Question #1 of 37 Question ID: 1687097

Janice Barefoot, CFA, has been managing a portfolio for a client who has asked Barefoot to use
the Dow Jones Industrial Average (DJIA) as a benchmark. In her first year Barefoot managed the
portfolio by choosing 29 of the 30 DJIA stocks. She selected a non-DJIA stock in the same
industry as the omitted stock to replace that stock. Compared to the DJIA, Barefoot has placed
a higher weight on the financial stocks and a lower weight on the other stocks still in the
portfolio. Over that year, the non-DJIA stock in the portfolio had a negative return while the
omitted DJIA stock had a positive return. The portfolio managed by Barefoot outperformed the
DJIA. Based on this we can say that the return from factor tilts and asset selection were:

A) positive and negative respectively.

B) both positive.
C) negative and positive respectively.

Question #2 of 37 Question ID: 1687071

Which of the following is not an assumption of the arbitrage pricing theory (APT)?

A) The market contains enough stocks so that unsystematic risk can be diversified away.
B) Security returns are normally distributed.
C) Returns on assets can be described by a multi-factor process.

Question #3 of 37 Question ID: 1687095

A common strategy in bond portfolio management is enhanced indexing by matching primary

risk factors. This strategy could be implemented by forming:

A) a portfolio with factor sensitivities equal to that of the index.

B) a portfolio with factor sensitivities that sum to one.
C) a portfolio with asset portfolio weights equal to that of the index.

Question #4 of 37 Question ID: 1687084

A multi-factor model that uses unexpected changes (surprises) in macroeconomic variables

(e.g., inflation and gross domestic product) as the factors to explain asset returns is called a:

A) statistical factor model.

B) fundamental factor model.
C) macroeconomic factor model.

Question #5 of 37 Question ID: 1687072

Which of the following is NOT an underlying assumption of the arbitrage pricing theory (APT)?

A) Asset returns are described by a K factor model.

There are a sufficient number of assets for investors to create diversified portfolios in
B)
which firm-specific risk is eliminated.
C) A market portfolio exists that contains all risky assets and is mean-variance efficient.

Question #6 of 37 Question ID: 1687094

A tracking portfolio is a portfolio with:

a specific set of factor sensitivities designed to replicate the factor exposures of a

A)
benchmark index.
a factor sensitivity of one to a particular factor in a multi-factor model and zero to all
B)
other factors.
factor sensitivities of zero to all factors, positive expected net cash flow, and an initial
C)
investment of zero.
Question #7 of 37 Question ID: 1687077

Arbitrage pricing models assume which risk is priced?

A) Both systematic and unsystematic.

B) Unsystematic.
C) Systematic.

Question #8 of 37 Question ID: 1687092

A portfolio with a specific set of factor sensitivities designed to replicate the factor exposures of
a benchmark index is called a:

A) factor portfolio.
B) tracking portfolio.
C) arbitrage portfolio.

Question #9 of 37 Question ID: 1687080

Given a three-factor arbitrage pricing theory (APT) model, what is the expected return on the
Premium Dividend Yield Fund?

The factor risk premiums to factors 1, 2 and 3 are 8%, 12% and 5%, respectively.
The fund has sensitivities to the factors 1, 2, and 3 of 2.0, 1.0 and 1.0, respectively.
The risk-free rate is 3.0%.

A) 33.0%.
B) 36.0%.
C) 50.0%.
Question #10 of 37 Question ID: 1687099

Rob Tanner, portfolio manager at Alpha Inc. meets his old college friend Del Torres for lunch.
Torres excitedly tells Tanner about his latest work with tracking and factor portfolios. Torres
says he has developed a tracking portfolio to aid in speculating on oil prices and is working on a
factor portfolio with a specific set of factor sensitivities to the Russell 2000.

Did Torres correctly describe tracking and factor portfolios?

