CAIA LEVEL #2 TEST QUESTIONS WITH
COMPLETE ANSWERS
Meta risks are qualitative risks not captured by specific and measurable financial risks.
events. - Answer-They include organizational and human behavior, moral hazard, the
misuse and excessive dependence on quantitative methods, market interaction, and
extreme capital market
A distressed securities strategy is most likely to earn returns from liquidity risk. -
Answer-Global macro and equity long/short are most likely to earn returns from
directional market risks.
Investor protection clauses are clauses within limited partnership agreement and
include - Answer-investment strategy, the investment committee, the LP advisory
committee, key-person terms, exclusivity, conflicts of interest, and termination
Issues facing negatively skewed assets can be addressed by - Answer-(1) changing the
optimization process to account for skewness and kurtosis; (2) adding constraints for
skewness and kurtosis; and (3) limiting the portfolio weights applicable to assets with
higher moments
The AMC requires that managers should provide at least quarterly performance
reporting to clients—and within. - Answer-30 days of the end of the period, if possible.
This should be done even for funds with lockup periods
AIFs are suitable for larger investors with significant funds to invest. AIFs have few
restrictions and can invest in a range of securities, including less liquid alternative
investments such as hedge funds, private equity, and real estate. SIFs are specialized
funds specifically aimed at qualified investors in Luxembourg. - Answer-UCITS funds
are suitable for smaller investors and typically invest in more liquid and safer
investments that are publicly traded. CISs encompass both UCITS funds and AIFs
Negative (or exclusionary) screening is an investment approach that avoids including -
Answer-in investment portfolios the equity or bond securities issued by entities with low
environmental, social, and governance (ESG) scores or weak ESG performance
Natural resource investments should adopt techniques to reduce the negative impact on
biodiversity. That would include achieving sufficient diversity of flora and fauna. -
Answer-Together with farming and timbering, mining can cause significant disruption
and degradation of soil conditions. ESG issues are quite similar between indirect and
direct investments in natural resources. Studies on protecting endangered species
should be taken before the development process to minimize any negative
environmental impacts
,From 2016 to 2018, ESG assets under management in alternative investments
increased nearly - Answer-threefold from $206 billion to $588 billion
Buildings to be significantly refurbished essentially face the same issues as buildings
that are being newly developed (e.g., quality of planning, design, and construction). -
Answer-Preparing demolition materials should ideally be done on site. Materials that are
safe to use may release toxic gases, so they are not always safely placed in landfills. A
predemolition audit is primarily designed to minimize the amount of landfill waste and to
promote safe handling of dangerous materials
Key drivers behind the movement of hedge funds toward ESG include: - Answer-
regulation, risk management, client demand, and the search for new alpha sources
Investments in PRIs qualify for tax advantages in the U.S., and nonprofit or charitable
entities can make tax-free distributions from PRIs. PRIs offer ESG impact but provide
below-average or no risk-adjusted returns. - Answer-On the other hand, MRIs offer both
competitive risk-adjusted returns and an ESG impact
There are 10 ESG metrics commonly requested by private equity investors: - Answer-1)
existence of an ESG policy, 2) person/group tasked with implementing ESG policy, 3)
existence of a corporate code of ethics, 4) existence of any litigation, 5) people diversity,
6) employee composition, 7) environmental policy, 8) CO2 footprint, 9) data and
cybersecurity incidents, and 10) health and safety incidents
The competitive advantage enjoyed by firms with an ESG strategy include higher-risk-
adjusted returns and reduced reputation risk. - Answer-About 65% of institutional
investors report that most of their investment managers do not consider ESG when
making investment decisions. Currently, there is an insufficient amount of guidance
available regarding the determination, and implementation of ESG strategies lacks
clarity. Very few alternative asset managers have the skills and knowledge to determine
their sources of ESG data and how to collect and assess that data.
Polluted water cannot be reused without being properly treated first. - Answer-
Remediation involves restoration of water by reversing or stopping any environmental
damage (e.g., pollution).
Common issues with risk parity are that historic returns may not provide reasonable
basis for future performance of low-volatility strategies; - Answer-absence of leverage
reduces the ability to adopt low-volatility strategies; and there are no studies that
support low-volatility strategies being extended to alternative asset classes
Risk budgeting is a process that limits allocation options without calculating portfolio
optimization. - Answer-It defines a set level of risk and allocates aggregate risk across
available subcategories
, Resampling returns can be executed by. - Answer-(1) repeated analysis of hypothetical
returns simulated from the original sample or (2) repeated analysis of new samples
drawn from the original sample
Empirical models do not directly evaluate the entity or its surroundings given the
difficulty in forecasting risk factors. Instead, empirical models produce a credit score that
is used to rank entities by creditworthiness. The Merton model does not produce a
credit score but instead is a structural model that prices capital structures with options -
Answer-Reduced-form models do not produce a credit score but instead focus on
default as a random event that can be quantified using economic and statistical models.
Structural credit risk models do not produce a credit score but instead focus on the
relationship between capital structure and default from the perspective of the equity
owner
Risk parity focuses on balancing the risk contributions of constituent assets rather than
setting a target for aggregate risk. - Answer-It seeks to equalize marginal risk and
factors correlation in defining portfolio weights
The Basic Model or Abstract Model aims to solve hypothetical challenges set in the
future. - Answer-This model seeks to explain any resulting behavior attributable to
specific hypothetical real-world scenarios. These are scenarios that are not currently
prevailing but that may occur in the future
Modern Portfolio Theory involves creating an asset portfolio by - Answer-combining a
riskless asset with the market portfolio to help enhance diversification benefits
Private investment funds are exempt from registration with the Securities and Exchange
Commission in the U.S. if they meet two exemptions: - Answer-the fund must have 100
beneficial owners or less, and the fund must be offered only to qualified purchasers.
Exempt funds cannot make public offerings. Qualified purchasers are individuals with $5
million or more in investments, institutional investors with $25 million or more in
investments, and entities where each beneficial owner is a qualified purchaser
The SASB Materiality Map segments ESG issues across both the - Answer-(1) ESG
category and (2) industry category. There are 5 ESG categories and 25 ESG
subcategories, and 10 industry categories, and around 75 subcategories
The PRI includes six aspirational principles, and the adoption of the PRI is voluntary. -
Answer-It is true that the PRI is designed as a global standard for responsible investing,
and incorporates ESG issues into investment analysis and decision-making
ESG materiality can be defined as the probability of occurrence of a material ESG event
multiplied by its expected loss. - Answer-In other words, the materiality of a given ESG
factor is based on the likelihood of its impact and the severity of the impact
COMPLETE ANSWERS
Meta risks are qualitative risks not captured by specific and measurable financial risks.
events. - Answer-They include organizational and human behavior, moral hazard, the
misuse and excessive dependence on quantitative methods, market interaction, and
extreme capital market
A distressed securities strategy is most likely to earn returns from liquidity risk. -
Answer-Global macro and equity long/short are most likely to earn returns from
directional market risks.
Investor protection clauses are clauses within limited partnership agreement and
include - Answer-investment strategy, the investment committee, the LP advisory
committee, key-person terms, exclusivity, conflicts of interest, and termination
Issues facing negatively skewed assets can be addressed by - Answer-(1) changing the
optimization process to account for skewness and kurtosis; (2) adding constraints for
skewness and kurtosis; and (3) limiting the portfolio weights applicable to assets with
higher moments
The AMC requires that managers should provide at least quarterly performance
reporting to clients—and within. - Answer-30 days of the end of the period, if possible.
