CFA Level II Portfolio Management Practice Questions
Question 1
A portfolio has a total VaR of USD 9.0 million, split among three risk components: equity USD 5.5 million, credit USD 2.4 million and interest rate. What is the component VaR of interest rate?
- A. USD 2.2 million
- B. USD 1.1 million
- C. USD 7.9 million
- D. USD 16.9 million
Show answer and explanation
Correct answer: B. USD 1.1 million
Component VaRs add up to total VaR. Interest rate component = 9.0 - 5.5 - 2.4 = USD 1.1 million. Component VaR attributes diversified portfolio risk, so it differs from stand-alone VaR figures that would not sum to the total.
- A. Doubles the correct answer with no basis.
- B. Correct: total less the other two components.
- C. That is the sum of equity and credit components.
- D. That sums all three figures and ignores that the total is given.
Question 2
An analyst builds a factor model in which the factors are standardized company attributes such as book-to-price, earnings yield and size. Each stock's sensitivity is its attribute value, and factor returns are estimated by cross-sectional regression each period. What type of model is this?
- A. Macroeconomic factor model
- B. Statistical factor model
- C. Single-index market model
- D. Fundamental factor model
Show answer and explanation
Correct answer: D. Fundamental factor model
In a fundamental factor model, factors are company attributes and the sensitivities are those attributes, with factor returns estimated each period. Macroeconomic models use surprises in variables such as inflation with sensitivities from time-series regression, and statistical models extract factors from return data.
- A. Macroeconomic models use economy-wide surprises, not company attributes.
- B. Statistical models extract factors from the return covariance, not from attributes.
- C. The single-index model has one market factor.
- D. Correct: attribute-based factors with cross-sectional estimation.
Question 3
A portfolio has sensitivities of 1.2 to the market factor, 0.5 to a size factor and -0.4 to a value factor. Factor risk premiums are 5.0% for the market, 2.0% for size and 3.0% for value, and the risk-free rate is 3.0%. What is the expected return under the multifactor model?
- A. 7.8%
- B. 8.8%
- C. 5.8%
- D. 11.2%
Show answer and explanation
Correct answer: B. 8.8%
Expected return = 3.0 + 1.2 x 5.0 + 0.5 x 2.0 + (-0.4) x 3.0 = 3.0 + 6.0 + 1.0 - 1.2 = 8.8%. The negative value sensitivity reduces expected return because the value premium is positive.
- A. Omits the size factor contribution.
- B. Correct: risk-free rate plus the sum of sensitivity times premium.
- C. Omits the risk-free rate.
- D. Treats the value loading as positive.
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A manager runs a Monte Carlo simulation of a multi-asset portfolio. Correlations are estimated from a calm five-year period and returns are drawn from normal distributions. Which result is most likely?
- A. Simulated tail losses are understated, because correlations rise and returns are fat-tailed in crises
- B. Simulated tail losses are understated for single-asset holdings but overstated for diversified ones
- C. Simulated tail losses are overstated, because calm periods contain extreme volatility
- D. Simulated tail losses are accurate, because the number of trials removes input error
Show answer and explanation
Correct answer: A. Simulated tail losses are understated, because correlations rise and returns are fat-tailed in crises
Monte Carlo output is only as good as its inputs. Calm-period correlations and normal draws miss that diversification weakens in stress and that extreme moves are more common than normality implies. More trials reduce sampling error, not input error.
- A. Correct: input assumptions drawn from calm markets understate crisis risk.
- B. Diversified portfolios are especially exposed when correlations rise.
- C. Calm periods contain little extreme volatility.
- D. More trials do not correct poor model inputs.