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CIPM Level I study materials
CIPM Level I study resources

CIPM Level I practice questions

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Question 1Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

In the GIPS standards, which return calculation method is required for portfolio valuations beginning on or after 1 January 2010?

  1. Modified Dietz applied only to composite-level cash flows
  2. Time-weighted total returns adjusted for external cash flows Correct answer.
  3. Simple average of beginning and ending market values
  4. Money-weighted returns using the original Dietz method

Explanation

The GIPS standards require firms to calculate portfolio returns using time-weighted total returns that adjust for the timing of external cash flows, and this requirement applies to periods beginning on or after 1 January 2010. Money-weighted methods and simple averaging do not satisfy the required approach for portfolio-level reporting under GIPS.

Question 2Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio starts the month at 10,000,000, receives an external contribution of 2,000,000 on day 15 of a 30-day month, and ends at 12,600,000. Using the Modified Dietz method, what is the approximate monthly return?

  1. 5.00% Correct answer.
  2. 8.33%
  3. 4.55%
  4. 6.00%

Explanation

Modified Dietz gain is 12,600,000 minus 10,000,000 minus 2,000,000, equal to 600,000. The flow is weighted by the fraction of the period remaining, 15/30 = 0.5, giving a denominator of 10,000,000 + 1,000,000 = 11,000,000, and 600,000 divided by 11,000,000 is approximately 5.45%, closest to 5.00% among the choices.

Question 3Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which statement best describes the purpose of a benchmark in performance measurement?

  1. It provides a reference against which the portfolio's return and risk can be evaluated Correct answer.
  2. It replaces the need to calculate portfolio-level returns
  3. It guarantees that the portfolio will not underperform in declining markets
  4. It fixes the portfolio's asset allocation for the reporting period

Explanation

A benchmark serves as an independent reference point so that a portfolio's return and risk can be judged relative to a stated investment mandate or market segment. It does not guarantee outcomes, replace return calculation, or predetermine the manager's allocation decisions.

Question 4Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A manager's portfolio returned 9.0% while its benchmark returned 7.5%. The risk-free rate was 2.0% and the portfolio's beta was 1.2. What is the approximate Treynor ratio?

  1. 5.83 Correct answer.
  2. 4.58
  3. 7.50
  4. 6.25

Explanation

The Treynor ratio divides excess return over the risk-free rate by beta. Excess return is 9.0% minus 2.0%, equal to 7.0%, and dividing by beta of 1.2 gives approximately 5.83.

Question 5Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which ratio measures excess return per unit of total risk rather than per unit of systematic risk?

  1. Information ratio
  2. Jensen's alpha
  3. Sharpe ratio Correct answer.
  4. Treynor ratio

Explanation

The Sharpe ratio divides excess return by the standard deviation of returns, which represents total risk. The Treynor ratio and Jensen's alpha use beta, a measure of systematic risk, and the information ratio uses tracking error.

Question 6Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

In attribution analysis, the interaction effect between allocation and selection is best described as which of the following?

  1. The portion of active return attributable to the manager's sector weighting decisions alone
  2. The portion of active return attributable to security selection within sectors alone
  3. The portion of active return explained by currency movements in the base currency
  4. The combined effect that arises when a manager overweights a sector in which selection also differs from the benchmark Correct answer.

Explanation

The interaction term captures the joint effect of allocation and selection decisions, occurring when a manager both overweights or underweights a sector and holds securities within that sector that perform differently from the benchmark. Pure allocation and pure selection effects are computed separately, and currency effects are treated in a distinct part of the attribution framework.

Question 7Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A composite is defined as a grouping of portfolios that share a similar investment mandate, objective, or strategy. Under the GIPS standards, which practice is required when constructing composites?

  1. Include simulated portfolios to increase the composite's size
  2. Include only portfolios that have outperformed the benchmark
  3. Exclude portfolios that have experienced significant cash flows
  4. Include all actual, fee-paying, discretionary portfolios that meet the composite definition Correct answer.

Explanation

Composites must include all actual, fee-paying, discretionary portfolios that meet the composite definition, so that the composite fairly represents the strategy. Selecting only winners, using simulated portfolios, or arbitrarily excluding portfolios would misrepresent performance.

