CIMA Risk & Return Analysis 3 β Questions and Answers
Question 1: A manager's portfolio earned 11% while the benchmark returned 8%. If the portfolio's tracking error is 5%, what is the information ratio?
- 0.60 (Correct answer)
- 0.55
- 0.40
- 0.70
Correct answer: 0.60
Information ratio = (11% β 8%) / 5% = 3% / 5% = 0.60.
Question 2: According to Modern Portfolio Theory, the efficient frontier represents portfolios that offer:
- Maximum expected return for a given level of risk (Correct answer)
- Minimum risk for any level of return below the minimum-variance portfolio
- The highest Sharpe ratio at every risk level
- Equal risk-return trade-offs regardless of investor preferences
Correct answer: Maximum expected return for a given level of risk
The efficient frontier consists of portfolios dominating all others by providing the highest return for each risk level.
Question 3: Value at Risk (VaR) at the 95% confidence level over one day means:
- There is a 5% probability that losses will exceed the VaR amount in a single day. (Correct answer)
- Losses will never exceed the VaR amount.
- The expected loss over one day equals the VaR.
- 95% of returns will be positive on any given day.
Correct answer: There is a 5% probability that losses will exceed the VaR amount in a single day.
A 95% one-day VaR implies a 5% chance (1 in 20 trading days) of losses exceeding the stated amount.
Question 4: Which limitation of VaR is directly addressed by Conditional VaR (CVaR)?
- VaR does not indicate the magnitude of losses beyond the threshold. (Correct answer)
- VaR uses historical data that may not predict future risks.
- VaR cannot be applied to non-normal return distributions.
- VaR requires subjective assumptions about the holding period.
Correct answer: VaR does not indicate the magnitude of losses beyond the threshold.
CVaR (Expected Shortfall) measures the average loss given that the loss exceeds the VaR threshold, addressing VaR's tail-blindness.
Question 5: A bond portfolio has a duration of 6 years. If interest rates rise by 50 basis points, the approximate percentage price change is:
- β3.0% (Correct answer)
- +3.0%
- β6.0%
- +6.0%
Correct answer: β3.0%
Approximate price change = βDuration Γ Ξy = β6 Γ 0.005 = β0.03 = β3.0%.
Question 6: The geometric mean return is preferred over the arithmetic mean for measuring historical portfolio performance because it:
- Accounts for the compounding effect and reflects the actual growth of wealth over time (Correct answer)
- Always produces a higher value than the arithmetic mean
- Eliminates the impact of outliers in the return series
- Is easier to compute when returns are volatile
Correct answer: Accounts for the compounding effect and reflects the actual growth of wealth over time
The geometric mean captures compounding and equals the constant annual return that would produce the same ending wealth.
Question 7: Kurtosis greater than 3 (leptokurtic distribution) in an asset's return distribution implies:
- Fatter tails and higher probability of extreme returns than a normal distribution (Correct answer)
- Returns are more evenly distributed around the mean than normal
- The distribution is skewed to the right
- Variance is lower than expected under normality
Correct answer: Fatter tails and higher probability of extreme returns than a normal distribution
Leptokurtic distributions have excess kurtosis > 0, meaning heavier tails and a higher likelihood of extreme outcomes.
CIMA Risk & Return Analysis 3
A manager's portfolio earned 11% while the benchmark returned 8%.
If the portfolio's tracking error is 5%, what is the information ratio?