CPM Risk Management 2 — Questions and Answers
Question 1: Systematic risk in a portfolio is best measured by:
- Standard deviation
- Alpha
- Beta (Correct answer)
- Tracking error
Correct answer: Beta
Beta measures the sensitivity of a portfolio's returns to broad market movements, capturing the systematic (non-diversifiable) component of risk.
Question 2: Which of the following best describes idiosyncratic risk?
- Risk that cannot be eliminated through diversification
- Risk specific to an individual security that can be diversified away (Correct answer)
- The risk of interest rate changes
- Macroeconomic risk
Correct answer: Risk specific to an individual security that can be diversified away
Idiosyncratic (unsystematic) risk is company- or sector-specific and can be reduced or eliminated through diversification across many holdings.
Question 3: A portfolio with a tracking error of 8% relative to its benchmark is described as:
- Fully passive
- Highly active with significant deviation from the benchmark (Correct answer)
- Neutral
- Benchmark-hugging
Correct answer: Highly active with significant deviation from the benchmark
A tracking error of 8% indicates substantial divergence from the benchmark, reflecting a highly active management style with meaningful active bets.
Question 4: Liquidity risk in a portfolio is MOST concerning when:
- Markets are highly liquid and volatile
- The portfolio holds large positions in thinly traded securities and faces redemption demands (Correct answer)
- Interest rates are stable
- The portfolio is 100% in cash
Correct answer: The portfolio holds large positions in thinly traded securities and faces redemption demands
Liquidity risk is highest when a manager must sell large positions in illiquid securities quickly, potentially at significant discounts, especially under redemption pressure.
Question 5: Which of the following best describes model risk in portfolio management?
- The risk that a portfolio manager leaves the firm
- The risk that quantitative models produce inaccurate results or are applied incorrectly (Correct answer)
- The risk of regulatory changes
- Currency translation risk
Correct answer: The risk that quantitative models produce inaccurate results or are applied incorrectly
Model risk arises when the assumptions or implementation of quantitative models are flawed, leading to incorrect valuations, risk estimates, or investment decisions.
Question 6: A portfolio manager uses stress testing to assess portfolio risk. Stress testing differs from standard VaR because it:
- Uses a confidence level of 95%
- Evaluates portfolio behavior under extreme, hypothetical scenarios beyond historical data (Correct answer)
- Only considers equity risk
- Applies only to fixed income portfolios
Correct answer: Evaluates portfolio behavior under extreme, hypothetical scenarios beyond historical data
Stress testing examines how a portfolio performs under severe, often hypothetical scenarios (e.g., a 2008-style crisis) that may not be captured by historical VaR calculations.
CPM Risk Management 2
Systematic risk in a portfolio is best measured by: