation
Attributable to the pure sector allocation effect: (0.65 - 0.50)(13.8 - 10.63) + (0.25 - 0.40)(8.3 - 10.63) + (0.10 - 0.10)(4.05 10.63) = 0.83%.
The benchmark return is calculated as the weighted average of individual asset returns in the benchmark: (.5 x 13.8) + (.4 x
8.3) + (.1 x 4.05) = 10.63%

Question #13 of 169

Question ID: 465754

The value added to the Triad Fund returns attributable to the within-sector selection effect is:
ᅞ A) 1.96%.
ᅚ B) 1.50%.
ᅞ C) 2.23%.
Explanation
Attributable to the within-sector selection effect: (0.5)(17.0 - 13.8) + (0.4)(8.1 - 8.3) + (0.10)(3.85 - 4.05) = 1.5%.

Question #14 of 169

Question ID: 465738

Which of the following would be regarded as the least appropriate method to measure the performance of a hedge fund?


ᅞ A) Separate long/short benchmarks.
ᅞ B) The Sharpe ratio.

ᅚ C) Relative performance comparisons with traditional benchmarks.
Explanation
Construct a separate long and short benchmark, which can then be combined together in their relevant proportions. The
Sharpe ratio compares the return to risk free rather than a benchmark. Relative performance using traditional benchmarks is
the least appropriate given hedge funds concentration on absolute returns and the lack of reliable traditional benchmarks.

Question #15 of 169

Question ID: 465718

Accounts that contain illiquid assets present additional problems of accurately measuring return. Which of the following
statements would NOT be regarded as a problem associated directly with illiquid assets?
ᅞ A) Assets are carried at the price of the last trade.
ᅚ B) Account valuations use trade date accounting as opposed to settlement accounting.
ᅞ C) Matrix pricing is used.
Explanation
The use of trade date accounting is regarded to be a key feature of a good return measurement process. The other options
are examples of the problems caused when illiquid assets are included in the account. Matrix pricing is using the quoted price
of a similar asset as a proxy for the market value of thinly traded fixed income securities.

Question #16 of 169

Question ID: 465729

Which of the following statements best describes the steps required to construct a custom security-based benchmark?
ᅞ A) Identify the manager's investment process including asset selection and
weighting; use representative assets and long run average weightings for the
benchmark; assess and rebalance the benchmark on a predetermined
schedule.
ᅚ B) Identify the manager's investment process including asset selection and weighting;

use the same assets and weighting for the benchmark; assess and rebalance the
benchmark on a predetermined schedule.
ᅞ C) Identify the manager's investment process including asset selection and weighting;
use the same assets as the manager and the long run average weighting for the
benchmark; assess and rebalance the benchmark on a predetermined schedule.
Explanation
The three steps required to construct a custom security-based benchmark are as follows:

1. Identify the manager's investment process including asset selection and weighting.
2. Use the same assets and weighting for the benchmark.
3. Assess and rebalance the benchmark on a predetermined schedule.


Question #17 of 169

Question ID: 465696

What is the major difference between the money-weighted and time-weighted rate of return? The money-weighted return:
ᅚ A) penalizes managers for cash flows that occur outside of their control while the
time-weighted return does not.
ᅞ B) computes the return more precisely using the internal rate of return computation while
time-weighted return computation is an approximation.
ᅞ C) is averaged across periods to arrive at an annual rate of return while the timeweighted return is compounded across periods to arrive at an annual rate of return.
Explanation
The time-weighted return is computed every time a cash flow occurs, so it does not penalize managers for cash flows that
occur outside of their control. The money-weighted return, on the other hand, is impacted by cash flows. Note that an
approximation for different time periods can be made when using the time-weighted return, however, using an approximation
would be at the discretion of the person calculating the return and is not part of the methodology behind the time-weighted
return calculation.

Question #18 of 169

Question ID: 465867

Which of the following is NOT a conclusion regarding quality control charts and how they are typically used to evaluate
manager performance?
ᅚ A) This is a two-tailed test.
ᅞ B) Keeping a manager who generates no value added would be a Type I error.
ᅞ C) H0 will be that the manager adds no value; Ha is that the manager adds positive value.
Explanation
The test is set up as null, the manager generates no added value and the alternative is that the manager adds value. So we
are looking for positive added value which is a one-tailed test. Therefore, the alternative will be that the manager generates
positive value added.