This should be done even for funds with lockup periods
AIFs are suitable for larger investors with significant funds to invest. AIFs have few
restrictions and can invest in a range of securities, including less liquid alternative
investments such as hedge funds, private equity, and real estate. SIFs are specialized
funds specifically aimed at qualified investors in Luxembourg. - Answer-UCITS funds
are suitable for smaller investors and typically invest in more liquid and safer
investments that are publicly traded. CISs encompass both UCITS funds and AIFs
Negative (or exclusionary) screening is an investment approach that avoids including -
Answer-in investment portfolios the equity or bond securities issued by entities with low
environmental, social, and governance (ESG) scores or weak ESG performance
Natural resource investments should adopt techniques to reduce the negative impact on
biodiversity. That would include achieving sufficient diversity of flora and fauna. -
Answer-Together with farming and timbering, mining can cause significant disruption
and degradation of soil conditions. ESG issues are quite similar between indirect and
direct investments in natural resources. Studies on protecting endangered species
should be taken before the development process to minimize any negative
environmental impacts
,From 2016 to 2018, ESG assets under management in alternative investments
increased nearly - Answer-threefold from $206 billion to $588 billion
Buildings to be significantly refurbished essentially face the same issues as buildings
that are being newly developed (e.g., quality of planning, design, and construction). -
Answer-Preparing demolition materials should ideally be done on site. Materials that are
safe to use may release toxic gases, so they are not always safely placed in landfills. A
predemolition audit is primarily designed to minimize the amount of landfill waste and to
promote safe handling of dangerous materials
Key drivers behind the movement of hedge funds toward ESG include: - Answer-
regulation, risk management, client demand, and the search for new alpha sources
Investments in PRIs qualify for tax advantages in the U.S., and nonprofit or charitable
entities can make tax-free distributions from PRIs. PRIs offer ESG impact but provide
below-average or no risk-adjusted returns. - Answer-On the other hand, MRIs offer both
competitive risk-adjusted returns and an ESG impact
There are 10 ESG metrics commonly requested by private equity investors: - Answer-1)
existence of an ESG policy, 2) person/group tasked with implementing ESG policy, 3)
existence of a corporate code of ethics, 4) existence of any litigation, 5) people diversity,
6) employee composition, 7) environmental policy, 8) CO2 footprint, 9) data and
cybersecurity incidents, and 10) health and safety incidents
The competitive advantage enjoyed by firms with an ESG strategy include higher-risk-
adjusted returns and reduced reputation risk. - Answer-About 65% of institutional
investors report that most of their investment managers do not consider ESG when
making investment decisions. Currently, there is an insufficient amount of guidance
available regarding the determination, and implementation of ESG strategies lacks
clarity. Very few alternative asset managers have the skills and knowledge to determine
their sources of ESG data and how to collect and assess that data.
Polluted water cannot be reused without being properly treated first. - Answer-
Remediation involves restoration of water by reversing or stopping any environmental
damage (e.g., pollution).
Common issues with risk parity are that historic returns may not provide reasonable
basis for future performance of low-volatility strategies; - Answer-absence of leverage
reduces the ability to adopt low-volatility strategies; and there are no studies that
support low-volatility strategies being extended to alternative asset classes
Risk budgeting is a process that limits allocation options without calculating portfolio
optimization. - Answer-It defines a set level of risk and allocates aggregate risk across
available subcategories
, Resampling returns can be executed by. - Answer-(1) repeated analysis of hypothetical
returns simulated from the original sample or (2) repeated analysis of new samples
drawn from the original sample
Empirical models do not directly evaluate the entity or its surroundings given the
difficulty in forecasting risk factors. Instead, empirical models produce a credit score that
is used to rank entities by creditworthiness. The Merton model does not produce a
credit score but instead is a structural model that prices capital structures with options -
Answer-Reduced-form models do not produce a credit score but instead focus on
default as a random event that can be quantified using economic and statistical models.
Structural credit risk models do not produce a credit score but instead focus on the
relationship between capital structure and default from the perspective of the equity
owner
Risk parity focuses on balancing the risk contributions of constituent assets rather than
setting a target for aggregate risk. - Answer-It seeks to equalize marginal risk and
factors correlation in defining portfolio weights
The Basic Model or Abstract Model aims to solve hypothetical challenges set in the
future. - Answer-This model seeks to explain any resulting behavior attributable to
specific hypothetical real-world scenarios. These are scenarios that are not currently
prevailing but that may occur in the future
Modern Portfolio Theory involves creating an asset portfolio by - Answer-combining a
riskless asset with the market portfolio to help enhance diversification benefits
Private investment funds are exempt from registration with the Securities and Exchange
Commission in the U.S. if they meet two exemptions: - Answer-the fund must have 100
beneficial owners or less, and the fund must be offered only to qualified purchasers.
Exempt funds cannot make public offerings. Qualified purchasers are individuals with $5
million or more in investments, institutional investors with $25 million or more in
investments, and entities where each beneficial owner is a qualified purchaser
The SASB Materiality Map segments ESG issues across both the - Answer-(1) ESG
category and (2) industry category. There are 5 ESG categories and 25 ESG
subcategories, and 10 industry categories, and around 75 subcategories
The PRI includes six aspirational principles, and the adoption of the PRI is voluntary. -
Answer-It is true that the PRI is designed as a global standard for responsible investing,
and incorporates ESG issues into investment analysis and decision-making
ESG materiality can be defined as the probability of occurrence of a material ESG event
multiplied by its expected loss. - Answer-In other words, the materiality of a given ESG
factor is based on the likelihood of its impact and the severity of the impact
