CAIA LEVEL 1 QUESTIONS WITH
VERIFIED ANSWERS
Value of IP Investment - Answer-probability of generating large positive cash flows*
cash flow expected in year 1 / investors required rate of return -g
Operational Risk - Answer-In breaking down the impact of operational risks on hedge
fund failures, fraud (i.e., lying about investments and/or performance) was the leading
cause, followed by (in order): theft of assets, style drift and unauthorized trades, and
inadequate resources.
fee for taking a firm private - Answer-typically 1%
cds/trs - Answer-A credit default swap (CDS) makes a payment only if a credit event
occurs. In a total return swap (TRS), the swap buyer receives the total return of the
reference asset regardless of whether a credit event occurs.
The buyer of a TRS (i.e., the credit protection seller) receives the total return of a
reference asset in exchange for LIBOR + spread, and assumes all credit risk exposure
associated with the asset. The seller of the TRS (i.e., the credit protection buyer) retains
ownership, but since cash flows are passed to the buyer, the seller receives a net cash
flow of LIBOR + spread.
payment trigger events - Answer-Payment trigger events.
Bankruptcy.
Failure to pay.
Restructuring.
Obligation acceleration.
Obligation default (technical default).
Repudiation/moratorium by a sovereign government.
Government intervention.
A CDS contract may be unwound by: - Answer-Offsetting: Taking an opposite position
either in another CDS contract or in the underlying asset.
Assignment/Novation: Finding a dealer or other third party that will take over the
obligations of the contract.
Terminating: The original counterparties agree to discontinue the contract.
There are six major types of participants in the credit derivatives marke - Answer-Bank
trading activities.
Bank loan portfolio managers.
,Hedge funds.
Asset managers.
Insurance companies.
Corporations.
leptokurtic - Answer-Leptokurtic returns have higher probability of extreme outcomes
(e.g., a leptokurtic distribution is "fat tailed"). What may appear to be a skill event
according to the normal distribution, may be merely a high risk or lucky event when
applied to a leptokurtic distribution.
Permitted and Stated - Answer-The actual investment strategy is the strategy
implemented at a particular point in time. The permitted investment strategy defines the
range of actions that a manager may take. There is no such thing as a negotiated
investment strategy per se.
biggest risk to a employee buyout - Answer-Financing risk refers to the uncertainty
regarding the ability of the acquiring firm or entity to obtain funding needed to
consummate a merger and therefore is a greater concern in an employee buyout deal.
The Code and Standards recommends the following procedures to minimize the
probability of incidents in which Standard I(B) is violated: - Answer-Protect the integrity
of opinions
Create a restricted list
Restrict special cost arrangements
Limit gifts
Restrict investments
Review procedures
Establish an independence policy
Appoint an officer with oversight responsibilities for compliance with the firm's code of
ethics
absolute returns - Answer-comped against a zero return
Expanding into Europe for hedgefunds - Answer-Regulation of hedge funds in Europe
centers on the concept of Undertakings for Collective Investment in Transferable
Securities (UCITS). In effect, a UCITS is a hedge fund-like investment pool that
conforms to European regulations such that the product can be sold throughout the
various members of the EU. Because UCITS funds are intended for retail investors,
they are subject to very strict investment restrictions and diversification requirements.
continuous compounding - Answer-e^0.08 − 1 = 1.08329
, Jarque-Bera test - Answer-The Jarque-Bera test is a popular test for normality. The
critical value indicates the level of confidence for the Jarque-Bera test. If the test
statistic measured is greater than the critical value, the null hypothesis of normality is
rejected at the stated level of confidence.
Fama-French Model - Answer-the Fama-French-Carhart model does not reference
breadth as a factor. The factors referenced are the market, growth versus value, size,
and momentum.
point-to-point IRR - Answer-Point-to-point IRRs are used if the CF(0) and CF(T) are
both appraised values or other values during the lifetime of the investment (i.e, after
inception and before termination).
Treynor Ratio - Answer-Expected Return - Risk-Free Rate) / Beta = (8% - 2%) / 0.8 =
0.0750
Ex ante alpha - Answer-CAPM predicts 6% return for Fund A (expected excess return of
the market × beta of the fund + the risk-free rate). However, the analyst's prediction is
8%. Thus, ex ante alpha for Fund A is 2%
beta expansion - Answer-Beta expansion is typically observed during down market
cycles and is primarily attributed to higher correlation between the hedge fund's returns
and market returns.
Nullhypothesis alternative, p value, level of significance - Answer-null hyp is the
statemenet they are trying to reject, alternative is the one they assume to be true if null
is rejected, null is rejected when p value is less than level of significance,
significance value: reflects prob that will tolerate null being rejected when its true
p-value: probability of obtaining test statistic by chance , assuming null was true
data dreging - Answer-Data dredging, or data snooping, refers to the overuse and
misuse of statistical tests to identify historical patterns. The difference between data
dredging and data mining is that data dredging involves performing too many tests,
especially regarding historical relationships for which there are not a priori reasons for
believing that the relationships reflect true causality. The problem with data dredging is
not so much the number of tests performed as the failure to take the number of tests
performed into account when analyzing the results. The potential error in data dredging
is to place too much confidence in findings without regard to the number of tests that led
to the finding
An analyst is using a statistical technique that adds and deletes variables until an
optimal model is identified. What are the terms for the technique and the criterion this
analyst is using, respectively? - Answer-Stepwise regression; t-statistic
VERIFIED ANSWERS
Value of IP Investment - Answer-probability of generating large positive cash flows*
cash flow expected in year 1 / investors required rate of return -g
Operational Risk - Answer-In breaking down the impact of operational risks on hedge
fund failures, fraud (i.e., lying about investments and/or performance) was the leading
cause, followed by (in order): theft of assets, style drift and unauthorized trades, and
inadequate resources.
fee for taking a firm private - Answer-typically 1%
cds/trs - Answer-A credit default swap (CDS) makes a payment only if a credit event
occurs. In a total return swap (TRS), the swap buyer receives the total return of the
reference asset regardless of whether a credit event occurs.
