Question #1 of 100

Jimmy Deininger, CAIA, manages several client portfolios in his position with Mountain Investments,
LLC. One of Deininger's clients offers him use of a cabin in a vacation spot in Colorado because the
client's investment results under Deininger's management have exceeded the client's goals. Deininger
discloses the gift to his employer. With reference to the Standards of Practice, Deininger:

A. has complied with the Standards and may accept the gift.
B. is not permitted to accept the gift because he does not have permission from his employer.
C. has appropriately disclosed the gift to his supervisor but must also disclose it to his other
clients.
D. is not permitted to accept the gift because the value of the gift likely exceeds the maximum
allowable amount.

Question #2 of 100
Judy Harter works for a large brokerage firm managing portfolios for individuals. In a meeting with
Patty Owen, an elderly client, Harter suggests moving a portion of Owen's portfolio to U.S. bank
certificates of deposit (CDs) to reduce the downside risk of the portfolio. Harter states that the
principal is guaranteed up to Federal Deposit Insurance Corporation limits. Harter has:

A. complied with CFA Institute Standards of Professional Conduct.

B. violated CFA Institute Standards by making an inappropriate assurance or guarantee.
C. violated CFA Institute's Standards by misrepresenting the terms and character of the
investment.
D. violated CFA Institute's Standards by failing to make this investment recommendation to all
clients simultaneously.

Question #3 of 100
The recommended procedures for the CFA Institute Standards on material nonpublic information
state that a firm's internal information firewall should include:

A. the distribution of a restricted list to all employees in the relevant departments of the firm.
B. a third-party monitoring system to ensure that company employees are not bypassing the
firewall.
C. a prohibition against buying and selling when the firm possesses material nonpublic
information.
D. a reporting system in which authorized personnel review and approve interdepartmental
communications.

Question #4 of 100
Which of the following actions most likely violates Standard II(B) Market Manipulation?

A. Entering an order to buy a large block of a thinly traded stock whenever its price falls below
$10.
B. Selling a security and repurchasing it immediately to change its cost basis for taxation
purposes.
C. Waiting for a down day in the market to release a ratings downgrade to maximize its impact
on a stock's price.

Exam 1 Section 2 1
 D. Posting a company's unexpectedly weak earnings report and negative comments to a popular
Internet forum for investors.

Question #5 of 100
Jerry Brock, CAIA, is a partner at a fund of hedge funds that caters to ultra high net worth individuals.
He has experienced a number of personal and financial setbacks over the past two years and has filed
for bankruptcy protection. Has Brock violated the CFA Institute Standards of Professional Conduct?

A. No, but he must disclose the bankruptcy filing to his clients.

B. No, unless his personal financial difficulties result from actions that reflect adversely on his
honesty and integrity.
C. Yes, because the bankruptcy is indicative of Brock's lack of financial knowledge.
D. Yes, because Brock must conduct his personal and professional business in a manner that
protects his reputation and integrity.

Question #6 of 100
For a portfolio manager to accept a bonus from a client, such as a free vacation, based on excellent
performance in a future period is:

A. a violation of the Standards if the bonus is from a client and not a third-party vendor.
B. a violation of the Standards unless the manager gets written consent from her employer.
C. not a violation of the Standards as long as the manager informs her employer that she intends
to accept the bonus.
D. not a violation of the Standards as long as client confidentiality is maintained.

Question #7 of 100
Victor Baltz manages the investment account of Martha Stallings, a widow who lives off her
investment accounts and is relatively risk averse. One of the securities in Stallings's account has a beta
of 1.5, and Baltz has also sold call options on these shares. With respect to these actions, Baltz has:

A. violated the Standards, both by buying the high-beta stock and by selling the calls.
B. violated the Standards by selling the options but not by purchasing the high-beta stock.
C. violated the Standards by purchasing the high-beta stock but not by selling the call options.
D. not necessarily violated the Standards because it is the risk of the entire portfolio that is
relevant in judging suitability.

Question #8 of 100
According to the CFA Institute Standard concerning fair dealing, new or changed investment
recommendations should be made available to:

A. only clients who have indicated a prior interest in that type of security.
B. all clients.
C. only clients who have selected a level of service that includes such notification.
D. only clients whose investment portfolios are of sufficient size.

Question #9 of 100
The CFA Institute Standard on performance presentation least likely recommends that investment
professionals:

Exam 1 Section 2 2
 A. include terminated accounts in performance history.
B. disclose whether performance is gross or net of fees.
C. support any forecast of future performance with actual data on past performance.
D. present performance of a weighted composite of similar portfolios rather than a single
account.

Question #10 of 100

Jill Fiedler is a portfolio manager for Aspire Investments, Inc. She has agreed to help manage the
endowment fund for her children's private school. She believes it will only take a couple of hours each
weekend, and she will receive a discount on tuition for her two children. To comply with the Standards
of Practice, Fiedler must:

A. do nothing; it's her own time and won't interfere with her work.
B. inform her employer of all the details of this arrangement and receive written permission
before beginning.
C. inform her employer of the arrangement but need not get permission before beginning as the
work is on her own time.
D. inform her employer of all the details of this arrangement and receive written or verbal
permission before beginning.

Question #11 of 100

With respect to the responsibilities of supervisors, the Code and Standards state that those with
supervisory responsibility:

A. may not delegate supervisory responsibility.

B. are in violation if an employee under their supervision commits securities fraud.
C. should not limit the activities of employees suspected of a compliance breach until the
investigation is complete.
D. must institute procedures to prevent and detect violations of rules and regulations by those
subject to their supervision.

Question #12 of 100

Wally Manaugh has been working on a research report covering BriteCo. He has nearly completed all
his research and has elected to rate the firm as ahold. Subsequently, he meets some friends for dinner
and overhears a group talking quite favorably about BriteCo. He is not certain, but he believes one of
the group members is a former employee of BriteCo. Upon returning to his office, he second guesses
his initial analysis and tilts his report to be a bit more favorable, although he retains the hold
recommendation. Manaugh has most likely violated the Standards because he:

A. failed to distinguish fact from opinion.

B. failed to cite the source of his information.
C. cannot trade or cause others to trade on this information.
D. does not have a reasonable and adequate basis to change his report.

Question #13 of 100

Rose Worth, CAIA, is analyzing Ocean Trading (OT) whose primary business is importing merchandise.
A large increase in import tariffs has been proposed in Congress, and the likelihood that it would harm
the import business has depressed OT's stock price. Worth speaks with her Congressman who tells

Exam 1 Section 2 3
her that he is certain the tariff increase does not have enough support to become law. Worth
distributes a report that says, "OT's earnings next year will be within management guidance because
the tariff increase will not be enacted." Worth has most likely:

A. not violated the Standards.

B. violated the Standard related to communication with clients.
C. violated the Standard related to preservation of confidentiality.
D. violated the Standard related to material nonpublic information.

Question #14 of 100

Laura Field, CAIA, is a portfolio manager for Valley Investments. Valley owns a significant position in
Datatronics, a local company. Most portfolios managed by Valley on behalf of its clients also include
Datatronics stock. Field meets with a prospect and discusses potential equities the firm might place in
her portfolio, including Datatronics. Field does not mention Valley's position in Datatronics. Field has:

A. not violated the Code and Standards.

B. violated the Code and Standards by not disclosing the firm's position in Datatronics.
C. violated the Code and Standards only if Datatronics stock is placed in the prospect's portfolio.
D. violated the Code and Standards by placing a stock into client portfolios in which her firm has
a significant ownership position.

Question #15 of 100

Isaac Jones is a portfolio manager for a major brokerage firm. Jones wishes to buy Maxima common
stock for some of his clients' accounts. Jones also wishes to purchase Maxima for his personal account.
In accordance with CFA Institute Standards, Jones:

A. may not purchase Maxima for his personal account due to the inherent conflict of interest.
B. may purchase Maxima for his personal account, but the transactions for his clients must take
priority.
C. may purchase Maxima for his personal account, so long as this is fully disclosed, in writing and
in advance, to his clients and employer.
D. may purchase Maxima for his personal account at any time, as long as the execution price is
not more favorable than the execution price given to the clients.

Question #16 of 100

What is the term for assets that are generally purchased and sold only in specific quantities due to the
difficulty associated with dividing them into smaller quantities?

A. Lumpy assets.
B. Inefficient assets.
C. Structured assets.
D. Non-normal assets.

Question #17 of 100

An investor who uses arbitrage to earn investment returns is most likely to use which of the following
strategies?

A. Passive alpha strategy.

Exam 1 Section 2 4
 B. Active relative return strategy.
C. Active absolute return strategy.

Question #18 of 100

Jan Watters is considering switching her investment portfolio to another firm that offers more
investment options. Watters just returned from a presentation by an investment advisory firm that
offers separately managed accounts (SMAs). Which of the following statements regarding the benefits
of SMAs is most accurate?

A. SMAs offer positive alpha and reduced systematic risk.

B. SMAs reduce systematic risk and also offer substantial tax advantages.
C. SMAs have fewer licensing requirements and are more flexible for the investor.
D. SMAs promote individually tailored objectives while also offering transparency to the client.

Question #19 of 100

RMG Investments offers a range of liquid alternative funds. Its most popular fund is Alpha1, which
mimics an existing private equity product and has both a liquidity and diversification constraint.
Alpha1 can most likely be categorized as which of the following categories of liquid alternative funds?

A. Constrained clones.
B. Unconstrained clones.
C. Liquidity-based replication products.
D. Diversified/absolute return products.

Question #20 of 100

An alternative investments analyst is using arithmetic log returns data to perform an internal analysis.
For external reporting purposes, if he were to convert the arithmetic mean log return into

A. Log normal return.

B. Discrete mean return.
C. Geometric mean return.
D. Continuously compounded return.

Question #21 of 100

Investment X has an initial cash inflow of $1 million and a one-time cash outflow of $1.5 million at the
end of year 1, and Investment Y has an initial cash outflow of $2 million and a one-time cash inflow of
$3 million at the end of year 1. A portfolio manager acquires both investments. The IRR for the
combined investments is closest to:

A. 0%
B. 25%
C. 50%
D. 100%

Question #22 of 100

An analyst examines a sample of three returns: 10%, 0%, and -10%. The sample standard deviation of
the data is closest to:

Exam 1 Section 2 5
 A. 1%.
B. 2%.
C. 10%.
D. 14%.

Question #23 of 100

Real estate property values are estimated using appraisals. The most likely impacts of the appraisal
process on real estate returns are:

A. positive autocorrelation and normal returns.

B. negative autocorrelation and normal returns.
C. positive autocorrelation and non-normal returns.
D. negative autocorrelation and non-normal returns.

Question #24 of 100

A statistician is studying whether or not a probability distribution is normally distributed. He wishes
to use a test statistic that is a function of a particular sample's relative skewness and excess kurtosis.
Which of the following would be the most appropriate test given the statistician's preferences?

A. Jarque-Bera.
B. Durbin-Watson.
C. Kullback-Leibler.
D. Quintile-Quintile plot.

Question #25 of 100

GHL Fund earned a return of 15% over the prior 12-month period. During that period, the risk-free
rate was 2.5%. The benchmark for the fund is the HFRI Equity Hedge Index, which earned a return of
13% over the same period. GHL has a beta of 1.5 relative to the HFRI Equity Hedge Index. Which of
the following is closest to the alpha earned by the GHL Fund?

A. -3.25%.
B. -2.00%.
C. 2.00%.
D. 3.25%.

Question #26 of 100

Which of the following parameters is least important for an investor who applies the capital asset
pricing model (CAPM) to her investment returns?

A. Mean returns.
B. Variance of returns.
C. Skewness of returns.
D. Standard deviation of returns.

Question #27 of 100

A university endowment fund uses factor models to analyze various risk exposures. The managers of
the fund are interested in including a factor that contrasts the stocks in its portfolio that performed

Exam 1 Section 2 6
well over the last year against those that performed poorly. Which of the following factor models
ismost appropriate for the fund?

A. Fama-French-Carhart model.
B. Ex post capital asset pricing model.
C. Fama-French model.
D. Ex ante capital asset pricing model.

Question #28 of 100

Ari Roth is expecting a major announcement from Xanlab, a publicly traded pharmaceutical company,
relating to the regulatory approval request for its memory-boosting drug. Roth is unsure whether the
announcement will be positive (approval granted) or negative (approval denied). Under either
scenario, he expects a major swing in the stock's price. Which of the following option strategies is
most appropriate for Roth?

A. Bull spread.
B. Covered call.
C. Long straddle.
D. Short strangle.

Question #29 of 100

The Black-Scholes put option formula differs from the Black-Scholes call option formula in that the put
option formula assumes:

A. a long position in the underlying security.

B. a short position in the underlying security and a long position in the bond.
C. a non-constant return volatility of the underlying security price.
D. a long position in the bond and a higher risk-free rate.

Question #30 of 100

Kimberly Grayson, CAIA, is reviewing and analyzing performance numbers for a relatively new venture
capital fund. Grayson would like to compare and contrast the performance of funds with similar
objectives. What term best describes a group of funds with similar objectives?

A. Peer group.
B. Proxy group.
C. Empirical group.
D. Benchmark group.

Question #31 of 100

The Markowitz model of efficient diversification is best described as a:

A. positive, applied model.

B. positive, abstract model.
C. normative, applied model.
D. normative, abstract model.

Exam 1 Section 2 7
Question #32 of 100
The specific issue associated with using the CAPM to evaluate alternative investments across multiple
periods centers around:

A. means and variances which vary across periods.

B. the absence of skewness and kurtosis in the model.
C. liquidity concerns which are not captured in the calculation.
D. the nature of non-normal distributions for most alternative investments.

Question #33 of 100

Assume that a less-than-reputable investment manager chooses to make a wide variety of random
investment recommendations, knowing that some recipients will receive correct predictions, thus
assuming this investment manager is skilled. Which of the following best characterizes this practice?

A. Fraud.
B. Chumming.
C. Cherry picking.
D. Data dredging.

Question #34 of 100

If one variable is correlated with another variable due to the fact that one variable partially or
completely determines the value of the other variable, what is the proper term for this condition?

A. Causality.
B. Type I error.
C. Nonlinearity.
D. Cross correlation.

Question #35 of 100

Consider a capital asset pricing model (CAPM)-based regression with the following results:

Estimate Standard Error

Intercept 0.05 0.10
Slope 0.50 0.20
Which of the following statements best describes the regression results, using a 5% level of
significance and assuming a large sample?

A. The beta estimation error is 0.20.

B. Both the alpha and the beta are significantly different from zero.
C. The alpha is not significantly different from zero, but the beta is significantly different from
zero.
D. For every one-unit change in the market excess return, the asset's excess return changes by
0.05 units.

Exam 1 Section 2 8
Question #36 of 100
Which of the following terms refers to a condition in which independent variables are highly correlated
with each other?

A. Multicollinearity.
B. Autocorrelation.
C. Serial correlation.
D. Heteroskedasticity.

Question #37 of 100

The investment committee of the Newburg Foundation is using a multifactor model to estimate the
alpha generated by one of its hedge fund managers. The foundation has estimated a model with four
risk factors but has neglected to include a relevant fifth risk factor. Newburg's multifactor model is
most likely to suffer from which of the following problems? The model will:

A. overestimate the unexplained portion of the hedge fund return.

B. underestimate the unexplained portion of the hedge fund return.
C. overestimate the contribution of risk factors to the return of the hedge fund.
D. underestimate the contribution of risk factors to the return of the hedge fund.

