CAIA EXAM QUESTIONS AND
ANSWERS
Over the past several weeks, an advisor mailed various newsletters with different
predictions to millions of readers. Which of the following terms best represents the
advisor's actions? - Answer-Chumming
Chumming is the fishing term used to describe the process of luring big fish by
scattering pieces of cheap fish as bait. In the world of finance, an unscrupulous advisor
chums when scattering investment advice, luring unsuspecting investors.
An analyst examines the following data for a private equity fund:
Mean return 10%
Standard deviation 20%
Beta 2
Risk-free rate 5%
Target return 8%
Target semi-standard deviation 40%
Benchmark mean return 9%
Tracking error 25%
The information ratio and the Sortino ratio for the private equity fund are closest to: -
Answer-4% and 5%, respectively.
The information ratio equals the portfolio's excess return (defined as the difference
between the mean returns for the portfolio and the benchmark) divided by the portfolio's
tracking error.
(.10 -.09)/.25 = .04
The Sortino ratio equals the portfolio excess return (defined as the difference between
the mean return for the portfolio and the target return) divided by the target semi-
standard deviation (a downside risk measure):
(.10-.08) / .40 = .05
An analyst derives a quarterly return series X, based on discrete compounding, and
another quarterly return series Y, based on continuous compounding. Assuming
monthly returns are normally distributed, which of the following statements best
describes the properties of the two series? - Answer-Return series X will not be
normally distributed and return series Y will be normally distributed.
, An advantage of continuous compounding is that continuously compounded returns
follow a normal distribution. In contrast, using discrete compounding, simple returns do
not follow a normal distribution
In hypothesis testing, the component that usually is designed to be rejected is the: -
Answer-null hypothesis.
In hypothesis testing, the null hypothesis is usually designed to be rejected.
An asset earned 20% last year. Its beta equals 1.30. The risk-free rate was 2% and the
market return was 16%. Using the ex post CAPM, the asset's idiosyncratic return for the
last year was closest to: - Answer-−0.2%
Using the ex post CAPM, the required return for the asset last year was:
Rf,t + β(Rm,t - Rf,t) = 0.02 + 1.30(0.16 - 0.02) = 0.2020 = 20.2%
The idiosyncratic return equals:
εt = Rt - [Rf,t + β (Rm,t - Rf,t)] = 0.20 - 0.2020 = -0.2 = -0.2%
The beta of a fund equals 2. Last year, the broad market return was 12%. The risk-free
rate is 4%. The return on the fund equaled 18% last year. In the context of the single
factor market model, the ex post alpha for the fund equals: - Answer-−2%.
ex post alpha = RFund,t − [Rf + βFund(Rmt−Rf)]
ex post alpha = 0.18 − [0.04 + 2(0.12 − 0.04)] = −0.02 = −2%
A security's returns exhibit negative skew. Which of the following is most likely correct
regarding the security's distribution? - Answer-A security's returns exhibit negative
skew. Which of the following is most likely correct regarding the security's distribution?
Passive indexing is best described as: - Answer-pure play on beta
A pure play on beta refers to passive investing such as a buy-and-hold strategy to
replicate a benchmark index. Return
The risk of moral hazard may occur when: - Answer-a bank sells its mortgages to a third
party and subsequently no longer closely monitors the risk of the loans.
Moral hazard describes a scenario where one party takes actions that disadvantage
another party. When a bank has less incentive to closely monitor mortgages sold to a
third party, credit and other risks may rise on the mortgages. When managers possess
superior information about firm performance, and when alternative investments contain
a complexity premium (to compensate an investor's time and expertise in analyzing it),
these are examples of information asymmetries. When an investor cannot earn profit
due to high costs and fees, this is an example of incomplete markets.
ANSWERS
Over the past several weeks, an advisor mailed various newsletters with different
predictions to millions of readers. Which of the following terms best represents the
advisor's actions? - Answer-Chumming
Chumming is the fishing term used to describe the process of luring big fish by
scattering pieces of cheap fish as bait. In the world of finance, an unscrupulous advisor
chums when scattering investment advice, luring unsuspecting investors.
An analyst examines the following data for a private equity fund:
Mean return 10%
Standard deviation 20%
Beta 2
Risk-free rate 5%
Target return 8%
Target semi-standard deviation 40%
Benchmark mean return 9%
Tracking error 25%
The information ratio and the Sortino ratio for the private equity fund are closest to: -
Answer-4% and 5%, respectively.
The information ratio equals the portfolio's excess return (defined as the difference
between the mean returns for the portfolio and the benchmark) divided by the portfolio's
tracking error.
(.10 -.09)/.25 = .04
The Sortino ratio equals the portfolio excess return (defined as the difference between
the mean return for the portfolio and the target return) divided by the target semi-
standard deviation (a downside risk measure):
(.10-.08) / .40 = .05
An analyst derives a quarterly return series X, based on discrete compounding, and
another quarterly return series Y, based on continuous compounding. Assuming
monthly returns are normally distributed, which of the following statements best
describes the properties of the two series? - Answer-Return series X will not be
normally distributed and return series Y will be normally distributed.
, An advantage of continuous compounding is that continuously compounded returns
follow a normal distribution. In contrast, using discrete compounding, simple returns do
not follow a normal distribution
In hypothesis testing, the component that usually is designed to be rejected is the: -
Answer-null hypothesis.
In hypothesis testing, the null hypothesis is usually designed to be rejected.
An asset earned 20% last year. Its beta equals 1.30. The risk-free rate was 2% and the
market return was 16%. Using the ex post CAPM, the asset's idiosyncratic return for the
last year was closest to: - Answer-−0.2%
Using the ex post CAPM, the required return for the asset last year was:
Rf,t + β(Rm,t - Rf,t) = 0.02 + 1.30(0.16 - 0.02) = 0.2020 = 20.2%
The idiosyncratic return equals:
εt = Rt - [Rf,t + β (Rm,t - Rf,t)] = 0.20 - 0.2020 = -0.2 = -0.2%
The beta of a fund equals 2. Last year, the broad market return was 12%. The risk-free
rate is 4%. The return on the fund equaled 18% last year. In the context of the single
factor market model, the ex post alpha for the fund equals: - Answer-−2%.
ex post alpha = RFund,t − [Rf + βFund(Rmt−Rf)]
ex post alpha = 0.18 − [0.04 + 2(0.12 − 0.04)] = −0.02 = −2%
A security's returns exhibit negative skew. Which of the following is most likely correct
regarding the security's distribution? - Answer-A security's returns exhibit negative
skew. Which of the following is most likely correct regarding the security's distribution?
Passive indexing is best described as: - Answer-pure play on beta
A pure play on beta refers to passive investing such as a buy-and-hold strategy to
replicate a benchmark index. Return
The risk of moral hazard may occur when: - Answer-a bank sells its mortgages to a third
party and subsequently no longer closely monitors the risk of the loans.
Moral hazard describes a scenario where one party takes actions that disadvantage
another party. When a bank has less incentive to closely monitor mortgages sold to a
third party, credit and other risks may rise on the mortgages. When managers possess
superior information about firm performance, and when alternative investments contain
a complexity premium (to compensate an investor's time and expertise in analyzing it),
these are examples of information asymmetries. When an investor cannot earn profit
due to high costs and fees, this is an example of incomplete markets.