The buyer of a TRS (i.e., the credit protection seller) receives the total return of a
reference asset in exchange for LIBOR + spread, and assumes all credit risk exposure
associated with the asset. The seller of the TRS (i.e., the credit protection buyer) retains
ownership, but since cash flows are passed to the buyer, the seller receives a net cash
flow of LIBOR + spread.
payment trigger events - Answer-Payment trigger events.
Bankruptcy.
Failure to pay.
Restructuring.
Obligation acceleration.
Obligation default (technical default).
Repudiation/moratorium by a sovereign government.
Government intervention.
A CDS contract may be unwound by: - Answer-Offsetting: Taking an opposite position
either in another CDS contract or in the underlying asset.
Assignment/Novation: Finding a dealer or other third party that will take over the
obligations of the contract.
Terminating: The original counterparties agree to discontinue the contract.
There are six major types of participants in the credit derivatives marke - Answer-Bank
trading activities.
Bank loan portfolio managers.
,Hedge funds.
Asset managers.
Insurance companies.
Corporations.
leptokurtic - Answer-Leptokurtic returns have higher probability of extreme outcomes
(e.g., a leptokurtic distribution is "fat tailed"). What may appear to be a skill event
according to the normal distribution, may be merely a high risk or lucky event when
applied to a leptokurtic distribution.
Permitted and Stated - Answer-The actual investment strategy is the strategy
implemented at a particular point in time. The permitted investment strategy defines the
range of actions that a manager may take. There is no such thing as a negotiated
investment strategy per se.
biggest risk to a employee buyout - Answer-Financing risk refers to the uncertainty
regarding the ability of the acquiring firm or entity to obtain funding needed to
consummate a merger and therefore is a greater concern in an employee buyout deal.
The Code and Standards recommends the following procedures to minimize the
probability of incidents in which Standard I(B) is violated: - Answer-Protect the integrity
of opinions
Create a restricted list
Restrict special cost arrangements
Limit gifts
Restrict investments
Review procedures
Establish an independence policy
Appoint an officer with oversight responsibilities for compliance with the firm's code of
ethics
absolute returns - Answer-comped against a zero return
Expanding into Europe for hedgefunds - Answer-Regulation of hedge funds in Europe
centers on the concept of Undertakings for Collective Investment in Transferable
Securities (UCITS). In effect, a UCITS is a hedge fund-like investment pool that
conforms to European regulations such that the product can be sold throughout the
various members of the EU. Because UCITS funds are intended for retail investors,
they are subject to very strict investment restrictions and diversification requirements.
continuous compounding - Answer-e^0.08 − 1 = 1.08329
, Jarque-Bera test - Answer-The Jarque-Bera test is a popular test for normality. The
critical value indicates the level of confidence for the Jarque-Bera test. If the test
statistic measured is greater than the critical value, the null hypothesis of normality is
rejected at the stated level of confidence.
Fama-French Model - Answer-the Fama-French-Carhart model does not reference
breadth as a factor. The factors referenced are the market, growth versus value, size,
and momentum.
point-to-point IRR - Answer-Point-to-point IRRs are used if the CF(0) and CF(T) are
both appraised values or other values during the lifetime of the investment (i.e, after
inception and before termination).
Treynor Ratio - Answer-Expected Return - Risk-Free Rate) / Beta = (8% - 2%) / 0.8 =
0.0750
Ex ante alpha - Answer-CAPM predicts 6% return for Fund A (expected excess return of
the market × beta of the fund + the risk-free rate). However, the analyst's prediction is
8%. Thus, ex ante alpha for Fund A is 2%
beta expansion - Answer-Beta expansion is typically observed during down market
cycles and is primarily attributed to higher correlation between the hedge fund's returns
and market returns.
Nullhypothesis alternative, p value, level of significance - Answer-null hyp is the
statemenet they are trying to reject, alternative is the one they assume to be true if null
is rejected, null is rejected when p value is less than level of significance,
significance value: reflects prob that will tolerate null being rejected when its true
p-value: probability of obtaining test statistic by chance , assuming null was true
data dreging - Answer-Data dredging, or data snooping, refers to the overuse and
misuse of statistical tests to identify historical patterns. The difference between data
dredging and data mining is that data dredging involves performing too many tests,
especially regarding historical relationships for which there are not a priori reasons for
believing that the relationships reflect true causality. The problem with data dredging is
not so much the number of tests performed as the failure to take the number of tests
performed into account when analyzing the results. The potential error in data dredging
is to place too much confidence in findings without regard to the number of tests that led
to the finding
An analyst is using a statistical technique that adds and deletes variables until an
optimal model is identified. What are the terms for the technique and the criterion this
analyst is using, respectively? - Answer-Stepwise regression; t-statistic