Question #38 of 100

Which of the following multifactor methods uses asset classes to analyze fund returns?

A. Style analysis method.

B. Similar strategy method.
C. Principal components method.
D. Specialized market factor method.

Question #39 of 100

The value of an option to convert natural resources into a commodity will be higher when:

A. deliverable input volatility is lower.

B. receivable output volatility is lower.
C. price correlation between deliverables and receivables is lower.
D. price correlation between deliverables and receivables is higher.

Question #40 of 100

Jim Boone, a real estate developer, is considering investing in undeveloped land. The value of the
property after development will increase if the overall economy strengthens and decrease if the
economy weakens. Boone will value the call option to develop the project using a single-period
binomial option-pricing model. To simplify the calculation, he assumes a 0% risk-free rate of interest.
Boone determines that if the economy weakens, the cost of construction will be $300,000 but the
value of the finished project will be $200,000. If the economy strengthens, the cost of construction
will increase to $400,000 but the value of the completed project will increase to $600,000. Boone
conducts an analysis of comparable finished projects in the region and finds that they are selling for
$300,000. The value of the option to develop the property is closest to:

A. $0. This call option is worthless, so Boone allows it to expire, unexercised.

Exam 1 Section 2 9
 B. $50,000.
C. $200,000.
D. $600,000.

Question #41 of 100

Will Hook is considering an investment in one of the two exchange traded funds (ETFs) that track the
S&P Timber and Forestry Index. He does some research on the performance of the ETFs and finds that,
on average, these ETFs have:

A. outperformed the index with less volatility.

B. outperformed the index with more volatility.
C. underperformed the index with less volatility.
D. underperformed the index with more volatility.

Question #42 of 100

Struthers Bakery, Inc., is concerned about the price of wheat. As a result, the company takes a long
position of 10 wheat contracts, each of which covers 5,000 bushels. Assume that the price is $3.00 per
bushel and that each contract requires an initial margin deposit of $125 and a maintenance margin of
$100. The total initial margin required for the 10-contract trade is $1,250. The maintenance margin
for the account is $1,000. Assuming a $0.05 decrease in price on Day 1, a $0.03 increase in price on
Day 2, and a $0.01 decrease in price on Day 3, calculate the margin balance for this position after Day
3.

A. $1,250.
B. $2,250.
C. $2,750.
D. $3,500.

Question #43 of 100

The DJIA is currently trading at 944. The risk-free rate is 2.2%. The current dividend yield on the DJIA
is 3.8%. Which of the following is closest to the price of a three-month futures contract on the DJIA?

A. $929.02.
B. $940.23.
C. $947.78.
D. $958.27.

Question #44 of 100

For commodity markets, which of the following statements regarding normal backwardation and
contango is most accurate?

A. In a contango market, the futures price is below the current spot price.
B. In normal backwardation, the futures price is below the current spot price.
C. In a contango market, the expected future spot price is above the futures price.
D. In normal backwardation, the futures price is below the expected future spot price.

Question #45 of 100

Which of the following statements regarding asset classes and economic conditions is most accurate?

Exam 1 Section 2 10
 A. Stock, bond, and commodity prices are based on expected future economic conditions.
B. Stock and bond prices are based on current economic conditions, while commodity prices are
based on past economic conditions.
C. Stock and bond prices are based on current economic conditions, while commodity prices are
based on expected future economic conditions.
D. Stock and bond prices are based on expected future economic conditions, while commodity
prices are based on current economic conditions.

Question #46 of 100

Lance Henderson has decided to allocate 10% of his investment portfolio to commodity investments.
However, Henderson is not familiar with some of the investment types available. As a result, he asks
you to check his notes for errors. Which of the following excerpts from Henderson's notes is least
accurate?

A. Commodity futures do not require physical delivery of the commodity to close a trading
position.
B. Commodity firm investments may fail to be an adequate proxy for commodities due to
systematic, unsystematic, and hedging risks.
C. Similar to forward contracts, commodity swaps are not traded on an exchange resulting in
lower liquidity, but increased transaction privacy.
D. A commodity-linked investment note typically has a higher coupon payment than regular debt
notes due to the presence of commodity market risks.

Question #47 of 100

What type of markets would be most advantageous to a futures trader with a long position, assuming
a constant term structure of forward prices and constant spot prices?

A. Stable markets.
B. Volatile markets.
C. Contango markets.
D. Backwardated markets.

Question #48 of 100

An analyst is examining scenarios in which commodity investments react to event risk. Which of the
following scenarios best describes the relationship between commodities and event risk?

A. Events that affect commodities tend to be correlated over time, allowing investors to earn
alpha by predicting event trends.
B. Droughts and floods tend to have similar impacts on commodity prices, ultimately resulting in
positively skewed return distributions.
C. Increases in inflation tend to be positively correlated with increases in commodity prices,
resulting in positively skewed return distributions.
D. Sudden increases in the supply of commodities tend to be uncorrelated with each other,
resulting in positive event exposure and diversification potential.

Question #49 of 100

Price changes associated with a commodity producing firm will have a correlation to the commodity
itself, which is dependent on all of the followingEXCEPT:

Exam 1 Section 2 11
 A. the sensitivity of the supply of the resource to price changes.
B. the sensitivity of the demand for the resource to price changes.
C. the firm's level of exposure to and dependency on the resource.
D. the correlation between the equity markets and the overall economy.

