FIA Portfolio Theory & Asset Management 5

Question 1

What does the 'two-fund separation theorem' state in portfolio theory?

Accepted Answer

All investors can hold an optimal portfolio using any combination of the risk-free asset and the market portfolio

Answer

The two-fund separation theorem states that any efficient portfolio is a combination of the risk-free asset and the tangency (market) portfolio.

Question 2

Which of the following best defines 'duration' in fixed income portfolio management?

Accepted Answer

The weighted average time to receive a bond's cash flows, measuring interest rate sensitivity

Answer

Duration is the weighted average time to receive cash flows and also measures how much a bond's price changes for a 1% change in interest rates.

Question 3

A pension fund with long-term liabilities should generally prefer assets with what characteristic?

Accepted Answer

Long duration to match liability duration

Answer

Matching long-duration assets to long-duration liabilities reduces the fund's net interest rate exposure.

Question 4

In multi-factor models, what does the Fama-French three-factor model add to the market factor?

Accepted Answer

Size (SMB) and value (HML) factors

Answer

The Fama-French model adds SMB (small minus big, a size factor) and HML (high minus low, a value factor) to the market return factor.

Question 5

What is the primary difference between systematic and active risk in portfolio management?

Accepted Answer

Active risk arises from deviations from the benchmark; systematic risk comes from market exposure

Answer

Systematic (market) risk stems from overall market exposure, while active risk (tracking error) results from deviations from the benchmark.

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