Question #19 of 169

Question ID: 465720

Which of the following is the most appropriate method of calculating the manager's active return? The manager's active return
is the:
ᅞ A) portfolio return minus the market return.
ᅞ B) market return minus the benchmark return.
ᅚ C) portfolio 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.

Questions #20-22 of 169

An analyst has gathered the following asset allocations and returns for the past twelve months, including an appropriate benchmark, for
the Supreme Fund.
Fund and Benchmark Weights
Asset Class

Fund

Benchmark

Stock

0.50

Bonds
Cash

Fund and Benchmark Returns
Excess

Fund

Benchmark

0.60

-0.10

14.50

12.90

1.60

0.45

0.30

0.15

7.20

6.90

0.30

0.05

0.10

-0.05

4.20

4.10

0.10

Question #20 of 169

Excess

Question ID: 465756

Based on the following information and assuming a risk free rate of 5%, what is the Sharpe ratio for the Plumb America index
fund?

Plumb America S&P 500
Return

22%

18%

Std. Deviation

30%

22%

1.2

1.0

Beta

ᅞ A) +0.6716.
ᅚ B) +0.5667.
ᅞ C) -0.5776.
Explanation
Sharpe ratio = (Return - risk free rate) / std. deviation = (0.22 − 0.05) / 0.30 = 0.5667

Question #21 of 169

Question ID: 465757

The value added to the Supreme Fund returns attributable to the sector effect is:
ᅞ A) -0.19%.
ᅞ B) 0.55%.
ᅚ C) -0.46%.
Explanation
The benchmark return is (.6 x 12.9) + (.3 x 6.9) + (.1 x 4.1) = 10.22
Attributable to the sector effect: (0.50 - 0.60)(12.9 - 10.22) + (0.45 - 0.30)(6.9 - 10.22) + (0.05 - 0.10)(4.1 - 10.22) = -0.46%.


Question #22 of 169

Question ID: 465758

The value added to the Supreme Fund returns attributable to the within-sector effect is:
ᅚ A) 1.06%.
ᅞ B) 0.94%.
ᅞ C) 0.67%.
Explanation
Attributable to the within-sector effect: (0.60)(14.5 - 12.9) + (0.30)(7.2 - 6.9) + (0.10)(4.2 - 4.1) = 1.06%.

Question #23 of 169

Question ID: 465864

When constructing a quality control chart which of the following is an important assumption that is made about the distribution

of the manager's value added returns?
ᅞ A) The investment process is consistent thus ensuring that a high degree of the
error term in one period can be explained by the error term in the previous
period.
ᅚ B) Value-added returns are independent from period to period and normally distributed.
ᅞ C) The null hypothesis states that the expected value-added return is the risk free rate of
return.
Explanation
The null hypothesis states that the expected value-added return is zero. We are testing the manager's ability to generate
positive expected value added returns. We want a consistent process to ensure that the distribution of value added returns
about their mean is constant. We do indeed assume that value-added returns are independent from one period to the next
and normally distributed.

Questions #24-25 of 169
Markus Smith, CFA, is looking at different measures of risk for bond portfolios as well as stock and bond mutual funds. He has
several projects currently underway.
Smith's first project is to decompose the various sources of return for the BBB Bond Fund (BBB) which yielded a return of 12%.
The actual treasury yield was 8%, which is 1.0% better than the expected yield of 7.0%. In addition, Smith has ascertained that
the BBB portfolio benefited by 0.50% due to maturity management and 1.25% from spread/quality management.
Smith's second project involves AAA Bond Fund (AAA). Smith gathers the following data:
Actual AAA portfolio return = 10% (duration of portfolio = 10 years).
Lehman Brothers Benchmark Index return = 8% (duration of portfolio = 8 years).
According to the bond market line (BML), the return for a portfolio with a10-year duration should be 9%.
The AAA Bond Fund's long-term strategic portfolio has a duration of 9 years, and a target return of 8.5%.
Smith now turns his attention towards his third project, Star Equity Fund. The table below details relevant information:


