FIA Portfolio Theory & Asset Management 3 — Questions and Answers
Question 1: According to CAPM, which type of risk is rewarded with higher expected returns?
- Total risk
- Unsystematic risk
- Specific risk
- Systematic risk (Correct answer)
Correct answer: Systematic risk
CAPM states that only systematic (market) risk is compensated because unsystematic risk can be diversified away.
Question 2: What does a portfolio beta of 1.5 indicate?
- The portfolio is 50% less volatile than the market
- The portfolio moves 1.5 times as much as the market (Correct answer)
- The portfolio has 50% higher idiosyncratic risk
- The portfolio's Sharpe ratio is 1.5
Correct answer: The portfolio moves 1.5 times as much as the market
A beta of 1.5 means the portfolio is expected to move 1.5% for every 1% move in the market.
Question 3: Which asset allocation strategy involves periodically buying and selling assets to maintain original target weights?
- Buy-and-hold
- Tactical asset allocation
- Rebalancing (Correct answer)
- Momentum investing
Correct answer: Rebalancing
Rebalancing restores a portfolio to its original strategic target weights after market movements cause drift.
Question 4: In portfolio management, what does 'alpha' represent?
- The portfolio's sensitivity to interest rate changes
- Return earned in excess of what CAPM predicts given the portfolio's beta (Correct answer)
- The proportion of unsystematic risk in a portfolio
- The portfolio's standard deviation minus the market's standard deviation
Correct answer: Return earned in excess of what CAPM predicts given the portfolio's beta
Alpha measures the portfolio's excess return beyond the expected return based on its systematic risk (beta).
Question 5: Which bond portfolio strategy aims to match asset duration to liability duration to reduce interest rate risk?
- Laddering
- Barbell strategy
- Immunization (Correct answer)
- Bullet strategy
Correct answer: Immunization
Immunization matches the duration of assets and liabilities so that interest rate changes have offsetting effects.
Question 6: A portfolio manager achieves a 10% return while the benchmark returns 8%. If tracking error is 4%, what is the Information Ratio?
- 0.25
- 0.50 (Correct answer)
- 1.25
- 2.50
Correct answer: 0.50
Information Ratio = (10% - 8%) / 4% = 2% / 4% = 0.50.
Question 7: What is the key assumption of the Efficient Market Hypothesis (EMH) in its strong form?
- Prices reflect all publicly available information only
- Prices reflect all public and private (insider) information (Correct answer)
- Technical analysis can consistently generate excess returns
- Fundamental analysis leads to superior returns
Correct answer: Prices reflect all public and private (insider) information
Strong-form EMH holds that prices incorporate all information, including insider information, making it impossible to earn consistent excess returns.
FIA Portfolio Theory & Asset Management 3
According to CAPM, which type of risk is rewarded with higher expected returns?