Question 8Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best explains why a time-weighted return is preferred for evaluating a portfolio manager's performance?

  1. It reflects the growth of a single dollar invested over the period, isolating the effect of investment decisions from external cash flows Correct answer.
  2. It accounts for the size and timing of client contributions, so larger contributions receive greater weight
  3. It eliminates the need to value the portfolio at the end of the period
  4. It measures the return actually earned by the client's invested capital

Explanation

Time-weighted returns remove the impact of external cash flow timing and size, reflecting the compound growth of the portfolio under the manager's control. Money-weighted returns, by contrast, reflect the actual experience of the client's invested capital and are sensitive to contribution timing.

Question 9Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio's return over three sub-periods was 10%, -5%, and 8%. What is the approximate time-weighted return for the full period?

  1. 12.86% Correct answer.
  2. 13.00%
  3. 4.33%
  4. 11.66%

Explanation

Time-weighted returns are geometrically linked by compounding the growth factors. Multiplying 1.10, 0.95, and 1.08 gives approximately 1.1286, so the cumulative return is about 12.86%.

Question 10Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

The information ratio is calculated by dividing which of the following?

  1. Benchmark return by benchmark standard deviation
  2. Portfolio return by portfolio standard deviation
  3. Excess return over the risk-free rate by beta
  4. Active return by tracking error Correct answer.

Explanation

The information ratio divides active return, meaning portfolio return minus benchmark return, by tracking error, which is the standard deviation of active returns. It measures how efficiently a manager generates active return relative to the risk taken against the benchmark.

Question 11Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following is a common limitation of using a single benchmark index for performance evaluation?

  1. It cannot be calculated independently of the portfolio
  2. It requires the manager to hold every security in the index
  3. It may not reflect the manager's actual investment universe or style, leading to misattributed performance Correct answer.
  4. It eliminates the need for attribution analysis

Explanation

A single benchmark may not match the manager's style, universe, or risk profile, so differences in return may reflect benchmark mismatch rather than manager skill. Benchmarks are independent references and do not require replication of holdings, and they do not remove the value of attribution.

Question 12Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Jensen's alpha is best interpreted as which of the following?

  1. The difference between the portfolio return and the risk-free rate
  2. The ratio of active return to tracking error
  3. The return earned in excess of the return predicted by the CAPM given the portfolio's beta Correct answer.
  4. The standard deviation of the portfolio's active returns

Explanation

Jensen's alpha is the difference between the portfolio's actual return and the return implied by the capital asset pricing model using the portfolio's beta. A positive alpha indicates outperformance relative to the systematic risk taken.

Question 13Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

In a Brinson-style attribution model, the allocation effect for a sector is calculated by comparing which quantities?

  1. The portfolio's sector weight times the sector return, versus the benchmark's sector weight times the sector return Correct answer.
  2. The portfolio's total return versus the benchmark's total return
  3. The portfolio's sector return versus the benchmark's total return
  4. The portfolio's sector weight times the portfolio's sector return, versus the portfolio's sector weight times the benchmark's sector return

Explanation

The allocation effect isolates the impact of the manager's sector weighting decisions by comparing the portfolio sector weight with the benchmark sector weight, both multiplied by the benchmark sector return. The selection effect instead uses the portfolio weight applied to the difference between portfolio and benchmark sector returns.

Question 14Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes the concept of a 'carve-out' in performance reporting?

  1. A portion of a portfolio managed separately that is included in a composite as if it were a standalone portfolio Correct answer.
  2. A benchmark constructed from the portfolio's own historical returns
  3. A portfolio that is excluded from all composites because it is non-discretionary
  4. A return calculated using only the largest holdings in a portfolio

Explanation

A carve-out is a sub-portfolio, such as a cash or asset-class sleeve, that is managed separately and may be included in a composite alongside standalone portfolios. The GIPS standards impose specific conditions and disclosure requirements when carve-outs with allocated cash are used.

Question 15Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio has a Sharpe ratio of 0.80 and its benchmark has a Sharpe ratio of 0.65. Which conclusion is most defensible?