Asset Class Star Fund Weights Star Fund Returns Benchmark Returns
Stocks

0.95

12%

14%

Cash

0.05

4%

5%

Overall Star Fund return = 11.60%
Overall benchmark return = 13.82%
Smith's last project is for the Plumb America Index Fund.
Plumb America S & P 500
Return

22%

18%

Standard Deviation

30%

22%

Beta

1.2

1.0

Question #24 of 169

Question ID: 465853

Assuming a risk-free rate of 5%, what is the Treynor measure for the Plumb America Index Fund?
ᅚ A) +0.1417.
ᅞ B) -0.1714.
ᅞ C) +0.2716.
Explanation
Treynor's measure = (Return - risk free rate) / beta = (0.22 − 0.05) / 1.2 = 0.1417

Question #25 of 169

Question ID: 465854

Assuming a risk-free rate of 5%, what is the Sharpe ratio for the Plumb America Index Fund?
ᅞ A) +0.6716.
ᅚ B) +0.5667.
ᅞ C) -0.5776.
Explanation
Sharpe ratio = (Return - risk free rate) / std. deviation = (0.22 − 0.05) / 0.30 = 0.5667

Question #26 of 169

Question ID: 465805

An analyst has gathered the following information about the performance of an equity fund and the S&P 500 index over the same time
period.

Return
Standard Deviation

Equity Fund

S&P 500

-12%

-16%

15%

19%


Beta

1.18

1.00

Risk-free rate is 6.00%
The difference between the Treynor measure for the equity fund and the Treynor measure for the S&P 500 is:

ᅞ A) 0.15.
ᅚ B) 0.07.
ᅞ C) 0.17.
Explanation
The equity fund: (-0.12 - 0.06)/1.18 = -0.15
The S&P 500: (-0.16 - 0.06)/1.00 = -0.22
The equity fund is (-0.15 - (-0.22) = 0.07 higher

Question #27 of 169

Question ID: 465722

Given the following data, how is the manager's performance most accurately characterized?

Manager's Return

7.6%

Benchmark Return

6.2%

Market Index Return

8.8%

ᅞ A) The manager earned an excess return from style but not from active
management.
ᅚ B) The manager earned an excess return from active management but not from style.
ᅞ C) The manager earned an excess return from style and active management.

Explanation
The manager earned a return from active management, where the active return is the manager's return minus the benchmark
return (7.60% − 6.20% = 1.40%). The manager did not earn a return from style, where the style return is the benchmark return
minus the market return (6.20% − 8.80% = -2.60%).

Question #28 of 169

Question ID: 465749

The following data pertains to the UBZ Balanced Fund:

Asset Class Fund Weight Benchmark Weight Fund Return (%) Benchmark Return (%)
Stock

0.625

0.500

9.85

8.64

Bond

0.250

0.333

5.34

5.92

Cash

0.125

0.167

2.38

2.47


What is the within-sector selection effect?

ᅞ A) 0.291%.
ᅚ B) 0.397%.
ᅞ C) 1.085%.
Explanation
The within-sector selection effect = Σ[(benchmark weight)(fund segment return - bench. segment return)]
= [(0.5)(9.85 − 8.64)] + [(0.333)(5.34 − 5.92)] + [(0.167)(2.38 − 2.47)] = 0.397%.

Questions #29-30 of 169
Peter Michaels, CFA, works at Composite Consulting, and is in charge of evaluating the performance of various portfolio
managers. His main tasks are to measure and evaluate the sources of return that can be attributed to manager performance.
Michaels understands the importance of incorporating risk into his analyses, but realizes the limitations associated with some
performance measurement techniques in accomplishing that particular objective. Michaels begins the evaluation of a number
of managers by examining return information from both the portfolio being evaluated and its designated benchmark.

Question #29 of 169

Question ID: 465794

Michaels has the following return information for the AM Growth Fund:

AM Growth Fund S&P 500
Return

14%

12%

Standard

25%

18%

1.15

1.00

deviation
Beta

If the risk-free rate is currently 4%, which of the following represent the calculation for the Sharpe Ratio and the Treynor
measure, respectively, for the AM Growth Fund?

ᅞ A) 0.56 and 0.12.
ᅚ B) 0.40 and 0.09.

