CAIA Level II Exam I Questions With Correct Answers

Collar strategy consists of... - Answer ownership of a risky asset with a long position in a put option on the underlying asset, and a short position in the call option on the underlying asset Hedging Bucket - Answer within a plan's asset-liability framework seeks to track the plan's liabilities and minimize the volatility of the plan surplus Overlay approach - Answer relies on derivatives contracts to create hedges growth bucket - Answer invests the surplus in riskier investments to generate greater return Duration matching approach - Answer is a hedging bucket approach that matches the duration of the plan assets with the plan's liabilities. Factors that lead to currency appreciation in one country relative to others: - Answer Low inflation High real interest rates Policies attracting capital flows Slow income growth (less demand for imports) Comparative advantage in export goods production Funded status of a pension plan - Answer calculated as market value of assets minus projected benefit obligation Risk Parity Approach to asset allocation - Answer Allocates the weights of asset classes of a portfolio so each asset class contributes the SAME percentage of risk to the portfolio. Consequently, over-weights LESS risky assets. Security Selection... - Answer Asset class return relative to a benchmark Strategic asset allocation... - Answer Calculated as the long-term asset allocation weights multiplied by the benchmark returns for each asset class Market Timing AKA Tactical Asset Allocation - Answer Earning excess returns by changing the asset class weights from target asset class weights Performance during a crisis - Answer Macro funds = good Managed futures = good Government bonds = good Hedge Fund Arbitrage = bad Four core factors that affect the risk of plan liabilities - Answer 1. interest rate levels and direction 2. inflation (both realized and expected) 3. the retirement cycle 4. mortality risk Three approaches to risk measurement for defined benefit plan - Answer 1. Asset-focused risk management 2. Asset-liability risk management 3. Integrated asset-liability risk management Asset-focused risk management - Answer Considers only the risk of plan assets Asset-liability risk management - Answer focuses on the surplus of plan assets over liabilities (most important high-level risk is the risk aka volatility of the surplus) Integrated asset-liability risk management - Answer integrates management of the surplus with the operations of the plan sponsor An asset with HIGH volatility and POSITIVE correlation with plan liabilities... - Answer can still be considered to have low risk under asset-liability framework Duration matching - Answer In DB plans tries to match assets and liabilities based upon duration (effective maturity)... addresses interest rate risk.. uses different fixed income instruments (not derivatives) Cash Flow matching - Answer In DB plans tries to match the timing of actual cash flows... relies heavily upon bond ladders (portfolio of fixed income where each bond has a different maturity date) Current Account - Answer measures trade in goods and services for a country Reserve Account - Answer records transactions in foreign currencies affected by inflows and outflows from international trade and investment Persistent trade deficits result in... - Answer trading capital and financial assets for the goods and services of another country Commodity exports' affect on reserve account - Answer because commodity prices can be highly volatile, countries with commodity-dependent economies have established STABILIZATION funds to smooth the impact of commodity prices Change in Reserve Account = .... - Answer Change in current account + change in capital account Current account surplus - Answer a country exports more than it imports Capital account - Answer measures cross-border investment, such as loans or purchases and sales of assets. Net inflows = capital account surplus A country's balance of payments accounts - Answer 1. current account 2. capital account 3. reserve account Four types of Sovereign Wealth Funds - Answer 1. Stabilization funds = smooth volatility (invests significantly in fixed income) 2. Savings funds = benefit future generations 3. Reserve funds = meet specific future liabilities 4. Development funds = promote economic diversity in the economy Futures contract tax treatment (section 1256) - Answer Favorable! 60% taxed as long-term gain 40% taxed as short-term gain Free port storage service - Answer Can be used for lifestyle assets (e.g. artwork) Benefits: 1. Provides security for artwork while owned 2. Provides storage solution while artwork is owned 3. DELAYS TAXATION of the purchased artwork until physical delivery is taken