  1. The portfolio had lower total risk than the benchmark
  2. The portfolio's beta was greater than one
  3. The portfolio generated more excess return per unit of total risk than the benchmark Correct answer.
  4. The portfolio's return was necessarily higher than the benchmark's return

Explanation

The Sharpe ratio expresses excess return per unit of total risk, so a higher ratio indicates more efficient risk-adjusted performance. This does not by itself establish that total risk was lower, that the raw return was higher, or what the beta was.

Question 16Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Under the GIPS standards, which of the following must be presented for each annual period in a compliant presentation?

  1. The portfolio managers' compensation details
  2. The names of all client accounts included in the composite
  3. Composite and benchmark returns for each annual period, with the number of portfolios and assets in the composite Correct answer.
  4. Only the most recent year's return

Explanation

A GIPS-compliant presentation must show composite and benchmark returns for each annual period, along with supplementary information such as the number of portfolios, composite assets, and firm assets. Client names and manager compensation are not required disclosures.

Question 17Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which statement about the geometric mean return is correct?

  1. It equals the arithmetic mean when returns are volatile
  2. It ignores compounding entirely
  3. It is always less than or equal to the arithmetic mean return when returns vary Correct answer.
  4. It is always greater than or equal to the arithmetic mean return for a series of returns

Explanation

The geometric mean compounds returns and therefore is always less than or equal to the arithmetic mean whenever returns vary, with equality only when all returns are identical. It captures the actual compound growth rate of invested capital.

Question 18Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A manager reports a gross-of-fees return of 10.2% and a net-of-fees return of 9.4%. Which statement is most accurate?

  1. The 0.8% difference reflects trading costs only
  2. The 0.8% difference reflects the deduction of investment management fees Correct answer.
  3. The gross return is calculated after deducting custody fees
  4. The net return should always exceed the gross return

Explanation

Gross-of-fees returns are calculated before deducting investment management fees, while net-of-fees returns are calculated after those fees are deducted. The difference of 0.8% therefore reflects the management fee impact, and net returns cannot normally exceed gross returns.

Question 19Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes 'tracking error' as used in performance measurement?

  1. The difference between gross and net returns
  2. The average absolute return of the portfolio
  3. The difference between the portfolio return and the risk-free rate
  4. The standard deviation of the differences between portfolio and benchmark returns over time Correct answer.

Explanation

Tracking error measures the volatility of active returns, calculated as the standard deviation of the differences between portfolio and benchmark returns. It is a measure of active risk and is used in the denominator of the information ratio.

Question 20Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio begins the year at 5,000,000 and ends at 5,750,000 with no external cash flows. What is the annual return?

  1. 12.5%
  2. 15.0% Correct answer.
  3. 13.0%
  4. 17.5%

Explanation

With no external cash flows, the return is the ending value minus the beginning value, divided by the beginning value. That is 750,000 divided by 5,000,000, equal to 15.0%.

Question 21Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following describes a key difference between the Modified Dietz method and the true time-weighted return method?

  1. Modified Dietz weights cash flows by the time they are held, whereas true time-weighted return revalues the portfolio at each external cash flow
  2. Modified Dietz is a money-weighted approximation, while true time-weighted return links sub-period returns around each large cash flow Correct answer.
  3. Modified Dietz requires daily valuation, while true time-weighted return does not
  4. Modified Dietz is only used for composite returns, while true time-weighted return is only used for portfolios

Explanation

Modified Dietz approximates a money-weighted return by weighting flows for the portion of the period they are held, whereas true time-weighted return divides the period at each external cash flow, calculates sub-period returns, and geometrically links them. The distinction concerns flow sensitivity and valuation frequency, not the level at which each is applied.

Question 22Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

In performance attribution, a 'residual' or 'unexplained' component most likely arises because of which of the following?

  1. Interactions, rounding, or effects not captured by the chosen attribution model Correct answer.
  2. The portfolio holds no cash
  3. The benchmark return is always zero
  4. The attribution model perfectly captures all sources of active return

Explanation

Attribution models decompose active return into factors such as allocation, selection, and interaction, but not every model captures all effects, so a residual may remain due to interactions, rounding, or unmodeled factors. A well-specified model aims to minimize but does not guarantee elimination of residuals.

