Tutorial 1

Question 1
An analyst gathers the following information:

Security Standard Deviation (%) Beta

Security 1 25 1.50

Security 2 15 1.40

Security 3 20 1.60

1. With respect to the capital asset pricing model, if the expected market risk premium is 6% and the
risk-free rate is 3%, the expected return for Security 1 is closest to …?
2. With respect to the capital asset pricing model, if expected return for Security 2 is equal to 11.4% and
the risk-free rate is 3%, the expected return for the market is closest to …?
3. With respect to the capital asset pricing model, if the expected market risk premium is 6% the
security with the highest expected return is …?
4. With respect to the capital asset pricing model, a decline in the expected market return will have
the greatest impact on the expected return of …?
5. If the correlation between the security 3 and the market is 0.7, what is the standard deviation of the
market return?

Question 3
A British pension fund has employed three investment managers, each of whom is responsible for
investing in one-third of all asset classes so that the pension fund has a well-diversified portfolio.
Information about the managers is given below.
Manager Return σ β
X 10% 20% 1.1
Y 11% 10% 0.7
Z 12% 25% 0.6
Market (M) 9% 19% ?
Risk-free rate (Rf) 3% ? ?
1. Calculate the expected return, Sharpe ratio, Treynor ratio, M2, and Jensen’s alpha. Analyze
your results and plot the returns and betas of these portfolios.
 Tutorial 3
The following information relates to Questions 1–5
Ed Smith is a new trainee in the foreign exchange (FX) services department of a major global bank. Smith’s
focus is to assist senior FX trader, Feliz Mehmet, CFA. Mehmet mentions that an Indian corporate client
exporting to the United Kingdom wants to estimate the potential hedging cost for a sale closing in one year.
Smith is to determine the premium/discount for an annual (360 day) forward contract using the exchange rate
data presented in Exhibit 1.
Exhibit 1. Select Currency Data for GBP and INR

Spot (INR/GBP) 79.5093

Annual (360-day) Libor 5.43%

(GBP)

Annual (360-day) Libor (INR) 7.52%

Mehmet is also looking at two possible trades to determine their profit potential. The first trade involves a
possible triangular arbitrage trade using the Swiss, US and Brazilian currencies, to be executed based on a
dealer’s bid/offer rate quote of 0.5161/0.5163 in CHF/BRL and the interbank spot rate quotes presented in
Exhibit 2.
Exhibit 2. Interbank Market Quotes

Currency Bid/Offer
Pair

CHF/USD 0.9099/0.9101

BRL/USD 1.7790/1.7792

Mehmet is also considering a carry trade involving the USD and the Euro. He anticipates it will generate a
higher return than buying a one-year domestic note at the current market quote due to low US interest rates
and his predictions of exchange rates in one year. To help Mehmet assess the carry trade, Smith provides
Mehmet with selected current market data and his one-year forecasts in Exhibit 3.
Exhibit 3. Spot Rates and Interest Rates for Proposed Carry Trade

Today’s one-year Currency pair Spot rate today Projected spot rate in one year
Libor (Price/Base)