ᅞ C) 0.08 and 0.02.
Explanation
The Sharpe ratio is the difference between the Growth Fund return and the risk-free rate divided by the Growth Fund standard
deviation [(0.14 - 0.04)/0.25 = 0.40]. The Treynor measure is the difference between the Growth Fund return and the risk-free
rate divided by the Growth Fund Beta [(0.14 - 0.04) / 1.15 = 0.09].

Question #30 of 169

Question ID: 465795


If the AM Growth Fund is considered to be well-diversified, which measure would be more appropriate in evaluating its
risk/return performance?
ᅚ A) The Treynor measure.
ᅞ B) Jensen's Alpha measure.
ᅞ C) The Sharpe ratio.
Explanation
If the AM Growth Fund is well diversified, 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.

Question #31 of 169

Question ID: 465765

In comparing macro and micro performance attribution methodologies to evaluate the drivers of investment performance, it is
most correct to say that:
ᅞ A) both macro and micro evaluation focus on the deviations from benchmarks.
ᅞ B) micro evaluation is an incremental approach and macro evaluation focuses on
deviations from benchmarks.
ᅚ C) macro evaluation is an incremental approach and micro evaluation focuses on

deviations from benchmarks.
Explanation
This is the most correct statement. The macro evaluation looks at the beginning and ending values of the entire fund and
attributes the return contributed at each level of decision making. Micro evaluation looks at individual portfolios and tries to
explain its return with respect to its deviation from a benchmark.

Question #32 of 169

Question ID: 465717

Frank Belanger would like to calculate the rate of return for an illiquid asset. He states that he will use matrix pricing to obtain a
substitute for the security's current price. Which of the following most accurately describes matrix pricing? In matrix pricing, the
analyst uses:
ᅞ A) the price from the last trade for the same security.
ᅞ B) an average of recent prices.
ᅚ C) dealer quotes for similar securities.
Explanation
Matrix pricing is used when the asset is illiquid and a security price is not readily available. In matrix pricing, the analyst uses
dealer quoted prices for similar securities.

Question #33 of 169

Question ID: 465822


Which of the following measures used to evaluate the performance of a portfolio manager is (are) NOT subject to the
assumptions of the capital asset pricing model (CAPM)?
ᅞ A) Jensen's alpha and the Treynor measure.
ᅞ B) Jensen's alpha.
ᅚ C) Sharpe measure.

Explanation
Both the Treynor measure and the Jensen's alpha assume that the CAPM is the underlying risk-adjustment model. The
Sharpe measure on the other hand does not make this assumption. It uses total risk of a portfolio, unlike the Treynor measure
and Jensen's alpha, which use the systematic (undiversifiable) risk as measured by beta to compute the risk-adjusted return of
a portfolio.

Question #34 of 169

Question ID: 465855

Which of the following statements regarding the Sharpe ratio is most accurate?
ᅚ A) The denominator of the Sharpe ratio is standard deviation which is comprised
partly of systematic risk called beta.
ᅞ B) Beta is not a component of the Sharpe ratio.
ᅞ C) The measure of risk used in the denominator of the Sharpe ratio is standard deviation
also known as unsystematic risk.
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.

Question #35 of 169

Question ID: 465870

Suppose that a portfolio management firm has abnormally high turnover in their staff. Which of the following is the most likely
scenario?
ᅞ A) The firm's Type I error rate is high and their Type II error rate is high.
ᅞ B) The firm's Type I error rate is high and their Type II error rate is low.
ᅚ C) The firm's Type I error rate is low and their Type II error rate is high.

Explanation
Type I error is retaining a poor manager and Type II error is firing a superior manager. If a firm has high turnover in staff, it is
unlikely they are retaining poor managers but more likely that they are firing good managers.

Question #36 of 169

Question ID: 465860


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 only a few number of stocks representing a limited number of industries?
ᅞ A) Information ratio.
ᅞ B) Treynor measure.
ᅚ C) Sharpe ratio.
Explanation
The equations for the 3 measures are as follows:
Sharpe ratio = (RP − RF) / σP
Treynor measure = (RP − RF) / βP
Information ratio = (RP − RB) / (σP − B)
Since both portfolios are not well diversified most of their risk comes from unsystematic (company specific) risk and is not tied
to the overall level of risk in the market thus in this case standard deviation is the best measure of risk to use. The Sharpe ratio
is the best measure to use to compare the two portfolios which are undiversified since the Sharpe ratio uses standard
deviation or total risk in the denominator of the equation as its measure of risk. The Treynor measure uses beta or systematic
market risk as the measure of risk in the denominator and the information ratio is best to use when comparing a portfolio to a
benchmark.

