FINANCIAL MODELING ACTUAL EXAM SCRIPT 2025/2026
QUESTIONS WITH ANSWERS GRADED A+
✔✔The capital market line (CML) - ✔✔When there is a risk free asset, the (CML) is the
straight line that connects the risk free asset with the tangency portfolio (P*) with the
global minimum variance portfolio (GMVP). To find P* we use the Sharpe Ratio
✔✔Sharp Ratio - ✔✔Used to find tangency portfolio (P*).
=(expected return-risk free rate)/sqrt(variance of portfolio).
You can then use solver to maximize sharp.
To eliminate short selling with a risk free asset, add the constraint where non of the
weights of the portfolio can be less than zero
To eliminate short selling with no risk free asset, use solver to minimize the standard
deviation subject to the short selling constraint for every expected return
✔✔passive portfolio management - ✔✔used when markets are efficient so the
percentage of a company is in a market is used as your portfolio weights
✔✔active portfolio management - ✔✔when it is believed that markets aren't perfectly
efficient all of the time and securities aren't priced correctly. So what ever stocks that
are believed to not be correctly priced will be shown in your portfolio
✔✔types of passive portfolio management - ✔✔1) full replication- investing in all of the
stocks in the benchmark example: exchange traded fund (ETF)
2) Sampling- investing in a representative selection of stocks in the benchmark
3) Quadratic programming- investing in a portfolio whose composition is designed to
track the benchmark as closely as possible i.e. minimize the tracking error of the
portfolio
✔✔ways identifying of mispriced stocks - ✔✔1) fundamental analysis- such as cash flow
valuation and screening on the basis of ratios
2) technical analysis- such as chartism and the use of moving average trading rules
✔✔Major problem in portfolio management - ✔✔the use of mean-variance optimization
can lead to estimation of optimal portfolio with extreme weights this is because we are
using the historical value instead of the prices that actually happen. You obviously can't
gather future price values
✔✔Black-Litterman model composed in two steps - ✔✔1) Establish what the market
thinks about expected returns
2) Incorporate investor opinions about expected returns
, ✔✔find market cap weights - ✔✔Take market cap of individual from yahoo finance and
divide it by the total market cap
(do this for each item in portfolio for market cap portfolio weights)
✔✔incorporating a single view - ✔✔have dumby cell of each asset in the portfolio and
add what percent more you think the asset will out/under perform the market. Then copy
the VCR matrix and take every cell and divide it by the cell that lines up with the same
company
✔✔The black-litterman model: Incorporating a single view - ✔✔This is interpreted as the
benchmark portfolio or a passive portfolio that reflects the manager's view
✔✔risk-adjusted performance - ✔✔CAPM is a good way to measure this
✔✔The single factor model (SFM) - ✔✔specified in terms of excess returns over the risk
free rate which is necessary if the risk free rate varies over time. This intercept is known
as the Alpha. Under the CAPM version it should be equal to zero.
✔✔Measurement error in Beta - ✔✔There is a measuring error in Beta because we
have estimated it using historical data. We know that estimates of Beta that are greater
than one are likely too high and estimates of Beta that are lower than one are too low.
✔✔To find Adjusted Beta - ✔✔You should look into yahoo finance and Bloomberg to
see how they adjusted their Beta
✔✔Equation of variance of an individual asset under the single index model - ✔✔The
second component on the right hand side represents the diversifiable component of the
asset's total risk which means it is uncorrelated with the market return.
The first component on the right hand side represents the non-diversifiable component
of the asset's total risk so that it is perfectly correlated with the market
✔✔Diversified vs non-diversified - ✔✔Well diversified investor is interested in non-
diversifiable risk while an undiversified investor is interested in total risk
✔✔Treynor's measure of risk - ✔✔excess return of a portfolio over the risk free rate
divided by the systematic risk of the portfolio
=(company average return-risk free rate)/company adjusted beta
✔✔Jensen's Alpha - ✔✔excess return of a portfolio over the expected return given the
portfolio's systematic risk
=(adjusted Alpha-risk free rate)8(1-adjusted beta)
QUESTIONS WITH ANSWERS GRADED A+
✔✔The capital market line (CML) - ✔✔When there is a risk free asset, the (CML) is the
straight line that connects the risk free asset with the tangency portfolio (P*) with the
global minimum variance portfolio (GMVP). To find P* we use the Sharpe Ratio
✔✔Sharp Ratio - ✔✔Used to find tangency portfolio (P*).
