CAIA LEVEL 1 EXAMINATION TEST 2025/2026 QUESTIONS
WITH ANSWERS TAGGED A+
✔✔Bootstrap the term structure of interest rates - ✔✔recursively estimate spot rates
using zero-coupon and coupon bonds
✔✔Term structure of interest rate theories - ✔✔unbiased expectations theory, liquidity
preference theory, and market segmentation theory
✔✔Implied forward rate - ✔✔interest rate differential implied by current term structures
of interest rates between two dates
✔✔Arbitrage-free models - ✔✔calculate asset prices by assuming that no arbitrage
opportunities exist
✔✔Binomial trees - ✔✔represent possible outcomes in a variable and can be used to
price outcomes in equities, interest rates, and derivatives
✔✔Duration - ✔✔a measure of a bond's price elasticity relative to changes in its yield
✔✔Structural credit models - ✔✔value debt securities by incorporating factors including
the corporate structure (e.g. debt-to-asset ratio) and the volatility of the firm's assets
✔✔Reduced-form credit models - ✔✔use market prices for liquid securities to infer the
implied default probability. Once calibrated, reduced-form models can be used to price
illiquid securities
✔✔Expected credit loss - ✔✔PD x EAD x LGD = PD x EAD x (1 - RR) where PD =
probability of default, EAD = exposure at default, LGD = loss given default, RR =
recovery rate
✔✔Advantages of reduced-form models - ✔✔ability to extract information from market
prices and flexibility
✔✔Disadvantages of reduced-form models - ✔✔potential lack of adequate market data
needed to calibrate the model, sensitivity to key assumptions, limited historical default
rates, and no guarantee that historical default rates represent future default rates
✔✔Approximate probability of bond default - ✔✔credit spread/1 - RR
✔✔Ex ante asset pricing models - ✔✔describe expected future returns
✔✔Ex post asset pricing models - ✔✔describe historical returns
,✔✔Simple linear regression - ✔✔statistical method that estimates a linear relationship
between a dependent variable and a single independent variable
✔✔Ordinary least squares - ✔✔method used to generate accurate estimates of
regression residuals. This relationship might encounter some data integrity challenges
in the presence of leptokurtosis, autocorrelation, or heteroskedasticity
✔✔Null hypothesis - ✔✔statement that the analyst attempts to reject. The null
hypothesis is examined using a test statistic such as the t-statistic
✔✔Alternative hypothesis - ✔✔represents the behavior that exists if the null hypothesis
is false
✔✔P-value - ✔✔equals the probability of observing a sample estimate as extreme as
the one observed, assuming the null hypothesis is true. It does not indicate the strength
of a relationship
✔✔Significance level - ✔✔denotes the probability that a significant result may be due to
random chance
✔✔Confidence level - ✔✔equals 100% - the significance level
✔✔Type I error - ✔✔occurs when a true null hypothesis is rejected
✔✔Type II error - ✔✔occurs when an untrue null hypothesis is not rejected
✔✔Selection bias - ✔✔refers to exclusion of certain observations from sample, causing
distortions in relevant characteristics of the population
✔✔Survivorship bias - ✔✔a type of selection bias that occurs when funds or companies
no longer in existence are excluded from sample
✔✔Self-selection bias - ✔✔fund managers decide to report or not to report
performance. As a result, affected databases likely exhibit an upward bias
✔✔Data mining - ✔✔vigorously testing data until valid relationships are found
✔✔Data dredging - ✔✔practice of overusing statistical tests to identify significant
relationships with little regard for underlying economic rationale
✔✔Forward contract - ✔✔bilateral contract that obligates one party to buy and one
party to sell specific quantity of asset, at set price, on specific date
✔✔Futures contract - ✔✔forward contract that is standardized and exchange traded
, ✔✔Forward rate agreement (FRA) - ✔✔contract settled in cash where one side of
transaction offers specific, fixed rate (FRA rate) over period of time and other side
agrees to pay that rate
✔✔Cost of carry - ✔✔financial difference between forward market position and cash
market position
✔✔Rolling contracts - ✔✔closing one contract near settlement and opening another
position on same underlying asset with longer settlement time
✔✔Put-call parity - ✔✔call + risk-free bond - put = underlying asset
✔✔Option spreads - ✔✔1) calls or puts 2) both long and short positions on the
underlying asset (e.g., bull spread)
✔✔Option combinations - ✔✔calls and puts on the underlying strategy (e.g., straddle)
✔✔Delta - ✔✔first derivative of option sensitivity to underlying asset price
✔✔Gamma - ✔✔second derivative of option price sensitivity to underlying asset price
✔✔Vega - ✔✔option price sensitivity to changes in volatility of underlying asset
✔✔Theta - ✔✔option price decline relative to passage of time
✔✔Rho - ✔✔option price sensitivity to changes in riskless interest rate
✔✔Conditional VaR (CVaR) - ✔✔expected loss given that the portfolio return already
lies below the prespecified worst-case quantile return
✔✔Monte Carlo VaR - ✔✔involves developing a model that simulates risk factor values
and estimates how changes in risk factors affect the fund's returns
✔✔Historical VaR - ✔✔data are simulated from realized historical returns
✔✔Index benchmarking - ✔✔used to isolate variables including asset allocation,
security selection, and market timing
✔✔Sharpe ratio - ✔✔appropriate if the portfolio is the investor's total stand-alone
portfolio
✔✔Treynor ratio - ✔✔appropriate when comparing components of a well-diversified
