CAIA Chapter 8 Exam Questions and Answers (Graded A+)

In CAPM model how is beta specified? - ANSWER-Beta is specified as the covariance of the asset's return with the return of the market portfolio, divided by the variance of the returns of the market portfolio What is the general interpretation outside the CAPM? - ANSWER-Beta refers to the a measure of risk, or the bearing the risk, wherein the underlying risk is systematic (shared by at least some other investments and usually unable to be diversified or fully hedged without cost) and is potentially rewarded with expected return. Outside the CAPM model, assets can have more than one beta, and a beta does not have to be a measure of the response of an assets to fluctuations in the entire market portfolio How can the term beta be used in alternative investments? - ANSWER-Beta can be used to refer to any systematic risk for which an investor might be rewarded. The term can apply to a specific systematic risk, from a single-factor or a multifactor model, or to the combined effects of multiple systematic risks from multiple factors. What does alpha refers to? - ANSWER-Alpha refers to any excess or deficient investment return after the return has been adjusted from the time value of money (the risk-free rate) and for the effects of bearing systematic risk (beta). For an investment strategy, alpha refers to the extent to which the skill, information, and knowledge of an investment manager generate superior risk-adjusted returns. What may be a result of misspecified risks? - ANSWER-If relevant beta risks are excluded, then manager skill may be overstated, because the perceived alpha may include compensation for beta risks omitted from a benchmark or asset pricing model Provide 2 common interpretations of the investment term alpha - ANSWER-1) Alpha refers to any excess or deficient investment return after the return has been adjusted for the time value of money (risk-free rate) and for the effects of bearing systematic risk (beta) 2) Alpha can also refer to the extent to which skill, information and knowledge of an investment manager generates superior risk-adjusted returns Provide 2 common interpretations of the investment term beta - ANSWER-1) Beta is the proportion by which an asset's excess return moves in the response to the market portoflio's excess return 2) Beta refers to any of a number of measures of risk or the bearing of risk, wherin the underlying risk is systematic and is potentially rewarded with expected return without necessarily specifying that the systematic risk is the risk of a market portfolio Does ex ante alpha lead to ex post alpha? - ANSWER-Not necessarily. While ex ante alpha may be viewed as expected idiosyncratic return, ex post alpha is realized i