=(expected return-risk free rate)/sqrt(variance of portfolio).
You can then use solver to maximize sharp.
To eliminate short selling with a risk free asset, add the constraint where non of the
weights of the portfolio can be less than zero
To eliminate short selling with no risk free asset, use solver to minimize the standard
deviation subject to the short selling constraint for every expected return
✔✔passive portfolio management - ✔✔used when markets are efficient so the
percentage of a company is in a market is used as your portfolio weights
✔✔active portfolio management - ✔✔when it is believed that markets aren't perfectly
efficient all of the time and securities aren't priced correctly. So what ever stocks that
are believed to not be correctly priced will be shown in your portfolio
✔✔types of passive portfolio management - ✔✔1) full replication- investing in all of the
stocks in the benchmark example: exchange traded fund (ETF)
2) Sampling- investing in a representative selection of stocks in the benchmark
3) Quadratic programming- investing in a portfolio whose composition is designed to
track the benchmark as closely as possible i.e. minimize the tracking error of the
portfolio
✔✔ways identifying of mispriced stocks - ✔✔1) fundamental analysis- such as cash flow
valuation and screening on the basis of ratios
2) technical analysis- such as chartism and the use of moving average trading rules
✔✔Major problem in portfolio management - ✔✔the use of mean-variance optimization
can lead to estimation of optimal portfolio with extreme weights this is because we are
using the historical value instead of the prices that actually happen. You obviously can't
gather future price values
✔✔Black-Litterman model composed in two steps - ✔✔1) Establish what the market
thinks about expected returns
2) Incorporate investor opinions about expected returns
, ✔✔find market cap weights - ✔✔Take market cap of individual from yahoo finance and
divide it by the total market cap
(do this for each item in portfolio for market cap portfolio weights)
✔✔incorporating a single view - ✔✔have dumby cell of each asset in the portfolio and
add what percent more you think the asset will out/under perform the market. Then copy
the VCR matrix and take every cell and divide it by the cell that lines up with the same
company
✔✔The black-litterman model: Incorporating a single view - ✔✔This is interpreted as the
benchmark portfolio or a passive portfolio that reflects the manager's view
✔✔risk-adjusted performance - ✔✔CAPM is a good way to measure this
✔✔The single factor model (SFM) - ✔✔specified in terms of excess returns over the risk
free rate which is necessary if the risk free rate varies over time. This intercept is known
as the Alpha. Under the CAPM version it should be equal to zero.
✔✔Measurement error in Beta - ✔✔There is a measuring error in Beta because we
have estimated it using historical data. We know that estimates of Beta that are greater
than one are likely too high and estimates of Beta that are lower than one are too low.
✔✔To find Adjusted Beta - ✔✔You should look into yahoo finance and Bloomberg to
see how they adjusted their Beta
✔✔Equation of variance of an individual asset under the single index model - ✔✔The
second component on the right hand side represents the diversifiable component of the
asset's total risk which means it is uncorrelated with the market return.
The first component on the right hand side represents the non-diversifiable component
of the asset's total risk so that it is perfectly correlated with the market
✔✔Diversified vs non-diversified - ✔✔Well diversified investor is interested in non-
diversifiable risk while an undiversified investor is interested in total risk
✔✔Treynor's measure of risk - ✔✔excess return of a portfolio over the risk free rate
divided by the systematic risk of the portfolio
=(company average return-risk free rate)/company adjusted beta
✔✔Jensen's Alpha - ✔✔excess return of a portfolio over the expected return given the
portfolio's systematic risk
=(adjusted Alpha-risk free rate)8(1-adjusted beta)