Tracking Factor

A) Yes No

B) No Yes

C) No No

Question #11 of 37 Question ID: 1687085

The macroeconomic factor models for the returns on Omni, Inc., (OM) and Garbo
Manufacturing (GAR) are:

ROM = 20.0% +1.0(FGDP) + 1.4(FQS) + εOM

RGAR = 15.0% +0.5(FGDP) + 0.8 (FQS) + εGAR

What is the expected return on a portfolio invested 60% in Omni and 40% in Garbo?

A) 18.0%.
B) 20.96%.
C) 19.96%.

Question #12 of 37 Question ID: 1687073

The Arbitrage Pricing Theory (APT) has all of the following characteristics EXCEPT it:
A) assumes that asset returns are described by a factor model.
B) assumes that arbitrage opportunities are available to investors.
C) is an equilibrium pricing model.

Question #13 of 37 Question ID: 1687105

A portfolio manager uses a two-factor model to manage her portfolio. The two factors are
confidence risk and time-horizon risk. If she wants to bet on an unexpected increase in the
confidence risk factor (which has a positive risk premium), but hedge away her exposure to
time-horizon risk (which has a negative risk premium), she should create a portfolio with a
sensitivity of:

A) 1.0 to the confidence risk factor and 0.0 to the time-horizon factor.
B) 1.0 to the confidence risk factor and -1.0 to the time-horizon factor.
C) −1.0 to the confidence risk factor and 1.0 to the time-horizon factor.

Question #14 of 37 Question ID: 1687093

A portfolio with a factor sensitivity of one to a particular factor in a multi-factor model and zero
to all other factors is called a(n):

A) factor portfolio.
B) tracking portfolio.
C) arbitrage portfolio.

Marianne Belair, CFA, is a wealth manager for a well-known company in Paris, France. She has
developed macroeconomic factor models on portfolios Alpha and Bravo.

Equations for the two portfolios:

RAlpha = 0.08 – 0.7 FINFL + 1.2 FGDP

 RBravo = 0.13 + 0.6 FINFL + 2.3 FGDP

Belair has asked her colleague Pierre Louboutin to calculate the return attributable to a 1.5%
surprise in GDP for an equally weighted portfolio comprising Alpha and Bravo.

Meanwhile, Belair is looking at Merci, a beauty stock for which she has developed a
macroeconomic factor model. The arbitrage-pricing model shows a required return of 10% and
the company-specific surprise for the year was 2%. Exhibit 1 shows additional information on
the model:

Exhibit 1:

Variable Actual Value (%) Expected Value (%) Factor Sensitivity

Interest rates 3.5% 2.5% –0.3

Unemployment level 6.5% 5.5% –0.7

Emily Grant, a senior manager at the firm, asks Louboutin to analyze the performance of three
managers using the information in Exhibit 2.

Exhibit 2: Decomposing Active Risk

Active factor
Active Active Active risk Active specific
risk (% of Active
Portfolio factor specific squared risk (% of Total
Total Active risk (%)
risk (%) risk (%) (%) Active Risk)
Risk)

EM 0.5 0.5 1 50 50 1

EC 25.2 10.8 36 70 30 6

EV 21.6 14.4 36 60 40 6

Finally, Belair would like to capitalize on her expectation that real business activity will increase
over the next year. As a separate concern, she has some existing positive exposure to inflation
risk, which she would like to hedge. To achieve her goals she can use the portfolios in the
Exhibit 3 which show the five relevant factors and respective factor sensitivities:

Exhibit 3:

Risk Factor A B C D E

Confidence 0.10 1.00 0.00 0.70 0.00

Time horizon 0.00 0.00 0.00 0.50 0.00

Inflation 1.00 0.00 0.00 0.30 1.00

Business cycle 0.90 1.00 1.00 0.00 0.00

Market timing 1.00 0.00 0.00 0.90 0.00

Question #15 - 18 of 37 Question ID: 1687101

Pierre's answer to Belair's first request regarding the equally weighted portfolio, is closest to:

A) 1.75%.
B) 2.13%.
C) 2.63%.