Question #50 of 100

A greenfield real estate project is one that:

A. must be constructed.
B. uses only green technologies for construction.
C. must be transferred from public to private ownership.
D. is classified as a social infrastructure project by RREEF Infrastructure.

Question #51 of 100

John Rose, CAIA, is studying benchmarks of mortgage prepayment speeds established by the Public
Securities Association (PSA). According to the PSA, if the Conditional Prepayment Rate (CPR) for a 30-
year mortgage is 0.6% in Month 3, what would the CPR be in the following month, assuming 100%
PSA?

A. 0.2%.
B. 0.4%.
C. 0.6%.
D. 0.8%.

Question #52 of 100

Which of the following is NOT an advantage of the real estate investment trust (REIT) structure for an
investor seeking exposure to the real estate asset class?

A. REITs allow investors to adjust their tactical asset allocation to real estate sectors.
B. REITs allow investors to diversify portfolios through lower systematic risk exposure.
C. REITs produce a reliable income stream due to high income distribution requirements.
D. REITs provide exposure to real estate assets while maintaining a high level of liquidity for
investors.

Question #53 of 100

Which of the following would be most helpful for valuing real estate given that a real estate
investment may be viewed as a string of real options?

A. A decision tree.
B. Income approach.
C. The appraisal method.
D. Black-Scholes option pricing model.

Question #54 of 100

Dustin Pastana, an analyst at a real estate investment company, recognizes that since the NCREIF
Property Index (NPI) relies on appraisals, the return series is a smoothed series. To correct for this,
Pastana uses a hedonic price index. Which of the following best describes this index?

Exam 1 Section 2 12
 A. The index only uses properties that were revalued due to significant events.
B. The index only uses properties that were actually sold in the most recent quarter.
C. The index uses a model that attributes property value changes to property characteristics.
D. The index uses a model that incorporates the current appraised value, last appraised value,
and a decay parameter to unsmooth appraisal values.

Question #55 of 100

Suppose a $200 million hedge fund has a 20% incentive fee. In addition, assume there is no hurdle
rate or high watermark (HWM). What is the incentive fee call option value if the annual volatility of
the net asset value (NAV) is 15%?

A. $1,100,000.
B. $2,400,000.
C. $4,200,000.
D. $6,000,000.

Question #56 of 100

An investor is considering investing in one of two hedge funds. BLR Fund deploys investor capital
among outside hedge fund managers in order to select managers or strategies expected to
outperform. HBS Fund utilizes its own staff to identify outperforming strategies and manage trades
designed to execute those strategies. Which of the following statements regarding these funds is most
accurate?

A. HBS will have a higher fee structure than BLR.

B. HBS will have more layers of risk management than BLR.
C. BLR will have a higher degree of diversification than HBS.
D. BLR will have lower levels of monitoring and due diligence than HBS.

Question #57 of 100

Which of the following statements regarding hedge fund performance is most accurate?

A. Hedge funds are substantially more volatile than most other asset classes.
B. Hedge fund returns are negatively correlated with financial assets, providing excellent
diversification benefits.
C. Hedge funds have experienced consistent, positive performance and have a low correlation
with traditional asset classes.

Question #58 of 100

Which of the following statements regarding survivorship bias and hedge funds is most accurate?

A. The impact of survivorship bias on hedge fund indices is minimal.

B. The upward bias on hedge fund databases due to survivorship bias is estimated to be 3-10%.
C. Survivorship bias occurs when hedge funds are allowed to include their historical returns upon
initial inclusion into a database.
D. While survivorship bias is not present in the mutual fund universe, the bias is present in the
hedge fund universe due to the lack of registration requirements.

Exam 1 Section 2 13
Question #59 of 100
Which of the following parties avoid SEC registration requirements by selling to institutional investors
and high net worth individuals?

A. Public commodity pool operators.

B. Private commodity pool operators.
C. Commodity pool operators with commodity trading advisors.
D. Commodity pool operators without commodity trading advisors.

Question #60 of 100

Which of the following price patterns would least likely be incorporated by a trend-following strategy?

A. Momentum.
B. Random walk.
C. Mean-reverting.
D. Comparisons of moving averages.

Question #61 of 100

An analyst is examining market movements. The analyst has decided to use the Relative Strength Index
(RSI) to spot range-trading opportunities. How would this strategy be best classified?

A. Countertrend strategy.
B. Price-trending strategy.
C. Moving average strategy.
D. Pattern recognition strategy.

Question #62 of 100

Which of the following is an example of a passive futures index that allows for both long and short
futures positions in physical commodities, financial securities, and currencies?

A. Hedge Fund Research, Inc.

B. Mount Lucas Management Index.
C. Morgan Stanley Commodity Index.
D. Barclays Global Aggregate Bond Index.

Question #63 of 100

Event-driven hedge fund strategies that focus on merger arbitrage are similar to selling insurance in
that:

A. speculators create a short position in the target firm and a long position in the acquiring firm.
B. speculators create a long position in the target firm and a short position in the acquiring firm.
C. existing target shareholders may not be willing to assume the event risk associated with a
merger announcement.
D. existing acquiring shareholders may not be willing to assume the event risk associated with a
merger announcement.

