CFA Portfolio Management 2 β Questions and Answers
Question 1: Jensen's alpha measures portfolio performance as:
- The portfolio return minus the benchmark return
- The actual portfolio return minus the CAPM-expected return given the portfolio's beta (Correct answer)
- The Sharpe ratio minus the Treynor ratio
- The excess return per unit of tracking error
Correct answer: The actual portfolio return minus the CAPM-expected return given the portfolio's beta
Jensen's alpha = Rp β [Rf + Ξ²(Rm β Rf)]; it compares actual portfolio return to the CAPM-predicted return for the same level of systematic risk.
Question 2: The information ratio (IR) is used to evaluate active portfolio managers and is calculated as:
- Active return (alpha) divided by tracking error (Correct answer)
- Portfolio return divided by portfolio standard deviation
- Excess return divided by total risk
- Alpha divided by portfolio beta
Correct answer: Active return (alpha) divided by tracking error
IR = Active return / Tracking error; it measures how much active return a manager generates per unit of active risk (deviation from the benchmark).
Question 3: In a defined benefit (DB) pension plan, the investment risk is borne by:
- The employees (plan participants)
- The plan sponsor (employer) (Correct answer)
- The government through PBGC insurance only
- Equally by employer and employees
Correct answer: The plan sponsor (employer)
In a DB plan, the employer guarantees a defined benefit and bears investment risk; if assets underperform, the sponsor must make additional contributions.
Question 4: Mean-variance optimization in portfolio construction is MOST limited by which of the following practical challenges?
- The inability to include bonds in the optimization
- Sensitivity to input estimates (expected returns, variances, correlations) which are difficult to forecast accurately (Correct answer)
- The exclusion of transaction costs from portfolio returns
- The requirement for all assets to have positive expected returns
Correct answer: Sensitivity to input estimates (expected returns, variances, correlations) which are difficult to forecast accurately
MVO is highly sensitive to small changes in input estimates, particularly expected returns, which leads to extreme and unstable portfolio weights in practice.
Question 5: A risk-averse investor will MOST likely select a portfolio that offers:
- The highest expected return regardless of risk
- The highest Sharpe ratio among available portfolios
- The lowest standard deviation regardless of expected return
- A portfolio on the efficient frontier matching their specific risk-return preference (Correct answer)
Correct answer: A portfolio on the efficient frontier matching their specific risk-return preference
A risk-averse investor selects an efficient frontier portfolio that maximizes their utility given their specific indifference curves, balancing return against their personal risk tolerance.
Question 6: Factor investing (smart beta) differs from traditional passive investing by:
- Using market-cap weighting to track a broad index
- Tilting the portfolio toward specific risk factors like value, momentum, or low volatility (Correct answer)
- Selecting stocks based on fundamental analysis only
- Avoiding any rebalancing to minimize transaction costs
Correct answer: Tilting the portfolio toward specific risk factors like value, momentum, or low volatility
Smart beta strategies systematically tilt toward rewarded factors (value, size, momentum, quality, low volatility) rather than pure market-cap weighting.
CFA Portfolio Management 2
Jensen's alpha measures portfolio performance as: