FYI, In general (during most of the year) I write daily questions according to the sequence of the Study Guide AIMs, which try to give a sufficiently deep dive into material.
However, I am now pausing that AIM-by-AIM process, until after the May exam. Instead, my new questions will constitute new BT Practice ("Mock") Exams. So, instead of the typical deep, AIM-by-AIM treatment, the new questions will instead address topics more generally (and, also, the intent is less "deep dive" and more to suss out testable material; e.g., I am referencing GARP's prior question to inform these). Thanks! David
Questions:
1. In each of the following cases according to theory (Stulz), a good risk management program should create firm value, EXCEPT for:
a. The program reduces idiosyncratic (firm-specific) risk while the firm depends on a large, active shareholder who is not diversified (e.g., private equity firm)
b. The program hedges the firm's exposure to oil prices--a common (systematic) risk factor--with a short position in oil futures contracts while the firm is owned by shareholders who are well-diversified
c. The program reduces the volatility of taxable earnings, effectively avoiding progressively higher tax rates in higher tax brackets
d. The program reduces the debt overhang which causes shareholders to avoid positive net present value projects
2. While the risk-free rate was 4.0%, a portfolio's realized a return of 14.0% exactly matched the return of its benchmark, the market index, which also returned 14.0%. The portfolio's covariance (of returns) with the market index was 0.01440 and the market's volatility was 20.0%. What was the Jensen's alpha of the portfolio?
a. -1.6%
b. Zero
c. +3.2%
d. +6.4%
3. A portfolio has an expected return of 11.0% with volatility of 24.0%. The benchmark has an expected return of 5.0% with volatility of 15%. The expected returns correlation is 0.80. What is the expected (ex ante) information ratio (IR)?
a. 0.40
b. 0.55
c. 0.69
d. 0.80
4. Which of the following factors LEAST contributed to the disaster at Metallgesellschaft?
a. Failure to deliver on a few high-profile customer contracts incurred unexpected reputational risk
b. Basis risk implied by short-term hedges against long-term exposures
c. Roll return on long futures contract was negative (creates losses) under contango in the oil forward curve
d. Unlike forwards, futures contracts required daily cash settlement
5. You colleague Roger is building a customized variation of the Merton model to estimate the credit risk of a portfolio of bonds issued by publicly-traded companies: his "structural" model will estimate each company's probability of default (EDF) by estimating the one- and three-year distance-to-default (DD), a measure of solvency which compares the predicted firm's asset value to a debt threshold. As the portfolio company have traded equities, the model does not perform any pricing; e.g., the value and volatility are exogenous inputs (given as assumptions). The model is strictly an application of risk measurement, not valuation or derivatives valuation. Roger makes four statements about his credit risk measurement model. Which is most likely problematic?
a. It is not precise
b. It does not discount to present value, it only estimates a future distribution
c. Justified by no arbitrage, it avoids the actual expected return and a physical distribution; and instead assumes the risk-free rate and a risk-neutral distribution
d. It replaces the Merton assumption of a lognormal asset price distribution with a alternative distribution
Answers:
However, I am now pausing that AIM-by-AIM process, until after the May exam. Instead, my new questions will constitute new BT Practice ("Mock") Exams. So, instead of the typical deep, AIM-by-AIM treatment, the new questions will instead address topics more generally (and, also, the intent is less "deep dive" and more to suss out testable material; e.g., I am referencing GARP's prior question to inform these). Thanks! David
Questions:
1. In each of the following cases according to theory (Stulz), a good risk management program should create firm value, EXCEPT for:
a. The program reduces idiosyncratic (firm-specific) risk while the firm depends on a large, active shareholder who is not diversified (e.g., private equity firm)
b. The program hedges the firm's exposure to oil prices--a common (systematic) risk factor--with a short position in oil futures contracts while the firm is owned by shareholders who are well-diversified
c. The program reduces the volatility of taxable earnings, effectively avoiding progressively higher tax rates in higher tax brackets
d. The program reduces the debt overhang which causes shareholders to avoid positive net present value projects
2. While the risk-free rate was 4.0%, a portfolio's realized a return of 14.0% exactly matched the return of its benchmark, the market index, which also returned 14.0%. The portfolio's covariance (of returns) with the market index was 0.01440 and the market's volatility was 20.0%. What was the Jensen's alpha of the portfolio?
a. -1.6%
b. Zero
c. +3.2%
d. +6.4%
3. A portfolio has an expected return of 11.0% with volatility of 24.0%. The benchmark has an expected return of 5.0% with volatility of 15%. The expected returns correlation is 0.80. What is the expected (ex ante) information ratio (IR)?
a. 0.40
b. 0.55
c. 0.69
d. 0.80
4. Which of the following factors LEAST contributed to the disaster at Metallgesellschaft?
a. Failure to deliver on a few high-profile customer contracts incurred unexpected reputational risk
b. Basis risk implied by short-term hedges against long-term exposures
c. Roll return on long futures contract was negative (creates losses) under contango in the oil forward curve
d. Unlike forwards, futures contracts required daily cash settlement
5. You colleague Roger is building a customized variation of the Merton model to estimate the credit risk of a portfolio of bonds issued by publicly-traded companies: his "structural" model will estimate each company's probability of default (EDF) by estimating the one- and three-year distance-to-default (DD), a measure of solvency which compares the predicted firm's asset value to a debt threshold. As the portfolio company have traded equities, the model does not perform any pricing; e.g., the value and volatility are exogenous inputs (given as assumptions). The model is strictly an application of risk measurement, not valuation or derivatives valuation. Roger makes four statements about his credit risk measurement model. Which is most likely problematic?
a. It is not precise
b. It does not discount to present value, it only estimates a future distribution
c. Justified by no arbitrage, it avoids the actual expected return and a physical distribution; and instead assumes the risk-free rate and a risk-neutral distribution
d. It replaces the Merton assumption of a lognormal asset price distribution with a alternative distribution
Answers:
