Updated: June 08, 2021

## Sample Level 2 CFA® Exam Questions: Portfolio Management

Megan Templer, CFA, is an employee of an asset management company. At the end of this month, she is to present a management plan for Chicago Safe Growth Fund 1 (CSGF 1) in front of the company's investment committee. Some of the characteristics of CSGF 1 are as follows:

• The fund is to provide a constant growth of net worth.
• The variance of its assets' returns should not be significant.
• The majority of the fund's portfolio is made up by large companies from well-developed industries.

Templer decides to use the arbitrage pricing theory in order to quantify risk and estimate rates of return. At the investment committee meeting, she begins with outlining her investment strategy and describing the APT. She presents the following assumptions of the theory:

Assumption 1: Nonsystematic risk is priced.

Assumption 2: No arbitrage opportunities exist.

Assumption 3: Return is explained by a multifactor model.

After presenting the assumptions, she chooses to emphasize the differences between the APT model and other multifactor models. She says, among other things, that:

Statement 1: The APT is useful for determining the expected return of an asset or a portfolio and if the market is in equilibrium, no arbitrage opportunities exist.

Statement 2: Assuming the APT, the intercept term is often the risk-free interest rate.

Statement 3: The intercept term in a macroeconomic model is usually equal to the risk-free interest rate and the factors are surprises in macroeconomic variables.

During the meeting, Megan presents a one-factor APT model for 3 different portfolios in order to show how to exploit an arbitrage opportunity:

Portfolio

Expected return (%)

Factor sensitivity

A

10%

1.5

B

12%

1.8

C

7%

0.8

Next, Megan presents her own model which she wants to use to determine the expected return of the fund. Templer shows the investment committee members the following equation:

$E(R_p)=R_F+\lambda_1\times\beta_{(\text{INF,1})}+\lambda_2\times\beta_{(\text{GDP,2})}+\lambda_3\times\beta_{(\text{CYCLE,3})}$

$E(R_p)=R_F+\lambda_1\times\beta_{(\text{INF,1})}+\\+\lambda_2\times\beta_{(\text{GDP,2})}+\lambda_3\times\beta_{(\text{CYCLE,3})}$

She also performs some sample calculations using the following data:

Factor 1

Factor 2

Factor 3

Factor sensitivity

-0.3

2.1

1.5

Factor risk premium (%)

-3.4

0.8

1.2

After the presentation, Templer and the investment committee members discuss her model in more detail.

QUESTION 1

Which of the following assumptions of the APT stated by Templer is least likely correct?

• a. Assumption 1
• b. Assumption 2
• c. Assumption 3

QUESTION 2

Which of the following statements uttered by Templer is least likely correct?

• a. Statement 1
• b. Statement 2
• c. Statement 3

QUESTION 3

Taking into account Portfolios B and C, which of the following are the parameters of the one-factor model presented by Templer?

• a. The risk-free rate of 5% and the factor price of 3%.
• b. The risk-free rate of 3% and the factor price of 5%.
• c. The risk-free rate of 5% and the factor risk premium of 5%.

QUESTION 4

Which of the following sample portfolios is most likely overvalued relative to its factor risk?

• a. Portfolio A
• b. Portfolio B
• c. Portfolio C

QUESTION 5

Which of the following statements best describes the process of arbitrage among sample one-factor portfolios?

• a. We should sell short Portfolios B and C and purchase the arbitrage portfolio with the same factor sensitivity as for Portfolio A.
• b. We should sell short the arbitrage portfolio and purchase Portfolio A with the same factor sensitivity as for the arbitrage portfolio.
• c. We should sell short Portfolio A and purchase Portfolios B and C in a proportion that gets us the same factor sensitivity as for Portfolio A.

QUESTION 6

Assuming that the return on T-bills is 4%, the expected return from Templer’s three-factor model is closest to:

• a. 6.46%.
• b. 7.48%.
• c. 8.50%.

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