USD 0.80% CAD/USD 1.0055 1.0006

CAD 1.71% EUR/CAD 0.7218 0.7279

EUR 2.20%

Finally, Mehmet asks Smith to assist with a trade involving a US multinational customer operating in Europe
and Japan. The customer is a very cost-conscious industrial company with a AA credit rating and strives to
execute its currency trades at the most favorable bid/offer spread. Because its Japanese subsidiary is about to
close on a major European acquisition in three business days, the client wants to lock in a trade involving the
Japanese yen and the Euro as early as possible the next morning, preferably by 8:05 AM New York time.
At lunch, Smith and other FX trainees discuss how best to analyze currency market volatility from ongoing
financial crises. The group agrees that a theoretical explanation of exchange rate movements, such as the
framework of the international parity conditions, should be applicable across all trading environments. They
note such analysis should enable traders to anticipate future spot exchange rates. But they disagree on which
parity condition best predicts exchange rates, voicing several different assessments. Smith concludes the
discussion on parity conditions by stating to the trainees:
“I believe that in the current environment both covered and uncovered interest rate parity conditions are in
effect.”
1. Based upon Exhibit 1, what is the forward premium (discount) for a 360-day INR/GBP forward
contract is?
2. Based on Exhibit 2, what is the most appropriate recommendation regarding the triangular arbitrage
trade?
3. Based on Exhibit 3, compute the potential all-in USD return on the carry trade.
4. Which factor is least likely to lead to a narrow bid/offer spread for the industrial company’s needed
currency trade?
5. If Smith’s statement on parity conditions is correct, how future spot exchange rates are most likely to
be forecast?
 Tutorial 4
5. An investor evaluating the returns of three recently formed exchange-traded funds gathers the
following information:
ET Time Since Return Since
Inceptio Inceptio
n n (%)
1 146 days 4.61
2 5 weeks 1.10
3 15 months 14.35
The ETF with the highest annualized rate of return is…?
6. With respect to capital market theory, which of the following asset characteristics is least
likely to impact the variance of an investor’s equally weighted portfolio?
A. Return on the asset.
B. Standard deviation of the asset.
C. Covariances of the asset with the other assets in the portfolio.
7. A portfolio manager creates the following portfolio:
Security Security Weight Expected Standard
(%) Deviation (%)
1 30 20
2 70 12
If the correlation of returns between the two securities is 0.40, the expected standard deviation of the
portfolio is closest to …?

8. A portfolio manager creates the following portfolio:

Security Security Weight (%) Expected Standard Deviation
(%)
1 30 20
2 70 12
If the covariance of returns between the two securities is −0.0240, the expected standard deviation of
the portfolio is closest to…?
 Tutorial 5
Question 1
0. Compare the assumptions of the arbitrage pricing theory (APT) with those of the capital
asset pricing model (CAPM).
1. Last year the return on Harry Company stock was 5 percent. The portion of the return on the
stock not explained by a two-factor macroeconomic factor model was 3 percent. Using the
data given below, calculate Harry Company stock’s expected return.
Macroeconomic Factor Model for Harry Company Stock
Variable Actual Value (%) Expected Value Stock’s Factor Sensitivity
(%)
Change in interest 2.0 0.0 –1.5
rate
Growth in GDP 1.0 4.0 2.0
2. Assume that the following one-factor model describes the expected return for portfolios:
E(Rp) = 0.10 + 0.12βp,1
Also assume that all investors agree on the expected returns and factor sensitivity of the three
highly diversified Portfolios A, B, and C given in the following table:
Portfoli Expected Return Factor
o Sensitivity
A 0.20 0.80
B 0.15 1.00
C 0.24 1.20
Assuming the one-factor model is correct and based on the data provided for Portfolios A, B,
and C, determine if an arbitrage opportunity exists and explain how it might be exploited.
3. Which type of factor model is most directly applicable to an analysis of the style orientation
(for example, growth vs. value) of an active equity investment manager? Justify your answer.
4. Suppose an active equity manager has earned an active return of 110 basis points, of which
80 basis points is the result of security selection ability. Explain the likely source of the
remaining 30 basis points of active return.
5. Address the following questions about the information ratio.
A. What is the information ratio of an index fund that effectively meets its investment
objective?
B. What are the two types of risk an active investment manager can assume in seeking
to increase his information ratio?
6. A wealthy investor has no other source of income beyond her investments and that income is
expected to reliably meet all her needs. Her investment advisor recommends that she tilt her
portfolio to cyclical stocks and high-yield bonds. Explain the advisor’s advice in terms of
comparative advantage in bearing risk.