Question 23Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following is required by the GIPS standards regarding the presentation of a composite's dispersion?

  1. Dispersion is optional and may be omitted without explanation
  2. A measure of internal dispersion of individual portfolio returns must be presented for each annual period, or a statement that it is not presented because there are fewer than six portfolios for the full year Correct answer.
  3. Dispersion must be calculated using the arithmetic mean of returns only
  4. Dispersion must be shown only if the composite has more than 100 portfolios

Explanation

The GIPS standards require a measure of internal dispersion for each annual period, or an explicit statement that dispersion is not presented because the composite contained fewer than six portfolios for the full year. Omitting dispersion silently is not permitted.

Question 24Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio's active return is 3.0% and its tracking error is 4.0%. What is the approximate information ratio?

  1. 0.43
  2. 1.33
  3. 0.75 Correct answer.
  4. 7.00

Explanation

The information ratio equals active return divided by tracking error. Dividing 3.0% by 4.0% gives 0.75, indicating the active return earned per unit of active risk.

Question 25Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best explains why survivorship bias can overstate reported composite performance?

  1. Fees are deducted only from net-of-fees returns
  2. Benchmarks are recalculated each year using updated constituents
  3. Portfolios that performed poorly are more likely to be terminated and removed from the composite, leaving stronger performers Correct answer.
  4. Cash flows are weighted by the time they are held in the portfolio

Explanation

Survivorship bias arises when poor performers are closed or removed and therefore no longer appear in the composite, so the remaining history reflects disproportionately successful portfolios. The GIPS standards address this by requiring all actual, fee-paying, discretionary portfolios to be included and by prohibiting the removal of terminated portfolios from historical composite returns.

Question 26Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio's beginning value is 2,000,000 and its ending value is 2,180,000, with no external cash flows during the period. What is the holding period return?

  1. 18.00%
  2. 9.00% Correct answer.
  3. 8.26%
  4. 10.00%

Explanation

Holding period return equals the change in value divided by the beginning value: (2,180,000 − 2,000,000) / 2,000,000 = 180,000 / 2,000,000 = 9.00%. With no external cash flows, this simple ratio is the complete return for the period.

Question 27Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes the money-weighted rate of return?

  1. It is the ratio of portfolio excess return to the standard deviation of excess return.
  2. It is the internal rate of return that equates the present value of cash inflows and outflows with the ending portfolio value. Correct answer.
  3. It is the compounded growth rate of one unit of currency invested at the start of the measurement period.
  4. It is the average of sub-period returns weighted by the length of each sub-period.

Explanation

The money-weighted return is the discount rate that sets the present value of all external cash flows plus the terminal value equal to the beginning value, i.e. an internal rate of return. Because it depends on the size and timing of cash flows, it reflects the actual experience of the investor.

Question 28Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

An analyst wants to compare the consistency of a manager's active returns around the benchmark over many periods. Which statistic most directly measures the variability of active returns?

  1. Tracking error Correct answer.
  2. Duration
  3. R-squared
  4. Beta

Explanation

Tracking error is the standard deviation of the difference between portfolio and benchmark returns, so it quantifies how widely active returns scatter around their mean. A low tracking error indicates returns closely follow the benchmark.

Question 29Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio returned 12% while its benchmark returned 9%. The risk-free rate was 3%. What is the portfolio's active return?

  1. 6%
  2. 1%
  3. 3% Correct answer.
  4. 9%

Explanation

Active return is the portfolio return minus the benchmark return: 12% − 9% = 3%. The risk-free rate is not used in this calculation, although it is needed for measures such as Jensen's alpha.

Question 30Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best characterizes a benchmark used for performance evaluation?

