CFA Portfolio Management 3 — Questions and Answers
Question 1: Which performance attribution method decomposes active return into allocation, selection, and interaction effects?
- Sharpe-Lintner attribution
- Brinson-Hood-Beebower (BHB) attribution (Correct answer)
- Factor-based attribution
- Risk-adjusted attribution
Correct answer: Brinson-Hood-Beebower (BHB) attribution
The Brinson-Hood-Beebower model decomposes active return into allocation effect, selection effect, and interaction effect.
Question 2: A pension fund has a liability duration of 12 years. To immunize against interest rate risk, the portfolio's asset duration should be:
- Less than 12 years to reduce risk
- Equal to 12 years (Correct answer)
- Greater than 12 years to earn a premium
- Unrelated to the liability duration
Correct answer: Equal to 12 years
Classical immunization requires matching asset duration to liability duration so that interest rate changes affect both equally.
Question 3: What does a high information ratio (IR) indicate about a portfolio manager?
- The portfolio has low tracking error relative to the market
- The manager consistently generates alpha per unit of active risk (Correct answer)
- The portfolio is highly correlated with the benchmark
- The manager takes on high systematic risk
Correct answer: The manager consistently generates alpha per unit of active risk
The information ratio measures alpha generated per unit of tracking error; a higher IR indicates superior active management skill.
Question 4: In a liability-driven investing (LDI) framework, the primary goal is to:
- Maximize absolute returns
- Match or exceed the growth of liabilities (Correct answer)
- Minimize tracking error versus an equity benchmark
- Maximize the Sharpe ratio of the asset portfolio
Correct answer: Match or exceed the growth of liabilities
LDI focuses on managing assets relative to liabilities, ensuring that asset growth keeps pace with or exceeds liability growth.
Question 5: Which of the following is an example of a tactical asset allocation (TAA) decision?
- Setting a long-term 60/40 equity/bond target
- Rebalancing back to target weights after a market move
- Temporarily overweighting equities due to a near-term bullish outlook (Correct answer)
- Defining acceptable asset classes in the IPS
Correct answer: Temporarily overweighting equities due to a near-term bullish outlook
TAA involves short-term deviations from the strategic asset allocation to exploit perceived market opportunities.
Question 6: The Jensen's alpha of a portfolio is +1.5%. This means the portfolio:
- Outperformed the risk-free rate by 1.5%
- Earned 1.5% more than predicted by CAPM given its beta (Correct answer)
- Had a Sharpe ratio 1.5 times higher than the market
- Took 1.5% less risk than the benchmark
Correct answer: Earned 1.5% more than predicted by CAPM given its beta
Jensen's alpha is the actual return minus the CAPM-predicted return; a positive alpha means the manager added value beyond systematic risk compensation.
Question 7: Which concept explains why combining two risky assets with a correlation of -1.0 can theoretically eliminate all portfolio risk?
- Systematic risk diversification
- Perfect negative correlation allows complete offset of price movements (Correct answer)
- The law of large numbers reduces variance
- Both assets have identical betas
Correct answer: Perfect negative correlation allows complete offset of price movements
When two assets have a correlation of -1.0, their price movements perfectly offset each other, allowing construction of a zero-variance portfolio.
CFA Portfolio Management 3
Which performance attribution method decomposes active return into allocation, selection, and interaction effects?