Question 2
Carlos Altuve is a manager-of-managers at an investment company that uses quantitative models
extensively. Altuve seeks to construct a multi-manager portfolio using some of the funds managed
by portfolio managers within the firm. Maya Zapata is assisting him.
Altuve uses arbitrage pricing theory (APT) as a basis for evaluating strategies and managing risks.
From his earlier analysis, Zapata knows that Funds A and B in Exhibit 1 are well diversified. He has
not previously worked with Fund C and is puzzled by the data because it is inconsistent with APT.
He asks Zapata gather additional information on Fund C’s holdings and to determine if an arbitrage
opportunity exists among these three investment alternatives. Her analysis, using the data in Exhibit
1, confirms that an arbitrage opportunity does exist.
Exhibit 1. Expected Returns and Factor Sensitivities (One-Factor Model)
Fun Expected Return Factor
d Sensitivity
A 0.02 0.5
B 0.04 1.5
C 0.03 0.9
The manager of Fund C makes some modifications to his portfolio and eliminates the arbitrage
opportunity. Using a two-factor model, Zapata now estimates the three funds’ sensitivity to inflation
and GDP growth. That information is presented in Exhibit 2. Zapata assumes a zero value for the
error terms when working with the selected two-factor model.
Exhibit 2. Expected Returns and Factor Sensitivities (Two-Factor Model)
Fun Expected Return Factor Sensitivity
d Inflatio GDP Growth
n
A 0.02 0.5 1.0
B 0.04 1.6 0.0
C 0.03 1.0 1.1
Altuve asks Zapata to calculate the return for Portfolio AC, composed of a 60% allocation to Fund A
and 40% allocation to Fund C, using the surprises in inflation and GDP growth in Exhibit 3.
Exhibit 3. Selected Data on Factors
Factor Research Staff Forecast Actual Value
Inflation 2.0% 2.2%
GDP Growth 1.5% 1.0%
Finally, Altuve asks Zapata about the return sensitivities of Portfolios A, B, and C given the
information provided in Exhibit 3.
1. Which of the following is not a key assumption of APT, which is used by Altuve to evaluate
strategies and manage risks?
A. A factor model describes asset returns.
B. Asset-specific risk can be eliminated through diversification.
C. Arbitrage opportunities exist among well-diversified portfolios.
2. The arbitrage opportunity identified by Zapata can be exploited with:
A. Strategy 1: Buy $50,000 Fund A and $50,000 Fund B; sell short $100,000 Fund C.
 B. Strategy 2: Buy $60,000 Fund A and $40,000 Fund B; sell short $100,000 Fund C.
C. Strategy 3: Sell short $60,000 of Fund A and $40,000 of Fund B; buy $100,000 Fund
3. The two-factor model Zapata uses is a:
A. statistical factor model.
B. fundamental factor model.
C. macroeconomic factor model.
4. Based on Exhibit 2, what is the most likely benefit of taking a short position in Fund B
relative to an equally sized long position in Fund C?
A. Lower inflation risk
B. Higher expected return
C. Lower GDP growth risk
5. Based on the data in Exhibits 2 and 3, the return for Portfolio AC, given the surprises in
inflation and GDP growth, is closest to:
A. 2.02%.
B. 2.40%.
C. 4.98%.
6. The surprise in which of the following had the greatest effect on fund returns?
A. Inflation on Fund B
B. GDP growth on Fund A
C. GDP growth on Fund C
7. Based on the data in Exhibit 2, which fund is most sensitive to the combined surprises in
inflation and GDP growth in Exhibit 3?
A. Fund A
B. Fund B
C. Fund C
 Tutorial 6

2. The benchmark weights and returns for each of the five stocks in the Capitol index are given
below. The Tukol Fund uses the Capitol Index as its benchmark, and the fund’s portfolio
weights are also shown in the table.
Stock Portfolio Weight (%) Benchmark Weight (%) 2016 Return (%)
1 30 24 14
2 30 20 15
3 20 20 12
4 10 18 8
5 10 18 10

What is the value added (active return) for the Tukol Fund?
A. 0.00%
B. 0.90%
C. 1.92%
3. Consider the following asset class returns for calendar year 2016:
Asset class Portfolio Benchmark Portfolio Benchmark
Weight (%) Weight (%) Return (%) Return (%)
Domestic equities 55 40 10 8
International 20 30 10 9
equities
Bonds 25 30 5 6
What is the value added (or active return) for the managed portfolio?
A. 0.25%
B. 0.35%
C. 1.05%
And