Question #37 of 169

Question ID: 465724

All of the following would be regarded as a specific disadvantage of factor-based-models, EXCEPT:
ᅞ A) it is possible to construct multiple benchmarks, all having the same factor
exposures but with different returns.
ᅞ B) the benchmark may not be investable.
ᅚ C) the manager's style may deviate from the style reflected in the benchmark.
Explanation
The manager's style may deviate from the style reflected in the benchmark is a weakness of broad based market indexes not
factor-model-based benchmarks. The other statements are regarded to be disadvantages of factor-model-based benchmarks.

Question #38 of 169
Which of the following statements about fund performance is CORRECT?
ᅞ A) A fund had total excess return of 1.82%. Of the total, 1.60% was due to the style
of the fund that was specified by the sponsor, and 0.22% was due to security
selection. The amount of the excess return that should be credited to the fund
manager is 1.82%.
ᅞ B) When analyzing the performance of a bond portfolio the manager should be evaluated
relative to a style universe. Focusing on maturity ranges or a particular market
segment is not one of the accepted style universes.

Question ID: 465798


ᅚ C) An equity fund had a return over the past year of 17% and a standard deviation of
returns of 12%. During this period the risk-free return was 3%. The Sharpe ratio for
the fund was 1.17.
Explanation
The Sharpe ratio = (0.17 - 0.03)0.12 = 1.17.
Note that focusing on maturity ranges or a particular market segment are definitions of style for a bond portfolio manager.
Also, managers whose styles are specified for them should only get credit for the excess return that is due to security
selection.

Questions #39-44 of 169
Question #39 of 169

Question ID: 465774

The following information relates to the Fabregas Pension Fund.
Value on September 1st

$210,000,000

Contributions received on September 1st

$1,050,000
0.4%

Risk-free returns (per month)

net contributions value is invested based on the fund sponsor's policy allocations $220,369,968
Value of the fund if: passively invested in the aggregate of the manager's respective benchmarks
invested in the aggregate of the manager's actual portfolios

$221,031,078
$221,141,594

The actual value of the fund at the end of September was

$221,318,507

What was the incremental percentage return contribution attributable to net contributions?

ᅞ A) 5.0%.
ᅚ B) 0.0%.
ᅞ C) 4.9%.
Explanation
Decision Making Level Fund Value Incremental % Return Contribution Incremental Value Contribution
Beginning value

$210,000,000

Net contributions

$211,050,000

0.0%

$1,050,000

($211,050,000 × 0.4%)

$211,894,200

0.4%

$844,200

Asset Category

$220,369,968

4.0%

$8,475,768

Risk-free asset


Benchmarks

$221,031,078

0.3%

$661,110

Investment Managers

$221,141,594

0.05%

$110,516

Allocation Effects

$221,318,507

0.08%

$176,913

Total Fund

$221,318,507

4.83%

$11,318,507

(Study Session 17, LOS 34.l)

Question #40 of 169

Question ID: 465775

What was the incremental percentage return contribution attributable to the risk free asset?
ᅚ A) 0.40%.
ᅞ B) 0.04%.
ᅞ C) 0.39%.
Explanation
Decision Making Level Fund Value Incremental % Return Contribution Incremental Value Contribution
Beginning value

$210,000,000

Net contributions

$211,050,000

0.0%

$1,050,000

($211,050,000 × 0.4%)

$211,894,200

0.4%

$844,200

Asset Category

$220,369,968

4.0%

$8,475,768

Benchmarks

$221,031,078

0.3%

$661,110

$221,141,594

0.05%

$110,516

Allocation Effects

$221,318,507

0.08%

$176,913

Total Fund

$221,318,507

4.83%

$11,318,507

Risk-free asset

Investment Managers

(Study Session 17, LOS 34.l)

Question #41 of 169

Question ID: 465776

What was the incremental percentage return contribution attributable to Asset Category?