Exam 1 Section 2 14
Question #64 of 100
A hedge fund just established a long position in the senior bonds of BNR Corporation, which recently
suffered a large ratings downgrade after a failed merger attempt and a substantial earnings decline.
The hedge fund also established a short position in the common stock of BNR. Which of the
followingbest describes the hedge fund's strategy?

A. Merger arbitrage.
B. Convertible arbitrage.
C. Fixed-income arbitrage.
D. Capital structure arbitrage.

Question #65 of 100

An analyst is studying convertible arbitrage strategies and the relationship between an option's price
and the underlying asset price. In this context, how would gamma be most accurately described?

A. Gamma is the smallest when the option is near the money.

B. Gamma is used to establish the proper hedge ratio in a convertible arbitrage strategy.
C. Gamma is the degree of curvature in the relationship between the option price and the
underlying asset price.
D. Gamma is the critical factor in understanding how hedge positions lose value if there are no
changes in the underlying.

Question #66 of 100

How would a tail risk strategy be most accurately described?

A. A tail risk strategy is long vega and benefits most during periods of rising volatility.
B. A tail risk strategy is market-neutral and is attractive to volatility arbitrage managers.
C. A tail risk strategy is long vega and short gamma, benefitting most from low volatility.
D. A tail risk strategy is short vega and short gamma, benefitting most from market drops.

Question #67 of 100

Quantitative Equity Design (QED) is a quantitative equity fund manager. QED forecasts monthly alphas
for stocks in its 3,000 stock universe. The number of independent forecasts made on a monthly basis
is 25. If the model employed by QED has an information coefficient of 0.15, the information ratio for
QED is closest to:

A. 0.75.
B. 2.60.
C. 28.46.
D. 45.00.

Question #68 of 100

Suppose a fund manager wants to implement a pairs trading strategy. The most common approach
would involve identifying pairs of stocks with:

A. low correlations and analyzing historical spreads.

B. similar market risk and analyzing historical spreads.
C. low standard deviations and analyzing historical spreads.

Exam 1 Section 2 15
 D. similar standard deviations and analyzing historical spreads.

Question #69 of 100

Suppose a short-bias hedge fund manager uses the capital asset pricing model (CAPM) to determine
the equilibrium values of assets. The manager uses an expected return on the market of 12%, and the
risk-free rate is 4%. If a short-bias fund has a beta of -0.8 and an expected return of -1%, what is the
ex ante alpha of the short-bias fund?

A. -2.4%.
B. -1.0%.
C. 1.4%.
D. 2.4%.

Question #70 of 100

Which of the following best describes the advantage and disadvantage of a fund of hedge funds versus
a regular hedge fund? The advantage of a fund of hedge funds is:

A. diversification across styles, and the disadvantage is higher fees.

B. diversification across managers, and the disadvantage is higher fees.
C. lower fees because of economies of scale, and the disadvantage is greater systematic risk.
D. lower fees because of economies of scale, and the disadvantage is more regulations because
of antitrust laws.

Question #71 of 100

Which of the following best describes the course of leveraged buyout (LBO) activity in the 1990s?

A. Junk bond financing fueled a large amount of growth in LBOs.

B. LBO activity declined due to recession and Russian sovereign bond default.
C. Management buyouts were very popular, leading to a rapid rise in LBO activity.
D. Kohlberg Kravis Roberts & Co. (KKR) had its vintage year and was responsible for 95% of the
financing of many LBO deals.

Question #72 of 100

What is the primary activity of a merchant banking unit of a bank? Merchant bankers:

A. buy and sell nonfinancial companies for a profit.

B. issue equity shares in firms through private investment in public equity (PIPE) transactions.
C. provide ancillary services to merchants, including credit card processing.
D. make negotiated private equity investments in registered securities of privately held firms.

Question #73 of 100

Tim Love, CAIA, is working with a client who has taken on additional debt to finance a new chain of
restaurants. Love is explaining the various types of debt covenants. Which of the following statements
made by Love regarding maintenance covenants is most accurate?

A. A maintenance covenant is stronger than an incurrence covenant.

B. A maintenance covenant requires a pre-specified cash level negotiated with the lender.

Exam 1 Section 2 16
 C. Erosion of earnings or cash flow does not trigger a maintenance covenant unless a payment
is missed.
D. A maintenance covenant prohibits a debtor from taking a specific action once a pre-specified
event occurs.

Question #74 of 100

Leveraged loans are loans that:

A. have a fixed spread over LIBOR that is less than or equal to 100 basis points.
B. do not carry an investment-grade credit rating because the borrower has a large amount of
debt on its balance sheet.
C. are floating rate loans and have been packaged into a portfolio that is leveraged using an
interest rate swap.
D. carry an investment grade credit rating and can easily be leveraged by the investor who can
sell short Treasuries and buy additional investment-grade debt.

Question #75 of 100

Which of the following is least accurate regarding fees collected by hedge funds and private equity
funds?

A. Having a lower hurdle rate allows private equity funds to be more aggressive in the bidding
process than hedge funds.
B. Hedge funds can receive incentive fees at any time, while private equity funds may receive
incentive fees only after returning capital to investors.
C. Hedge fund incentive fees are based on changes in NAV, while private equity fund incentive
fees are based on realized profits.
D. Hedge funds typically do not have provisions for the clawback of management or incentive
fees, while private equity funds do.

Question #76 of 100

AMS Company, an LBO fund, is in the process of taking over Saline Solutions, Inc. for $300 million.
Saline has an annual EBITDA of $20 million. AMS will use 60% debt to complete the takeover. The debt
paydown period is six years. At the end of this period, it is forecasted that Saline's value will be $950
million. The annual return on this LBO transaction is closest to:

A. 20%.
B. 30%.
C. 40%.
D. 50%.

Question #77 of 100

Jon Greene is a manager of a leveraged buyout (LBO) fund. Greene is speaking at a business
conference. An audience member asks Greene what, if any, benefit LBO firms provide to the public
market. Greene should mention all of the following EXCEPT:

A. strong corporate governance principles often remain in place after a firm taken private by an
LBO firm becomes public again.

Exam 1 Section 2 17
 B. the incentive and monitoring programs created by LBO firms can provide a road map for
management and shareholders after the firm becomes public again.
C. the threat of an LBO takeover serves as a warning to public companies and provides current
management an incentive to enact better corporate governance principles.
D. that LBO profitability measures are more important than current cash flows.

Question #78 of 100

Which of the following statements regarding the characteristics of mezzanine debt relative to other
forms of debt financing is most accurate?

A. Compared to leveraged loans, mezzanine debt has relatively few covenants.

B. Leveraged loans have relatively low liquidity as compared to mezzanine debt.
C. Mezzanine debt has a maturity of 7-10 years, whereas high-yield debt has a maturity of 4-6
years.
D. Mezzanine debt has a coupon rate of 8%-12%, whereas high-yield debt has a coupon rate of
12%-15%.

Question #79 of 100

Which of the following statements regarding reorganization plans under a Chapter 11 bankruptcy is
least accurate?

A. A reorganization plan requires the approval of all classes of claimants.

B. To block a reorganization plan, the blocking party must constitute 2/3 of the number or 50%
of the value of a claimant class.
C. A prepackaged bankruptcy filing contains a reorganization plan that has already been
negotiated between the distressed firm and its creditors.
D. If there is no prepackaged reorganization plan, a debtor company has 120 days in which to file
a plan of reorganization, and then has 60 days to lobby creditors to accept the plan.

Question #80 of 100

Which of the following are the main sources of risk for distressed debt investors?

A. Market risk and data risk.

B. Business risk and data risk.
C. Market risk and liquidity risk.
D. Business risk and liquidity risk.

Question #81 of 100

A mid-sized regional U.S. bank has a sizeable bond portfolio that has a high concentration to a
particular issuer. The bank's management is worried that the bond issuer may no longer have the
capacity to repay the entire face value in the event of a credit default. Which of the following items is
the most appropriate hedge for the bank?

A. Equity-linked note.
B. Credit default swap.
C. Collateralized debt obligation.
D. A tailored structured product that can shift long-term capital gains tax.

Exam 1 Section 2 18
Question #82 of 100
Which of the following statements regarding interest-only (IO) and principal-only (PO) tranches is
CORRECT?

A. PO tranches are positively exposed to contraction risk.

B. The cash flows received by IO investors increase over time.
C. There is an inverse relationship between the values of IO tranches and PO tranches.
D. PO tranches can only be issued for fixed-rate underlying mortgages while IO tranches can be
issued for both adjustable- and fixed-rate underlying mortgages.

Question #83 of 100

A firm has only one class of equity and a single zero-coupon debt issue. According to the Merton
model, if the value of the assets at bond maturity is less than the face value of the bond, the payoff to
bondholders will be:

A. zero.
B. the face value of the bond.
C. the value of the assets at bond maturity.
D. the difference in the face value of the bond and the value of the assets.

Question #84 of 100

An institutional investor just exercised a credit option, which had three months left until expiration.
The option stipulates that if the bonds of Tera Corp. fall below an A credit rating, the investor may
force Tera Corp. to repurchase the bonds from the investor at face value. Which of the following credit
options did the investor exercise?

A. European credit put option.

B. American credit put option.
C. European credit call option.
D. American credit call option.

Question #85 of 100

A newly issued collateralized debt obligation (CDO) has the following characteristics:

• A money management firm is the CDO sponsor.

• Investors act as credit protection sellers.

• The CDO utilizes credit derivatives to transfer the risk exposure of the collateral pool.

Based on the above information, this CDO is most likely:

A. an arbitrage market value CDO.

B. a balance sheet CDO that is cash funded.
C. an arbitrage synthetic CDO that is unfunded.
D. a balance sheet synthetic CDO that is unfunded.

Exam 1 Section 2 19
Question #86 of 100
Collateral assets are sold to generate cash flows to meet collateralized debt obligation (CDO) tranche
payments in a:

A. synthetic arbitrage CDO.

B. cash flow arbitrage CDO.
C. market value arbitrage CDO.
D. credit enhancement arbitrage CDO.

Question #87 of 100

Which of the following statements regarding single-tranche collateralized debt obligations (CDOs) is
most accurate? A single-tranche CDO:

A. functions like a balance sheet CDO by using a CDS to transfer risk exposure.
B. has higher model risk than a CDO squared due to the concentration of pool assets.
C. bundles the entire underlying collateral pool into one tranche and then sells this tranche to a
single investor.
D. is more customizable for investors than other CDOs and does not use a waterfall approach to
distribute cash flows.

