FIA Portfolio Theory & Asset Management 4 — Questions and Answers
Question 1: Which of the following is an example of unsystematic risk?
- Changes in GDP growth
- A sudden increase in inflation
- A product recall at a specific company (Correct answer)
- Rising interest rates across the economy
Correct answer: A product recall at a specific company
A company-specific product recall is unsystematic risk because it affects only that firm and can be diversified away.
Question 2: In the Security Market Line (SML), what is plotted on the x-axis?
- Standard deviation
- Variance
- Beta (Correct answer)
- Correlation coefficient
Correct answer: Beta
The SML plots expected return against beta (systematic risk), unlike the CML which uses standard deviation.
Question 3: Which portfolio construction approach uses mean-variance optimization to select asset weights?
- Equal weighting
- Markowitz optimization (Correct answer)
- Fundamental indexing
- Price-weighting
Correct answer: Markowitz optimization
Markowitz optimization selects asset weights by maximizing expected return for a given variance (or minimizing variance for a given return).
Question 4: What does a negative Jensen's alpha indicate about a portfolio manager's performance?
- The portfolio outperformed the market on a risk-adjusted basis
- The portfolio underperformed relative to its expected CAPM return (Correct answer)
- The portfolio had negative absolute returns
- The portfolio had lower beta than the market
Correct answer: The portfolio underperformed relative to its expected CAPM return
Negative alpha means the portfolio delivered less return than CAPM would predict given its level of systematic risk.
Question 5: What is the primary benefit of international diversification in portfolio management?
- Eliminates currency risk entirely
- Reduces portfolio risk by including assets with low correlation to domestic markets (Correct answer)
- Guarantees higher returns than domestic-only portfolios
- Removes exposure to systematic risk
Correct answer: Reduces portfolio risk by including assets with low correlation to domestic markets
International diversification adds assets with lower correlation to domestic markets, reducing overall portfolio risk.
Question 6: Which risk measure captures the potential loss in a portfolio at a specified confidence level over a given time period?
- Standard deviation
- Beta
- Value at Risk (VaR) (Correct answer)
- Tracking error
Correct answer: Value at Risk (VaR)
VaR quantifies the maximum expected loss at a given confidence level (e.g., 95%) over a specified horizon.
Question 7: In tactical asset allocation (TAA), what does a portfolio manager primarily do?
- Maintains fixed strategic weights regardless of market conditions
- Temporarily deviates from strategic weights based on short-term market views (Correct answer)
- Invests exclusively in passive index funds
- Eliminates all equity exposure during downturns
Correct answer: Temporarily deviates from strategic weights based on short-term market views
TAA involves short-term deviations from the strategic asset allocation based on anticipated market conditions.
FIA Portfolio Theory & Asset Management 4
Which of the following is an example of unsystematic risk?