Question #16 - 18 of 37 Question ID: 1687102

The actual return of Merci is closest to:

A) 9%.
B) 10%.
C) 11%.
Question #17 - 18 of 37 Question ID: 1687103

Using Exhibit 2, the portfolio that has the most exposure to asset selection risk is:

A) EM.
B) EC.
C) EV.

Question #18 - 18 of 37 Question ID: 1687104

Which two portfolios from Exhibit 3 best achieve Belair's goals in relation to business activity
and inflation risk?

A) B and A.
B) B and E.
C) C and E.

Question #19 of 37 Question ID: 1687089

Assume you are considering forming a common stock portfolio consisting of 25% Stonebrook
Corporation (Stone) and 75% Rockway Corporation (Rock). As expressed in the two-factor
returns models presented below, both of these stocks' returns are affected by two common
factors: surprises in interest rates and surprises in the unemployment rate.

RStone = 0.11 + 1.0FInt + 1.2FUn + εStone

RRock = 0.13 + 0.8FInt + 3.5FUn + εRock

Assume that at the beginning of the year, interest rates were expected to be 5.1% and
unemployment was expected to be 6.8%. Further, assume that at the end of the year, interest
rates were actually 5.3%, the actual unemployment rate was 7.2%, and there were no company-
specific surprises in returns. This information is summarized in Table 1 below:

Table 1: Expected versus Actual Interest Rates and Unemployment Rates

Company-specific returns
Actual Expected
surprises

Interest Rate 0.053 0.051 0.0

Unemployment Rate 0.072 0.068 0.0

What is the portfolio's sensitivity to interest rate surprises?

A) 0.85.
B) 0.25.
C) 0.95.

Question #20 of 37 Question ID: 1687074

Which of the following does NOT describe the arbitrage pricing theory (APT)?

A) It requires a weaker set of assumptions than the CAPM to derive.

B) It is an equilibrium-pricing model like the CAPM.
C) There are assumed to be at least five factors that explain asset returns.
Question #21 of 37 Question ID: 1687081

Given a three-factor arbitrage pricing theory APT model, what is the expected return on the
Freedom Fund?

The factor risk premiums to factors 1, 2, and 3 are 10%, 7% and 6%, respectively.
The Freedom Fund has sensitivities to the factors 1, 2, and 3 of 1.0, 2.0 and 0.0,
respectively.
The risk-free rate is 6.0%.

A) 33.0%.
B) 30.0%.
C) 24.0%.

Question #22 of 37 Question ID: 1687088

Assume you are considering forming a common stock portfolio consisting of 25% Stonebrook
Corporation (Stone) and 75% Rockway Corporation (Rock). As expressed in the two-factor
returns models presented below, both of these stocks' returns are affected by two common
factors: surprises in interest rates and surprises in the unemployment rate.

RStone = 0.11 + 1.0FInt + 1.2FUn + εStone

RRock = 0.13 + 0.8FInt + 3.5FUn + εRock

Assume that at the beginning of the year, interest rates were expected to be 5.1% and
unemployment was expected to be 6.8%. Further, assume that at the end of the year, interest
rates were actually 5.3%, the actual unemployment rate was 7.2%, and there were no company-
specific surprises in returns. This information is summarized in Table 1 below:

Table 1: Expected versus Actual Interest Rates and Unemployment Rates

Company-specific returns
Actual Expected
surprises

Interest Rate 0.053 0.051 0.0

Unemployment Rate 0.072 0.068 0.0

What is the expected return for Stonebrook in the absence of surprises?

A) 13.2%.
B) 13.0%.
C) 11.0%.