portfolio
WITH ANSWERS TAGGED A+
✔✔Bootstrap the term structure of interest rates - ✔✔recursively estimate spot rates
using zero-coupon and coupon bonds
✔✔Term structure of interest rate theories - ✔✔unbiased expectations theory, liquidity
preference theory, and market segmentation theory
✔✔Implied forward rate - ✔✔interest rate differential implied by current term structures
of interest rates between two dates
✔✔Arbitrage-free models - ✔✔calculate asset prices by assuming that no arbitrage
opportunities exist
✔✔Binomial trees - ✔✔represent possible outcomes in a variable and can be used to
price outcomes in equities, interest rates, and derivatives
✔✔Duration - ✔✔a measure of a bond's price elasticity relative to changes in its yield
✔✔Structural credit models - ✔✔value debt securities by incorporating factors including
the corporate structure (e.g. debt-to-asset ratio) and the volatility of the firm's assets
✔✔Reduced-form credit models - ✔✔use market prices for liquid securities to infer the
implied default probability. Once calibrated, reduced-form models can be used to price
illiquid securities
✔✔Expected credit loss - ✔✔PD x EAD x LGD = PD x EAD x (1 - RR) where PD =
probability of default, EAD = exposure at default, LGD = loss given default, RR =
recovery rate
✔✔Advantages of reduced-form models - ✔✔ability to extract information from market
prices and flexibility
✔✔Disadvantages of reduced-form models - ✔✔potential lack of adequate market data
needed to calibrate the model, sensitivity to key assumptions, limited historical default
rates, and no guarantee that historical default rates represent future default rates
✔✔Approximate probability of bond default - ✔✔credit spread/1 - RR
✔✔Ex ante asset pricing models - ✔✔describe expected future returns
✔✔Ex post asset pricing models - ✔✔describe historical returns
,✔✔Simple linear regression - ✔✔statistical method that estimates a linear relationship
between a dependent variable and a single independent variable
✔✔Ordinary least squares - ✔✔method used to generate accurate estimates of
regression residuals. This relationship might encounter some data integrity challenges
in the presence of leptokurtosis, autocorrelation, or heteroskedasticity
✔✔Null hypothesis - ✔✔statement that the analyst attempts to reject. The null
hypothesis is examined using a test statistic such as the t-statistic
✔✔Alternative hypothesis - ✔✔represents the behavior that exists if the null hypothesis
is false
✔✔P-value - ✔✔equals the probability of observing a sample estimate as extreme as
the one observed, assuming the null hypothesis is true. It does not indicate the strength
of a relationship
✔✔Significance level - ✔✔denotes the probability that a significant result may be due to
random chance
✔✔Confidence level - ✔✔equals 100% - the significance level
✔✔Type I error - ✔✔occurs when a true null hypothesis is rejected
✔✔Type II error - ✔✔occurs when an untrue null hypothesis is not rejected
✔✔Selection bias - ✔✔refers to exclusion of certain observations from sample, causing
distortions in relevant characteristics of the population
✔✔Survivorship bias - ✔✔a type of selection bias that occurs when funds or companies
no longer in existence are excluded from sample
✔✔Self-selection bias - ✔✔fund managers decide to report or not to report
performance. As a result, affected databases likely exhibit an upward bias
✔✔Data mining - ✔✔vigorously testing data until valid relationships are found
✔✔Data dredging - ✔✔practice of overusing statistical tests to identify significant
relationships with little regard for underlying economic rationale
✔✔Forward contract - ✔✔bilateral contract that obligates one party to buy and one
party to sell specific quantity of asset, at set price, on specific date
✔✔Futures contract - ✔✔forward contract that is standardized and exchange traded
, ✔✔Forward rate agreement (FRA) - ✔✔contract settled in cash where one side of
transaction offers specific, fixed rate (FRA rate) over period of time and other side
agrees to pay that rate
✔✔Cost of carry - ✔✔financial difference between forward market position and cash
market position
✔✔Rolling contracts - ✔✔closing one contract near settlement and opening another
position on same underlying asset with longer settlement time
✔✔Put-call parity - ✔✔call + risk-free bond - put = underlying asset
✔✔Option spreads - ✔✔1) calls or puts 2) both long and short positions on the
underlying asset (e.g., bull spread)
✔✔Option combinations - ✔✔calls and puts on the underlying strategy (e.g., straddle)
✔✔Delta - ✔✔first derivative of option sensitivity to underlying asset price
✔✔Gamma - ✔✔second derivative of option price sensitivity to underlying asset price
✔✔Vega - ✔✔option price sensitivity to changes in volatility of underlying asset
✔✔Theta - ✔✔option price decline relative to passage of time
✔✔Rho - ✔✔option price sensitivity to changes in riskless interest rate
✔✔Conditional VaR (CVaR) - ✔✔expected loss given that the portfolio return already
lies below the prespecified worst-case quantile return
✔✔Monte Carlo VaR - ✔✔involves developing a model that simulates risk factor values
and estimates how changes in risk factors affect the fund's returns
✔✔Historical VaR - ✔✔data are simulated from realized historical returns
✔✔Index benchmarking - ✔✔used to isolate variables including asset allocation,
security selection, and market timing
✔✔Sharpe ratio - ✔✔appropriate if the portfolio is the investor's total stand-alone
portfolio
✔✔Treynor ratio - ✔✔appropriate when comparing components of a well-diversified
portfolio
