CFM Quantitative Methods & Statistics for Fund Management 3

Question 1

Why is the geometric mean return preferred over the arithmetic mean for multi-period performance reporting?

Accepted Answer

Geometric mean accounts for compounding while arithmetic mean does not

Answer

The geometric mean (CAGR) accounts for compounding of returns over multiple periods and is always ≤ the arithmetic mean, making it the standard for multi-period performance measurement.

Question 2

What is the primary limitation of using historical volatility to forecast future portfolio risk?

Accepted Answer

Historical volatility assumes past patterns of return dispersion will repeat in the future

Answer

Historical volatility assumes past return distributions will persist, but market conditions change, so past volatility may not accurately predict future risk — especially during regime shifts.

Question 3

Which method is most commonly used to assess whether a fund manager generated genuine alpha after controlling for systematic risk?

Accepted Answer

Jensen's alpha from CAPM regression

Answer

Jensen's alpha is the intercept from a CAPM regression of fund returns on market returns; a statistically significant positive alpha indicates excess return beyond what systematic risk exposure would predict.

Question 4

What does a tracking error of 4% indicate for an active equity fund manager?

Accepted Answer

The annualized standard deviation of the fund's active returns versus the benchmark is 4%

Answer

Tracking error is the annualized standard deviation of the difference between portfolio returns and benchmark returns; 4% tracking error means active returns vary around the benchmark by about 4% per year.

Question 5

What does the Information Ratio measure in active fund management?

Accepted Answer

The consistency of alpha generation per unit of tracking error

Answer

The Information Ratio divides active return (alpha) by tracking error, measuring how consistently a manager generates excess returns per unit of active risk taken relative to the benchmark.

(CFM) Certified Fund Manager Practice Test

(CFM) Certified Fund Manager Practice Test

CFM Quantitative Methods & Statistics for Fund Management 3