Question #88 of 100

Bart Adams constructs synthetic balance sheet collateralized debt obligations (CDOs) using credit
default swaps (CDSs) for a bank. With respect to managing the risk of the structure, Adams's primary
job as the CDO manager is to:

A. minimize liquidity risk so that the bank can exit the position if necessary.
B. maximize regulatory capital so that risk to the underlying investors is minimized.
C. structure the CDSs to minimize correlation risk so that multiple loans are not likely to default
at once.
D. ensure the insurance premiums on the CDSs are as low as possible since loan defaults will
rarely trigger the terms of the CDS.

Question #89 of 100

Which of the following is NOT a key risk associated with collateralized debt obligations (CDOs)?

A. Basis risk.
B. Collateral default risk.
C. Credit spread expansion.
D. Financial engineering risk.

Question #90 of 100

Eric Spence is investing his excess funds into a tax-deferred, tax-deductible investment for 20 years.
His current tax rate is 30% and is expected to decrease to 25% in 20 years, at which time he will
withdraw the entire amount of the investment. If the pre-tax return on the investment is 6%, which
of the following amounts is closest to the after-tax return on the investment?

A. 4.50%.
B. 5%.

Exam 1 Section 2 20
 C. 5.64%.
D. 6.37%.

Question #91 of 100

A knock-in call option where the underlying asset is below the barrier is described as which of the
following?

A. Up-and-in call.
B. Down-and-in call.
C. Up-and-out call.
D. Down-and-out call.

Question #92 of 100

Which of the following is most likely to be the best preventative measure to avoid investor losses due
to mismanagement or fraud?

A. Investor due diligence.

B. Comprehensive audits.
C. Increased transparency.
D. Increased regulatory oversight.

Question #93 of 100

Which of the following factors is least important to managing operational risks in a firm?

A. Creating an appropriate fund culture that values integrity.

B. Creating an operational system that can detect problems early.
C. All functions related to valuation are handled by independent and objective parties.
D. Strict controls that require fund managers to stay within the bounds of the investment
mandate.

Question #94 of 100

Which of the following hedge fund strategies is most likely to rely on its superior ability to gather
information as a competitive advantage?

A. Stub-trading strategy.
B. Concentrated strategy.
C. Volatility arbitrage strategy.
D. Quantitative equity long/short strategy.

Question #95 of 100

Which of the following is least likely to be a cause of concern for a potential hedge fund investor?

A. High levels of employee turnover at the fund.

B. The chief investment officer of the fund is also the risk officer.
C. The fund manager handles investor withdrawals.
D. The chief financial officer is also responsible for reporting the fund's performance to investors.

Exam 1 Section 2 21
Question #96 of 100
Hanover Fund maintains long equity positions designed to mimic the risk exposure of the MSCI
Emerging Market Index (MXEF). The current price of the MXEF is $1,120. Hanover has just sold a put
option on the index at $1,105 and a call option at $1,130. Which of the following best describes the
strategy Hanover is using?

A. Event driven.
B. Global macro.
C. Short volatility.
D. Relative value arbitrage.

Question #97 of 100

An analyst is concerned that the returns on one of the hedge funds in which his firm has invested, a
hedge fund index managed by an outside party, will fall short of the benchmark. The analyst is most
likely concerned with which of the following risks?

A. Active risk.
B. Leverage risk.
C. Counterparty risk.
D. Short volatility risk.

Question #98 of 100

A fund has a hurdle rate of return equal to 6%. The fund manager is paid an incentive fee on a quarterly
basis. For the year, the manager has earned an incentive fee in three out of four quarters. The fund
return for the year was 5%, and the fund is above the high watermark. Which of the following is most
likely to occur?

A. Additional incentive fees will be paid.

B. The management fee will be forfeited.
C. A clawback will be initiated by investors.
D. The manager will extend the lockup period.

Question #99 of 100

Sarah Reagan, a manager for Camp Funds, is adopting a strategy where she generates alpha from an
options strategy despite the fact that the S&P 500 is the appropriate benchmark for Reagan's fund.
She does believe that with positions in futures, she can manage the beta exposure of the fund with a
target of 1.0 (i.e., the beta of the S&P 500). Reagan is attempting to:

A. port beta.
B. transfer alpha from beta.
C. separate alpha from beta.
D. distinguish alpha from beta.

Question #100 of 100

Rick Stewart, an active fund manager, intends to generate alpha by investing in small-cap stocks.
However, the investment mandate requires that the systematic risk of the fund cannot exceed the
beta of the S&P 500. Stewart intends to use futures contracts in the relevant indices to generate alpha

Exam 1 Section 2 22
and control beta risk. Which of the following steps would NOT be part of Stewart's portable alpha
strategy?

A. Invest cash in the small-cap stocks required to generate alpha.

B. Take a short position in a small-cap index to lay off small-cap risk.
C. Take a long position in S&P 500 futures contracts to layer on the risk exposure of large-cap
stocks.
D. Take a long position in a small cap index such as the Russell 2000 to increase alpha using
leverage.

Exam 1 Section 2 23