ᅞ A) 4.02%.
ᅚ B) 4.00%.
ᅞ C) 4.94%.
Explanation
Decision Making Level Fund Value Incremental % Return Contribution Incremental Value Contribution


Beginning value

$210,000,000

Net contributions

$211,050,000

0.0%

$1,050,000

($211,050,000 × 0.4%)

$211,894,200

0.4%

$844,200

Asset Category

$220,369,968

4.0%

$8,475,768

Benchmarks

$221,031,078

0.3%

$661,110

Investment Managers

$221,141,594

0.05%

$110,516

Allocation Effects

$221,318,507

0.08%

$176,913

Total Fund

$221,318,507

4.83%

$11,318,507

Risk-free asset

(Study Session 17, LOS 34.l)

Question #42 of 169

Question ID: 465777

What was the incremental percentage return contribution attributable to benchmarks?
ᅚ A) 0.30%.
ᅞ B) 0.03%.
ᅞ C) 0.31%.
Explanation
Decision Making Level Fund Value Incremental % Return Contribution Incremental Value Contribution
Beginning value

$210,000,000

Net contributions

$211,050,000

0.0%

$1,050,000

($211,050,000 × 0.4%)

$211,894,200

0.4%

$844,200

Asset Category

$220,369,968

4.0%

$8,475,768

Benchmarks

$221,031,078

0.3%

$661,110

Investment Managers

$221,141,594

0.05%

$110,516

Allocation Effects

$221,318,507

0.08%

$176,913

Total Fund

$221,318,507

4.83%

$11,318,507

Risk-free asset

(Study Session 17, LOS 34.l)

Question #43 of 169
What was the incremental percentage return contribution attributable to Investment Managers?
ᅞ A) 0.500%.

Question ID: 465778

ᅚ B) 0.050%.
ᅞ C) 0.053%.
Explanation
Decision Making Level Fund Value Incremental % Return Contribution Incremental Value Contribution
Beginning value

$210,000,000

Net contributions

$211,050,000

0.0%

$1,050,000

($211,050,000 × 0.4%)

$211,894,200

0.4%

$844,200

Asset Category

$220,369,968

4.0%

$8,475,768

Benchmarks

$221,031,078

0.3%

$661,110

Investment Managers

$221,141,594

0.05%

$110,516

Allocation Effects

$221,318,507

0.08%

$176,913

Total Fund

$221,318,507

4.83%

$11,318,507

Risk-free asset

(Study Session 17, LOS 34.l)

Question #44 of 169

Question ID: 465779

What was the incremental percentage return contribution attributable to allocation effects?
ᅚ A) 0.080%.
ᅞ B) 0.800%.
ᅞ C) 0.084%.
Explanation
Decision Making Level Fund Value Incremental % Return Contribution Incremental Value Contribution
Beginning value

$210,000,000

Net contributions

$211,050,000

0.0%

$1,050,000

($211,050,000 × 0.4%)

$211,894,200

0.4%

$844,200

Asset Category

$220,369,968

4.0%

$8,475,768

Benchmarks

$221,031,078

0.3%

$661,110

Investment Managers

$221,141,594

0.05%

$110,516

Allocation Effects

$221,318,507

0.08%

$176,913

Risk-free asset


Total Fund

$221,318,507

4.83%

$11,318,507

(Study Session 17, LOS 34.l)

Question #45 of 169

Question ID: 465869

Suppose that all of a firm's managers are outperforming the benchmark, some by a little, some by a lot. If the confidence

intervals for a quality control charts in portfolio management were widened, what would the most likely effect be?
ᅚ A) Type I error would become less likely and Type II error would become more
likely.
ᅞ B) Type I error would become more likely and Type II error would become less likely.
ᅞ C) Type I error would become more likely and Type II error would become more likely.
Explanation
Type I error is retaining a poorly performing manager. If the confidence intervals are widened and a poor manager is barely
outperforming the benchmark, it is less likely that they will have statistically significant excess returns. We are thus more likely
to fire them and hence less likely to commit Type I error. At the same time, we may be firing good managers who are
outperforming the benchmark but yet do not have statistically significant excess returns. We are thus more likely to commit
Type II error as Type II error is firing a superior manager.

