CFA Exam Question of the Day

Level I | Level II | Level III

2022-07-01

Question:
If the spot exchange rate is 1.05, the home country short-term interest rate is 0.06, and the foreign country short-term interest rate is 0.07, what is the forward exchange rate?

Select an Answer:
0.94
1.54
1.14
1.04
1.23
Rationale:
Forward exchange rate =



It follows:


2022-06-30

Question:
A single government bond has a current market value of $1,000,000 and duration of 1.22.

The daily standard deviation associated with such bonds is 0.85%, and the current yield is 10%. The time until the risk associated with the bond is eliminated is 6 days. The standardized value from a normal distribution associated with the target probability is 2.65.

What is the VAR?

Select an Answer:
$6,731.32
$7,731.32
$6,751.32
$6,831.32
Rationale:
We know that the Change in yield basis points per day = Daily standard deviation × Yield level × Standardized value from normal distribution associated with the target probability. It follows that the Change in yield basis points per day = 0.0085 × 0.1 × 2.65 = 0.0022525 = 22.525 basis points. Further, we know that:



It follows that:



Further, we know that:



It follows that:


2022-06-29

Question:
A single government bond has a current market value of $1,000 and duration of 0.62.

The daily standard deviation associated with such bonds is 0.32%, and the current yield is 13%. The time until the risk associated with the bond is eliminated is 25 days. The standardized value from a normal distribution associated with the target probability is 1.65.

What is the VAR?

Select an Answer:
$2.1278
$10.4256
-$1.4256
$20.4256
Rationale:
We know that the Change in yield basis points per day = Daily standard deviation × Yield level × Standardized value from normal distribution associated with the target probability. It follows that the Change in yield basis points per day = 0.0032 × 0.13 × 1.65 = 0.0006864 = 6.864 basis points. Further, we know that:



It follows that:



Further, we know that:



It follows that:


2022-06-28

Vignette:
Tom Malloy, Jonathan Mueller, and Mark Serra are passive indexing managers at Standard Asset Management Company. They are attending an investment committee meeting discussing the appropriate tracking index for each of the three new passive indexing funds that will be launched later this year.

Tom Malloy prefers to track an index that does not require continuous share number adjustments for the index components because of corporate events such as stock splits, stock dividends, or reverse splits. Malloy's fund will invest in global emerging markets. He is considering the international XYZ tracking index. XYZ covers more than 90% of the market and was launched six months ago.

Jonathan Mueller states that his fund will be fully replicated and invested mainly in large-cap growth stocks. His main goal is to achieve an active risk close to zero with very low portfolio turnover. The fund won't be subject to weight limits and certain concentrated positions will be allowed in order to facilitate tracking error minimization.

Mark Serra states that his fund will be invested mainly in large and mid cap stocks and will avoid small market cap stocks because they are relatively illiquid. He is also very concerned about the transaction costs and will aim to avoid frequent rebalancing because the prospective investors in the fund are tax sensitive. He is considering the widely accepted and popular DMA tracking index.

Question:
Given his investment scope, which tracking index weighting scheme would be the most appropriate choice for Jonathan Mueller?

Select an Answer:
return-weighted index
float adjusted market capitalization weighted index
equally-weighted index
price-weighted index
Rationale:
A float adjusted market capitalization weighted index is the most appropriate choice because it tends to be mostly affected by the largest and overvalued companies with high P/E ratios such as growth stocks. The full replication method results in a fund structure that is almost identical to the structure of the tracking index. This makes the value (float)-weighting scheme again the most appropriate choice.

Usually, the bias towards large market cap issues leads to less diversified and more concentrated portfolios. In this case, Mueller's fund won't be subject to weight limits and certain concentrated positions will be allowed in order to facilitate tracking error minimization. This makes tracking of some value/float weighted index feasible. Finally, Mueller's main goal is to achieve an active risk close to zero with very low portfolio turnover. A free float-weighting scheme facilitates this goal to the fullest extent.

2022-06-27

Vignette:
Robert Atkinson, Philip Hubbard, and Arthur Keller are members of the investment committee of International Equity Group (IEG). IEG is planning to launch a new equity fund later this year. They are discussing which equity approach to choose for the new fund among the main three equity investment approaches - passive management, active management, and semi-active management. The new fund will be mainly invested in global emerging markets, in large-cap equities.

Atkinson believes that the equity market is efficient and that equity research and analysis won't generate a sufficient incremental return to compensate for the incremental cost. He mentions that it is more realistic to aim to mimic the benchmark in terms of performance and risk-return characteristics. He prefers a strategy with a passive implementation that will generate very low transaction cost because once the stocks are bought, they are held long term. Atkinson suggests that IEG pursue a passive indexing approach.

Philip Hubbard believes that it is possible to find consistently large pockets of inefficiency through thorough equity research thereby generating positive incremental return, net of all incremental cost, over the benchmark. It is a realistic goal to earn an active return by overweighting or underweighting the stocks that the manager has an opinion about, while holding all other stocks at the same weight as the benchmark. Hubbard suggests that IEG pursue an active management approach.

Arthur Keller agrees with Hubbard that the equity market is often inefficient. He believes that it is realistic to attempt to generate some active return over the benchmark while keeping the active risk (i.e., tracking error) at a very low level. He continues that a portfolio manager can outperform a benchmark index by identifying stocks that will perform better/worse than the benchmark and respectively buying/avoiding them and not holding stocks that he or she has no opinion about. Keller suggests that IEG pursue a semi-active management approach.

Philip Hubbard points out that any active management strategy is expected to generate a higher active return and hence a higher information ratio compared to any enhanced indexing strategy. That is why Hubbard states that the active investment approach provides the most attractive risk-return relationship and delivers an active return in the most efficient way. Arthur Keller argues that the enhanced indexing strategy is expected to earn a less active return at a much lower level of active risk compared to the full active strategy, resulting in a higher information ratio than a full active strategy. Therefore, the semi-active investment approach offers the most efficient active return - active risk pay off.

Robert Atkinson reminds his colleagues that the passive indexing strategy is the most suitable for tax sensitive investors because of the lowest level of transaction cost as compared to the active approach. Philip Hubbard agrees with Atkinson, but notes that despite the lowest portfolio turnover and the lowest management fees of indexing portfolios, in the long run the active management strategies manage to beat the passive indexing performance, net-of-expenses.

Question:
Given the information that the new fund will be mainly invested in international large-cap equities, which investment approach is considered most appropriate?

Select an Answer:
active management
passive management
risk controlled active management
semi-active management
Rationale:
The passive indexing approach has a comparative advantage to the active and semi-active management approaches in efficient market segments.

The large-cap market segment is highly efficient and it is very difficult to outperform the respective benchmark index by identifying and consistently taking advantage of inefficient prices.

In addition, passive indexing is very appropriate for markets with which an investor is relatively unfamiliar - like emerging international markets.

In these markets, the local investors will usually have an informational advantage as compared to foreign investors.