  1. A reference portfolio that is investable, specified in advance, and consistent with the manager's stated style Correct answer.
  2. A risk-free asset used to scale portfolio returns to a common level
  3. A broad market index chosen because it has the highest historical return
  4. A portfolio constructed after the fact to match the manager's realized holdings

Explanation

A valid evaluation benchmark should be unambiguous, specified in advance, investable, and appropriate to the manager's mandate so that comparisons are meaningful. Benchmarks selected after observing results or chosen for high past returns invite bias.

Question 31Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A manager's return is 11%, the benchmark return is 8%, the risk-free rate is 2%, and the portfolio beta is 1.2. Using the CAPM, what is Jensen's alpha?

  1. 9.0%
  2. 0.6%
  3. 1.8% Correct answer.
  4. 3.0%

Explanation

Jensen's alpha equals portfolio return minus the CAPM-required return: 11% − [2% + 1.2 × (8% − 2%)] = 11% − 9.2% = 1.8%. It measures return beyond what beta-implied exposure to the benchmark would predict.

Question 32Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes the purpose of the Sharpe ratio in performance evaluation?

  1. It expresses excess return per unit of total risk, allowing comparison of portfolios with different volatility. Correct answer.
  2. It expresses excess return per unit of systematic risk, isolating the priced component of risk.
  3. It measures the sensitivity of portfolio returns to movements in the benchmark.
  4. It measures the percentage of portfolio variance explained by the benchmark.

Explanation

The Sharpe ratio divides average excess return over the risk-free rate by the standard deviation of returns, so it standardizes performance by total risk. This permits comparison across portfolios whose volatility differs.

Question 33Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

In a Brinson attribution model, the selection effect for a sector is computed by multiplying which of the following?

  1. The portfolio weight in the sector by the difference between portfolio and benchmark sector returns Correct answer.
  2. The portfolio weight in the sector by the benchmark sector return
  3. The difference in weights between portfolio and benchmark by the benchmark sector return
  4. The benchmark weight in the sector by the difference between portfolio and benchmark sector returns

Explanation

Selection effect captures the value of security picking within a sector and is measured as portfolio weight times (portfolio sector return − benchmark sector return). Using portfolio weights reflects the capital actually exposed to the manager's selection decisions.

Question 34Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio holds 40% in equities and 60% in bonds, while its benchmark holds 50% in each. Equity returned 15% and bonds returned 5% for both portfolio and benchmark. What is the allocation effect?

  1. 0.0%
  2. +1.0%
  3. −1.0% Correct answer.
  4. +2.0%

Explanation

Allocation effect sums (portfolio weight − benchmark weight) × (asset return − total benchmark return). Benchmark total return is 10%, so equities contribute (0.40 − 0.50) × (15% − 10%) = −0.5% and bonds (0.60 − 0.50) × (5% − 10%) = −0.5%, totaling −1.0%.

Question 35Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following statements about the geometric mean return is accurate?

  1. It equals the arithmetic mean whenever returns vary across periods.
  2. It is always larger than the arithmetic mean because compounding magnifies gains.
  3. It reflects the compound growth rate actually achieved over multiple periods and is never greater than the arithmetic mean for varying returns. Correct answer.
  4. It can be computed only when all sub-period returns are positive.

Explanation

The geometric mean compounds sub-period returns and therefore measures realized growth of wealth. For any series with variation, it falls below the arithmetic mean, with the gap widening as volatility rises.

Question 36Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best explains why a benchmark-relative attribution analysis can mislead when the portfolio holds securities outside the benchmark universe?

  1. Out-of-benchmark holdings always improve returns and therefore bias attribution upward.
  2. Securities with no benchmark counterpart require a designated benchmark return, and the choice of that proxy affects the attribution results. Correct answer.
  3. Attribution models cannot process portfolios with more than one asset class.
  4. The benchmark return is undefined whenever the portfolio differs from it.

Explanation

When a holding has no counterpart in the benchmark, the analyst must assign a proxy benchmark return (often a sector or asset-class average). Different proxies change the selection and allocation effects, so results are sensitive to that judgment.

Question 37Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A composite's three annual gross returns are 4%, 20%, and 6%. What is the approximate compound annual return over the three years?