Question #46 of 169

Question ID: 465866

Suppose that a portfolio management firm has decided that the costs of hiring and firing managers are excessive. Which of
the following would be their most appropriate course of action? The firm should:
ᅚ A) tolerate more Type I error to reduce Type II error.
ᅞ B) tolerate more Type II error to reduce Type I error.
ᅞ C) reduce both Type I and Type II errors.
Explanation
Type I error is retaining a poor manager and Type II error is firing a superior manager. If a firm wishes to reduce the costs of
hiring and firing managers, then they should reduce staff turnover. So they should err on the side of retaining poor managers
(Type I error) to reduce the chance of firing superior managers (Type II error). They might do this by relaxing the performance
criteria managers must meet.

Questions #47-48 of 169
Peter Michaels, CFA, works at Composite Investment Management Consulting (Composite), where he is in charge of
evaluating the performance of all separate account managers that Composite uses for its institutional clientele. His main tasks

are to measure and evaluate the sources of return that can be attributed to manager performance. Michaels understands the
importance of incorporating risk into his analyses, but realizes there are limitations associated with some performance
measurement techniques in accomplishing that particular objective.


Currently Michaels is working on an evaluation of the AMG large capitalization growth fund and has assembled the following
one-year return information.
AMG Fund

S&P 500

Return

14%

12%

Standard Deviation

25%

18%

Beta

1.15

1.00

Risk-Free Rate

4%

4%

Question #47 of 169

Question ID: 465844

The Sharpe and Treynor ratios, respectively, for the AM Growth Fund are:
ᅞ A) -0.44 and -0.10.
ᅚ B) 0.40 and 0.09.
ᅞ C) 0.08 and 0.02.
Explanation
Sharpe ratio = (R - Rf) / σ
where:
R = return
Rf = risk-free return
σ = standard deviation
The Sharpe ratio is the difference between the Growth Fund return and the risk-free rate divided by the Growth Fund standard
deviation [(0.14 - 0.04)/0.25 = 0.40].
Treynor measure = (R - Rf) / β
where:
R = return
Rf = risk-free return
β = beta
The Treynor measure is the difference between the Growth Fund return and the risk-free rate divided by the Growth Fund
Beta [(0.14 - 0.04) / 1.15 = 0.09].

Question #48 of 169

Question ID: 465845

If the AM Growth Fund is considered a focused, undiversified portfolio, which measure would be more appropriate in
evaluating its risk/return performance?
ᅚ A) The Sharpe ratio.
ᅞ B) The Treynor measure.
ᅞ C) Jensen's Alpha measure.
Explanation
If the AM Growth Fund is undiversified, the Sharpe ratio would be more appropriate. The Sharpe ratio measures excess return
per unit of total risk, while Treynor measures excess return per unit of systematic risk. For a well-diversified portfolio, the
rankings between the Sharpe and Treynor measures will be insignificant as total risk and systematic risk will be approximately


the same. However, if a portfolio is not well diversified, the Treynor measure may overstate the portfolio's ranking because
only systematic risk is considered. Sharpe will consider unsystematic risk, which will give the undiversified portfolio a more
appropriate ranking.

Question #49 of 169

Question ID: 465741

Which of the following would be least appropriate in macro performance evaluation?
ᅚ A) Market indices would be used for manager styles.
ᅞ B) External cash flows would be used to determine the impact of the sponsor's decision
making.
ᅞ C) A benchmark return is calculated as a weighted average of the individual managers'
benchmark returns.
Explanation
Broad market indices would be used for asset categories. Narrow indices would be used for manager's investment styles.

Question #50 of 169

Question ID: 465797

Which of the following statements regarding diversification and risk adjusted performance measures is least accurate?

ᅚ A) Investors want their portfolio managers to completely diversify their portfolios.
ᅞ B) Treynor's performance measure should be used to evaluate portfolios that will be an addition
to an overall larger portfolio.

ᅞ C) Treynor's performance measure assumes a well diversified portfolio.
Explanation
If a portfolio manager completely diversifies (i.e., eliminates all non-systematic risk), then the appropriate rate of return would be that of
the market. However, why would you pay active management fees to get the same return of a passively managed index product? Treynor
uses beta as its risk measure, which means that it should be used in the context of a diversified portfolio.