Question #23 of 37 Question ID: 1687083

Portfolios A and B have an expected return of 4.4% and 5.3% respectively. Assume that a one-
factor APT model is appropriate and the factor sensitivities of portfolios A and B are 0.8 and 1.1
respectively. The risk-free rate and factor risk premium are closest to:

Factor Risk
Risk Free Rate
Premium
A) 2.00% 3.00%

B) 3.00% 2.00%

C) 2.50% 3.00%

Question #24 of 37 Question ID: 1687079

Michael Paul, a portfolio manager, is screening potential investments and suspects that an
arbitrage opportunity may be available. The three portfolios that meet his screening criteria are
detailed below:

Portfolio Expected Return Beta

X 12% 1.0

Y 16% 1.3

Z 8% 0.9

Which of the following portfolio combinations produces the highest return while maintaining a
beta of 1.00?

Portfolio X Portfolio Y Portfolio Z

A) 25% 50% 25%

B) 100% 0% 0%

C) 50% 12% 38%

Question #25 of 37 Question ID: 1687090

Assume you are considering forming a common stock portfolio consisting of 25% Stonebrook
Corporation (Stone) and 75% Rockway Corporation (Rock). As expressed in the two-factor
returns models presented below, both of these stocks' returns are affected by two common
factors: surprises in interest rates and surprises in the unemployment rate.

RStone = 0.11 + 1.0FInt + 1.2FUn + εStone

RRock = 0.13 + 0.8FInt + 3.5FUn + εRock

Assume that at the beginning of the year, interest rates were expected to be 5.1% and
unemployment was expected to be 6.8%. Further, assume that at the end of the year, interest
rates were actually 5.3%, the actual unemployment rate was 7.2%, and there were no company-
specific surprises in returns. This information is summarized in Table 1 below:

Table 1: Expected versus Actual Interest Rates and Unemployment Rates

Company-specific returns
Actual Expected
surprises

Interest Rate 0.053 0.051 0.0

Unemployment Rate 0.072 0.068 0.0

What is the predicted return for Stonebrook if the return unexplained by the model was -1%?

A) 12.00%.
B) 10.68%.
C) 1.40%.

Question #26 of 37 Question ID: 1687086

Identify the most accurate statement regarding multifactor models from among the following.

Macroeconomic factor models include explanatory variables such as the business

A) cycle, interest rates, and inflation, and fundamental factor models include explanatory
variables such as firm size and the price-to-earnings ratio.
 Macroeconomic factor models include explanatory variables such as real GDP growth
B) and the price-to-earnings ratio and fundamental factor models include explanatory
variables such as firm size and unexpected inflation.
Macroeconomic factor models include explanatory variables such as firm size and the
C) price-to-earnings ratio and fundamental factor models include explanatory variables
such as real GDP growth and unexpected inflation.

Question #27 of 37 Question ID: 1687070

Which of the following is an equilibrium-pricing model?

A) Fundamental factor model.

B) Macroeconomic factor model.
C) The arbitrage pricing theory (APT).

Question #28 of 37 Question ID: 1687078

Diversification can reduce:

A) macroeconomic risks.
B) unsystematic risk.
C) systematic risk.

Question #29 of 37 Question ID: 1687106

In the context of multi-factor models, investors with lower-than-average exposure to recession

risk (e.g. those without labor income) can earn a risk premium for holding dimensions of risk
unrelated to market movements by creating equity portfolios with:

A) less-than-average exposure to the recession risk factor.

B) greater-than-average market risk exposure.
C) greater-than-average exposure to the recession risk factor.

Question #30 of 37 Question ID: 1687091

Janice Barefoot, CFA, has managed a portfolio where she used the Dow Jones Industrial Average
(DJIA) as a benchmark. In the past two years the average monthly return on her portfolio has
been higher than that of the DJIA. To get a measure of active return per unit of active risk
Barefoot should compute the:

information ratio, which is the average excess portfolio return over the benchmark
A) divided by the standard deviation of the differences between the portfolio and
benchmark returns.
Sharpe ratio, which is the standard deviation of the differences between the portfolio
B)
and benchmark returns divided into the average of those differences.
information ratio, which is the standard deviation of the differences between the
C)
portfolio and benchmark returns divided by the average of those differences.