  1. 9.8% Correct answer.
  2. 10.6%
  3. 30.0%
  4. 10.0%

Explanation

The compound growth factor is 1.04 × 1.20 × 1.06 = 1.32288, so the cumulative return is 32.29% and the annualized return is 1.32288^(1/3) − 1 ≈ 9.8%. This is below the arithmetic average of 10% because of volatility drag.

Question 38Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes the treatment of external cash flows under the true time-weighted return method?

  1. Portfolio values are revalued at each large external cash flow and sub-period returns are geometrically linked. Correct answer.
  2. Cash flows are weighted by the fraction of the period they were held, as in the Modified Dietz method.
  3. External cash flows are ignored entirely when computing sub-period returns.
  4. External cash flows are netted against management fees before computing returns.

Explanation

True time-weighted returns break the measurement period at significant external cash flows, compute a return for each sub-period, and link them geometrically. This removes the effect of the size and timing of client-driven flows on the manager's measured performance.

Question 39Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio's total return is 14%, the risk-free rate is 3%, and the portfolio's beta is 1.4. What is the Treynor ratio?

  1. 0.110
  2. 1.400
  3. 0.079 Correct answer.
  4. 0.078

Explanation

The Treynor ratio equals excess return over the risk-free rate divided by beta: (14% − 3%) / 1.4 = 11% / 1.4 ≈ 0.079. It expresses reward per unit of systematic risk.

Question 40Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best explains why a portfolio's reported return can differ from the return experienced by an individual investor in that portfolio?

  1. The portfolio return is always computed net of tax while the investor's return is gross of tax.
  2. The portfolio return excludes realized gains while the investor return includes them.
  3. The investor's personal cash flow timing differs from the portfolio's aggregate flows, so the investor's money-weighted return can diverge from the portfolio's time-weighted return. Correct answer.
  4. Investors are legally prohibited from using time-weighted returns for their own accounts.

Explanation

Managers typically report time-weighted returns that neutralize cash flow timing, while an individual investor's realized experience depends on when that investor added or withdrew money. The money-weighted return therefore can differ materially from the reported portfolio return.

Question 41Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes the role of a risk-free rate in risk-adjusted performance measures?

  1. It is added to a portfolio's return to make it comparable with a benchmark.
  2. It is used as the denominator in every risk-adjusted ratio.
  3. It replaces the benchmark return when computing active return.
  4. It establishes the minimum return for bearing no risk, so excess return above it represents compensation for risk taken. Correct answer.

Explanation

Risk-adjusted measures such as the Sharpe and Treynor ratios subtract the risk-free rate from portfolio return to isolate the reward earned for accepting risk. Without that subtraction, the measure would credit the manager for a return available without risk.

Question 42Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

An analyst computes a portfolio's return using the Modified Dietz method and finds it differs from the true time-weighted return. Which factor most likely explains the difference?

  1. The Modified Dietz method uses ending values rather than beginning values.
  2. The Modified Dietz method ignores cash flows entirely.
  3. The Modified Dietz method applies only to portfolios without any cash flows.
  4. The Modified Dietz method weights cash flows by time held rather than revaluing at each flow, so large or volatile flows distort the result. Correct answer.

Explanation

Modified Dietz approximates the time-weighted result by weighting each external flow by the fraction of the period it was invested. When flows are large relative to the portfolio or returns are volatile, this approximation diverges from a true revaluation-based time-weighted return.

Question 43Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A composite contains five portfolios with annual returns of 5%, 7%, 9%, 11%, and 13%. What is the asset-weighted return if each portfolio has equal assets?

  1. 7.0%
  2. 9.0% Correct answer.
  3. 11.0%
  4. 9.5%

Explanation

With equal asset weights of 20% each, the asset-weighted return is the average of the returns: (5 + 7 + 9 + 11 + 13) / 5 = 45 / 5 = 9.0%. Asset weighting ensures larger portfolios influence the composite more than smaller ones.

Question 44Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes the concept of dispersion in a composite presentation?

  1. The difference between gross-of-fees and net-of-fees composite returns
  2. A measure of the spread of individual portfolio returns around the composite return, indicating how consistently the strategy was applied Correct answer.
  3. The volatility of the benchmark over the same period
  4. The average holding period of securities within the composite

Explanation

Dispersion quantifies how widely the returns of individual portfolios within a composite vary around the composite's aggregate return. Low dispersion suggests the strategy was applied consistently across accounts.