7. The benchmark portfolio is the S&P 500. Which of the following three portfolios can be
combined with the benchmark portfolio to produce the highest combined Sharpe ratio?
S&P Portfolio A Portfolio B Portfolio C
500
Expected annual return 9.0% 10.0% 9.5% 9.0%
Return standard deviation 18.0% 20.0% 20.0% 18.0%
Sharpe ratio 0.333 0.350 0.325 0.333
Active return 0 1.0% 0.5% 0
Active risk 0 10.0% 3.0% 2.0%
A. Portfolio A
B. Portfolio B
C. Portfolio C
8. Based on the fundamental law of active management, if a portfolio manager has an
information ratio of 0.75, an information coefficient of 0.1819, and a transfer coefficient of
 1.0, how many securities are in the portfolio manager’s fund, making the assumption that the
active returns are uncorrelated.
A. About 2
B. About 4
C. About 17
9. Two analysts make the following statements about the transfer coefficient in the full
fundamental law of active management:
Analyst One says, “The transfer coefficient measures how well the realized returns
correlate with the anticipated returns, adjusted for risk.”
Analyst Two says, “The transfer coefficient measures how well the realized returns
correlate with the active weights, adjusted for risk.”
Which, if either, analyst is correct?
A. Only Analyst One is correct.
B. Only Analyst Two is correct
C. Neither analyst is correct.
10. The full fundamental law of active management is stated as follows:
E(RA)=(TC)(IC)√ BR σA
Which component on the right-hand side represents the extent to which the portfolio
manager’s expectations are realized? The
A. transfer coefficient, TC.
B. information coefficient, IC.
C. breadth, BR.
 Tutorial 7
Question 1.
A hypothetical portfolio B has an annual 1% VaR of $45,000. Which of the following statements is most
likely true about the portfolio?
a. The expected minimum loss over one year, 1% of the time, is $45,000.
b. There is a 99% probability that the expected loss over the next year is more than $45,000.
c. The likelihood of losing $45,000 over the next year is 1%.
Question. 2
The standard deviation of the daily returns of asset A is given as 0.0231, and its mean as 0.0012. Estimate the
5% annual VaR for asset A, given that there are 250 trading days in a year, and the value of A is $200,000.
Question. 3 You are provided the following information about two assets, Security A and Security B:

Security Standard deviation of daily Mean daily Covariance of daily

Security A 0.0158 0.0004

0.000106
0.0112 0.0003
Security B

Use the given information to estimate the 5% VaR for a Portfolio of 10 million that is 60% invested in
security A and remaining in security B.
 Tutorial 10
The following information relates to questions 0-9
Aline Nuñes is a junior analyst in the derivatives research division of an international securities
firm. Nuñes’s supervisor, Cátia Pereira, asks her to conduct an analysis of various options trading
strategies relating to shares of three companies: IZD, QWY, and XDF. On 1 February, Nuñes gathers
selected option premium data on the companies, which is presented in Exhibit 1.
Exhibit 1. Share Price and Options Premiums as of 1 February (share prices and option premiums
are in euros)
Share Price Call Premium Option Date/Strike Put Premium
9.45 April/87.50 1.67
IZD 93.93 2.67 April/95.00 4.49
1.68 April/97.50 5.78
4.77 April/24.00 0.35
QWY 28.49 3.96 April/25.00 0.50
0.32 April/31.00 3.00
0.23 February/80.00 5.52
XDF 74.98 2.54 April/75.00 3.22
2.47 December/80.00 9.73
Nuñes considers the following option strategies relating to IZD.
Strategy Constructing a synthetic long put position in IZD
1
Strategy Buying 100 shares of IZD and writing the April €95.00 strike call option on IZD
2
Strategy Implementing a covered call position in IZD using the April €97.50 strike option
3
Nuñes next reviews the following option strategies relating to QWY.
Strategy 4 Implementing a protective put position in QWY using the April €25.00 strike
option
Strategy 5 Buying 100 shares of QWY, buying the April €24.00 strike put option, and writing
the April €31.00 strike call option
Strategy 6 Implementing a bear spread in QWY using the April €25.00 and April €31.00
strike options
Finally, Nuñes considers two option strategies relating to XDF.
Strategy 7 Writing both the April €75.00 strike call option and the April €75.00 strike put
option on XDF
Strategy 8 Writing the February €80.00 strike call option and buying the December €80.00
strike call option on XDF
Over the past few months, Nuñes and Pereira have followed news reports on a proposed merger
between XDF and one of its competitors. A government antitrust committee is currently reviewing
the potential merger. Pereira expects the share price to move sharply up or down depending on
whether the committee decides to approve or reject the merger next week.
Pereira asks Nuñes to recommend an option trade that might allow the firm to benefit from a
significant move in the XDF share price regardless of the direction of the move.
1. Strategy 1 would require Nuñes to buy:
A. shares of IZD.
B. a put option on IZD.
C. a call option on IZD.
2. Based on Exhibit 1, Nuñes should expect Strategy 2 to be least profitable if the share price of
IZD at option expiration is:
A. less than €91.26.
B. between €91.26 and €95.00.
C. more than €95.00.
3. Based on Exhibit 1, the breakeven share price of Strategy 3 is closest to:
A. €92.25.
B. €95.61.
C. €95.82.
4. Based on Exhibit 1, the maximum loss per share that would be incurred if Strategy 4 was
implemented is:
A. €2.99.
B. €3.99.
C. unlimited.
5. Strategy 5 is best described as a:
A. collar.
B. straddle.
C. bear spread.
6. Based on Exhibit 1, Strategy 5 offers:
A. unlimited upside.
B. a maximum profit of €2.48 per share.
C. protection against losses if QWY’s share price falls below €28.14.
7. Based on Exhibit 1, the breakeven share price for Strategy 6 is closest to:
A. €22.50.
B. €28.50.
C. €33.50.
8. Based on Exhibit 1, the maximum gain per share that could be earned if Strategy 7 is
implemented is:
A. €5.74.
B. €5.76.
C. unlimited.
9. Based on Exhibit 1, the best explanation for Nuñes to implement Strategy 8 would be that,
between the February and December expiration dates, she expects the share price of XDF to:
A. decrease.
B. remain unchanged.
C. increase.
10. The option trade that Nuñes should recommend relating to the government committee’s
decision is a:
A. collar.
B. bull spread.
C. long straddle.
 Tutorial 11
Question 5
A firm’s assets are currently valued at $700 million, its current liabilities are $120 million, and long-term
liabilities are $300. The standard deviation of expected asset value is $76 million. Assume the firm has no
other debt and that the ratio of long term liabilities to short term liabilities is less than 1.5. What will be the
appropriate distance to default measure when utilizing Moody’s KMV Credit Monitor Model?
a. 9.21 standard deviation
b. 5.66 standard deviation
c. 3.68 standard deviation
d. 1.87 standard deviation
Question 6
Calculate the price of call and put options on a stock that does not pay any dividend using the following
information:
Maturity  1year
Exercise price  $88
Current price  $83.96
Expected return volatility  10%
Risk-free rate of return  6%
Question 7
Using the Merton model, calculate the value of the firm’s equity at t given that the current value of the firm
is $60 million, the principal amount due in 3 years on the zero-coupon bond is $50 million, the annual interest
rate, r, is 5%, and the volatility on the firm, sigma, is 10%.
Question 8
Suppose a firm with a value of $60 million has a bond outstanding with a face value of $50 million that
matures in three years. The current interest rate is 6% and the volatility of the firm is 25%. What is the
probability that the firm will default on its debt if the expected return on the firm, XX, is 15%? What is the
expected loss given default?