Question #1 of 37 Question ID: 1473941

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) macroeconomic factor model.
C) fundamental factor model.

Question #2 of 37 Question ID: 1473926

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

A) A large number of assets are available to investors.

B) Asset returns are described by a k-factor model.
The priced factors risks can be hedged without taking short positions in any
C)
portfolios.

Question #3 of 37 Question ID: 1473954

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) positive and negative respectively.

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

Question #4 of 37 Question ID: 1473944

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) Management tenure and qualifications.

B) Companies’ position in the business cycle.
C) Changes in payout ratios.

Question #5 of 37 Question ID: 1473951

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 that sum to one.

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

Question #6 of 37 Question ID: 1473963

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

Question #7 of 37 Question ID: 1473945

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) 11.0%.
C) 13.0%.
Question #8 of 37 Question ID: 1473932

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

A) a factor portfolio with a positive expected risk premium.

an investment that has an expected positive net cash flow but requires no initial
B)
investment.
C) a portfolio with factor exposures that sum to one.

Question #9 of 37 Question ID: 1473952

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% short position in the inflation tracking portfolio.

B) 30% long position in the inflation factor portfolio.
C) 30% short position in the inflation factor portfolio.

Question #10 of 37 Question ID: 1508679

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

Question #11 of 37 Question ID: 1473929

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

A) A market portfolio exists that contains all risky assets and is mean-variance efficient.
There are a sufficient number of assets for investors to create diversified portfolios
B)
in which firm-specific risk is eliminated.
C) Asset returns are described by a K factor model.
Question #12 of 37 Question ID: 1473949

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

Question #13 of 37 Question ID: 1473962

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) greater-than-average market risk exposure.

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

Question #14 of 37 Question ID: 1473933

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) 37.0% −37.9%

B) 3.1% −3.16%

C) 33.5% −41.4%

Question #15 of 37 Question ID: 1473950

A tracking portfolio is a portfolio with:

factor sensitivities of zero to all factors, positive expected net cash flow, and an
A)
initial investment of zero.
a factor sensitivity of one to a particular factor in a multi-factor model and zero to all
B)
other factors.
a specific set of factor sensitivities designed to replicate the factor exposures of a
C)
benchmark index.
Question #16 of 37 Question ID: 1473927

Which of the following is an equilibrium-pricing model?

A) Macroeconomic factor model.

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

Question #17 of 37 Question ID: 1473939

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

Question #18 of 37 Question ID: 1473937

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 #19 of 37 Question ID: 1473961

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

Question #20 of 37 Question ID: 1473935

Diversification can reduce:

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

Question #21 of 37 Question ID: 1473940

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) 2.50% 3.00%

B) 2.00% 3.00%

C) 3.00% 2.00%
Question #22 of 37 Question ID: 1473928

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

A) Returns on assets can be described by a multi-factor process.

B) Security returns are normally distributed.
The market contains enough stocks so that unsystematic risk can be diversified
C)
away.

Question #23 of 37 Question ID: 1473946

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) 0.25.
B) 0.85.
C) 0.95.
Question #24 of 37 Question ID: 1473948

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

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

Question #25 of 37 Question ID: 1473931

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) There are assumed to be at least five factors that explain asset returns.
C) It is an equilibrium-pricing model like the CAPM.

Question #26 of 37 Question ID: 1473955

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) No Yes

B) Yes No

C) No No
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 Active Active

Active Active risk
factor risk factor risk specific risk Active
Portfolio specific risk squared
squared (% of Total (% of Total risk (%)
squared (%) (%)
(%) Active Risk) Active 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 #27 - 30 of 37 Question ID: 1473957

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 #28 - 30 of 37 Question ID: 1473958

The actual return of Merci is closest to:

A) 9%.
B) 10%.
C) 11%.

Question #29 - 30 of 37 Question ID: 1473959

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

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

Question #30 - 30 of 37 Question ID: 1473960

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 #31 of 37 Question ID: 1473936

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) 50% 12% 38%

C) 100% 0% 0%

Question #32 of 37 Question ID: 1473943

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

Macroeconomic factor models include explanatory variables such as real GDP

A) growth 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
B) the price-to-earnings ratio and fundamental factor models include explanatory
variables such as real GDP growth and unexpected inflation.
Macroeconomic factor models include explanatory variables such as the business
C) cycle, interest rates, and inflation, and fundamental factor models include
explanatory variables such as firm size and the price-to-earnings ratio.
Question #33 of 37 Question ID: 1473930

The Arbitrage Pricing Theory (APT) has all of the following characteristics EXCEPT it:

A) is an equilibrium pricing model.

B) assumes that asset returns are described by a factor model.
C) assumes that arbitrage opportunities are available to investors.

Question #34 of 37 Question ID: 1473934

Arbitrage pricing models assume which risk is priced?

A) Systematic.
B) Unsystematic.
C) Both systematic and unsystematic.

Question #35 of 37 Question ID: 1473942

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

Question #36 of 37 Question ID: 1473953

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) negative and positive respectively.
C) both positive.

Question #37 of 37 Question ID: 1473938

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%.