Question #31 of 37 Question ID: 1687087

Summer Vista decides to develop a fundamental factor model. She establishes a proxy for the
market portfolio, and then considers the importance of various factors in determining stock
returns. She decides to use the following factors in her model:

Changes in payout ratios.

Credit rating changes.
Companies' position in the business cycle.
Management tenure and qualifications.

Which of the following factors is least appropriate for Vista's factor model?

A) Changes in payout ratios.

B) Management tenure and qualifications.
C) Companies’ position in the business cycle.

Question #32 of 37 Question ID: 1687076

Marcie Deiner is an investment manager with G&G Investment Corporation. She works with a
variety of clients who differ in terms of experience, risk aversion and wealth. Deiner recently
attended a seminar on multifactor analysis. Among other things, the seminar taught how the
assumptions concerning the Arbitrage Pricing Theory (APT) model are different from those of
the Capital Asset Pricing Model (CAPM). One of the examples used in the seminar is below.

E(Ri) = Rf + f1 Bi,1 + f2 Bi,2 + f3 Bi,3. where: f1 =3.0%, f2 = −40.0%, and f3 =50.0%.

Beta estimates for Growth and Value funds for a three factor model

Factor 1 Factor 2 Factor 3

Betas for Growth 0.5 0.7 1.2

Betas for Value 0.2 1.8 0.6

For the model used as an example in the seminar, if the T-bill rate is 3.5%, what are the
expected returns for the Growth and Value Funds?

E(RGrowth) E(RValue)

A) 33.5% −41.4%

B) 3.1% −3.16%

C) 37.0% −37.9%

Question #33 of 37 Question ID: 1687096

The Real Value Fund is designed to have zero exposure to inflation. However its current
inflation factor sensitivity is 0.30. To correct for this, the portfolio manager should take a:
A) 30% long position in the inflation factor portfolio.
B) 30% short position in the inflation factor portfolio.
C) 30% short position in the inflation tracking portfolio.

Question #34 of 37 Question ID: 1687069

Which of the following is NOT an assumption necessary to derive the arbitrage pricing theory
(APT)?

A) Asset returns are described by a k-factor model.

B) The priced factors risks can be hedged without taking short positions in any portfolios.
C) A large number of assets are available to investors.

Question #35 of 37 Question ID: 1687098

Janice Barefoot, CFA, has been managing a portfolio for a client who has asked Barefoot to use
the Dow Jones Industrial Average (DJIA) as a benchmark. In her second year, Barefoot used 29
of the 30 DJIA stocks. She selected a non-DJIA stock in the same industry as the omitted DJIA
stock to replace that stock. Compared to the DJIA, Barefoot placed a lower weight on the
communication stocks and a higher weight on the other stocks still in the portfolio. Over that
year, the non-DJIA stock in the portfolio had a positive and higher return than the omitted DJIA
stock. The communication stocks had a negative return while all of the other stocks had a
positive return. The portfolio managed by Barefoot outperformed the DJIA. Based on this we
can say that the return from factor tilts and asset selection were:

A) both positive.
B) positive and negative respectively.
C) negative and positive respectively.
Question #36 of 37 Question ID: 1687082

Assume you are attempting to estimate the equilibrium expected return for a portfolio using a
two-factor arbitrage pricing theory (APT) model. Assume that you have estimated the risk
premium for factor 1 to be 0.02, and the risk premium for factor 2 to be 0.03. The sensitivity of
the portfolio to factor 1 is –1.2 and the portfolios sensitivity to factor 2 is 0.80. Given a risk free
rate equal to 0.03, what is the expected return for the asset?

A) 2.4%.
B) 5.0%.
C) 3.0%.

Question #37 of 37 Question ID: 1687075

One of the assumptions of the arbitrage pricing theory (APT) is that there are no arbitrage
opportunities available. An arbitrage opportunity is:

A) a portfolio with factor exposures that sum to one.

B) a factor portfolio with a positive expected risk premium.
an investment that has an expected positive net cash flow but requires no initial
C)
investment.