Question #51 of 169

Question ID: 465787

The following are a number of contributions to return for a fixed-income portfolio:
1. Return on interest rate management
2. Return on trading activity
3. Return due to changes in forward rates
4. Return on the default-free benchmark
Which of the above statements is (are) CORRECT?
Effect of External

Contribution of the

Interest

Management

Environment

Process


ᅚ A) 3 and 4

1 and 2

ᅞ B) 3

1, 2 and 4

ᅞ C) 1 and 3

2 and 4

Explanation
Changes in forward rates and the return on the default free benchmark are outside of the manager's influence and are
therefore part of the external interest environment. Interest rate management and trading activity are an integral part of the
role of the manager and are therefore part of the management process. Remember we could also include return from
sector/quality management and return from the selection of specific securities.

Question #52 of 169

Question ID: 465806

Jensen's alpha for a portfolio measures the:
ᅚ A) fund's return in excess of the required rate of return given the systematic risk
of the portfolio.
ᅞ B) difference between a fund's return and the market return.
ᅞ C) fund's return in excess of the required rate of return given the unsystematic risk of the
portfolio.
Explanation
Jensen's alpha measures the return above the required rate of return based on the fund's systematic risk. Said differently,
Jensen's alpha is the amount of return earned by the fund over and above the return predicted for the fund based on the
capital asset pricing model, given the fund's systematic risk.

Question #53 of 169

Question ID: 465868

Jack Jensen is the president of Jensen Management. Jensen prides himself on the care of his employees. He states that in 30
years of portfolio management, he has only had to fire two employees. Tom Mercer is president of Analytical Investors. His
policy has been to replace poorly performing managers, where poor performance equals underperforming their benchmark for
two successive quarters. Which of the following best describes these managers' continuation decisions?
ᅚ A) Jensen is likely committing Type I error and Mercer is likely committing Type II
error.
ᅞ B) Jensen is likely committing Type II error and Mercer is likely committing Type I error.
ᅞ C) Jensen is not likely to be committing any error and Mercer is likely committing Type II
error.
Explanation
Type I error is retaining (or hiring) a poorly performing manager. Jensen is likely committing Type I error because he rarely
fires anyone. Type II error is firing (or not hiring) a superior manager. Jensen is likely committing Type II error because he
fires managers after only two quarters of underperformance. Two quarters is not enough time to properly evaluate a manager.

Question #54 of 169

Question ID: 465792

The Sharpe ratio, Treynor measure, the M2 measure and Jensen's Alpha techniques all measure the risk/return performance
of portfolios. Which of the following statements about these measurement techniques is least accurate?
ᅞ A) While the Treynor measure computes excess return per unit of risk, Jensen's
Alpha measures differential return for a given level of risk.
ᅞ B) Using the capital market line the M2 compares the account's return to the market
return and is a comparative measure.
ᅚ C) The Sharpe ratio measures the slope of the capital allocation line (CAL), with the
lowest slope having the most desirable risk/return combination.
Explanation
Although it is true that the Sharpe ratio measures the slope of the CAL, the higher the slope the more desirable the portfolio.
Your goal is to select the portfolio that has the highest Sharpe measure, which will also have the steepest slope. At any given
risk level, the higher the slope the greater the return.

Question #55 of 169

Question ID: 465732

Which of the following best describes the impact of survivorship bias on using manager universes as benchmarks?
ᅚ A) Fund sponsors will terminate underperforming managers, underperforming
accounts will not survive, and the median will be biased upwards.
ᅞ B) As consistently underperforming funds are terminated by the fund sponsors, the
surviving funds shrink in number such that in a fairly short period of time the number
of funds is too small to allow meaningful benchmarking.
ᅞ C) Fund sponsors are reluctant to terminate underperforming funds, these accounts

survive in the benchmark, and the median will be biased downwards.
Explanation
The evidence is clear. Fund sponsors will rationally terminate underperforming managers, underperforming accounts will not
survive, and the median will be biased upwards. Fund sponsors demonstrate little appetite for underperforming accounts and
they are quickly removed.

Question #56 of 169

Question ID: 465781

Which of the following statements relating to allocation/selection attribution and fundamental factor model attribution is least
accurate?
ᅞ A) The strength of allocation/selection attribution is that it disaggregates
performance effects of manager's decisions between sectors and securities.
ᅚ B) The strength of fundamental factor analysis is its simplicity and the reliability of the
correlations it produces.