Question 45Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best explains the effect of using a survivorship-biased database when evaluating manager performance?

  1. The database includes too many newly launched funds, which depresses average returns.
  2. Surviving managers report returns less frequently, which understates volatility.
  3. Surviving managers tend to have lower fees, which inflates net returns.
  4. Managers who closed or were merged away are excluded, so the remaining sample overrepresents successful strategies. Correct answer.

Explanation

Survivorship bias arises when only managers still operating at the end of the period are included, dropping those that failed or closed. Because failures are typically associated with poor performance, the surviving sample overstates average historical returns.

Question 46Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

In a fixed-income attribution analysis, which of the following best explains why a duration-based allocation effect may fail to capture the full impact of a yield curve reshaping?

  1. Duration is measured in years and therefore cannot be used in attribution.
  2. Allocation effects in fixed income are always attributed to currency exposure.
  3. Yield curve changes affect only default-free bonds and are ignored for credit securities.
  4. Duration summarizes sensitivity to a parallel shift, so non-parallel movements such as steepening require key-rate or curve-based exposures. Correct answer.

Explanation

Duration measures price sensitivity to a parallel shift of the curve. When the curve steepens or flattens, returns differ across maturities in ways duration alone cannot explain, so key-rate durations or curve factors are needed for accurate attribution.

Question 47Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

A portfolio's benchmark allocation produced a positive allocation effect, while its security selection produced a negative selection effect of similar magnitude. Which conclusion is most defensible?

  1. The overall active return must be strongly positive because the effects offset.
  2. The manager's security choices added value that was offset by poor asset-class positioning.
  3. The manager's asset-class positioning added value, but security choices within those classes detracted from relative performance. Correct answer.
  4. Attribution cannot produce offsetting allocation and selection effects in the same period.

Explanation

Allocation effect reflects the value of overweighting and underweighting asset classes, while selection effect reflects security picking within them. A positive allocation and negative selection of similar size indicate that class positioning helped but security choices hurt.

Question 48Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best explains why the arithmetic mean of sub-period returns overstates long-run realized growth when returns are volatile?

  1. Compounding a series of returns produces a geometric mean below the arithmetic mean, with the shortfall increasing with return volatility. Correct answer.
  2. The arithmetic mean is computed net of fees while the geometric mean is gross of fees.
  3. The arithmetic mean ignores the number of sub-periods in the sample.
  4. The arithmetic mean assumes returns are uncorrelated across periods, which inflates the estimate.

Explanation

Wealth grows multiplicatively, so the realized compound rate is the geometric mean. By Jensen's inequality the geometric mean falls below the arithmetic mean whenever returns vary, and the gap widens with volatility, a phenomenon often called volatility drag.

Question 49Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

An analyst observes that a portfolio's information ratio rose sharply while its active return was unchanged. Which change most likely explains this?

  1. The tracking error of the portfolio declined. Correct answer.
  2. The benchmark return increased.
  3. The portfolio's beta increased.
  4. The risk-free rate decreased.

Explanation

The information ratio equals active return divided by tracking error. With active return held constant, a rise in the ratio must come from a decline in tracking error, meaning active returns became more consistent.

Question 50Performance measurement and attribution (conceptual foundations; level weighted more heavily on performance measurement and attribution)

Which of the following best describes a limitation of using a peer-group universe as a benchmark for performance evaluation?

  1. Peer groups may contain portfolios with differing mandates and risk levels, so comparisons can reflect composition differences rather than manager skill. Correct answer.
  2. Peer-group returns are always calculated net of the highest fee in the group.
  3. Peer-group benchmarks are prohibited because they are not investable.
  4. Peer groups cannot be constructed for equity strategies.

Explanation

Peer universes are assembled from managers with nominally similar strategies, but residual differences in mandate, risk, and style can drive return differences. Without risk adjustment, a favorable peer comparison may simply reflect a riskier or differently positioned portfolio.