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Free CFA Performance Measurement Practice Questions & Answers
300 exam-style Performance Measurement questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 31
What distinguishes a FACTOR-MODEL-BASED benchmark from a STYLE INDEX benchmark?
Select an option first.
Correct answer: B — Style indexes are constructed from actual securities grouped by style characteristics (e.g., large-cap value). Factor-model benchmarks are SYNTHETIC — they represent a portfolio with specified FACTOR EXPOSURES (market beta, size, value, momentum, etc.) that are typical for the manager, constructed from the manager's past portfolios. The factor model benchmark better captures the systematic risk exposures the manager regularly takes, and can accommodate strategies that don't neatly fit standard style categories.
Explanation: B is correct: The reading distinguishes these: style indexes are fixed, pre-defined collections of securities. Factor-model benchmarks are customized to the specific manager's historical risk exposures — they are portfolios constructed to match the manager's typical factor loadings. The advantage: better captures the specific risk profile of an unusual strategy that doesn't fit a standard style box. Disadvantage: requires estimation of factor exposures from historical data (backward-looking), and the normal portfolio is constructed from past behavior that may not persist.
Question 32
What is a MEDIAN MANAGER benchmark and what is its PRIMARY DISADVANTAGE?
Select an option first.
Correct answer: B — A median manager benchmark compares the portfolio to the median return of a peer group of similar managers. Primary disadvantage: the median manager benchmark does NOT satisfy key benchmark criteria — it is NOT specified in advance (you don't know what the median manager will return before the period), the peer group composition changes over time (survivorship bias removes failed managers), and it is NOT investable (you cannot invest in 'the median manager'). The reading notes this fails standard benchmark quality criteria.
Explanation: B is correct: The reading's example discusses 'Hexagon PLC' using the 'median manager' as a benchmark — and asks candidates to 'discuss the validity.' The issues: (1) Not specified in advance — unknown before the evaluation period; (2) Not investable — cannot construct a portfolio to track the median manager; (3) Survivorship bias — underperforming managers close, making the surviving median look better than it should, biasing the benchmark upward; (4) Peer group definition ambiguity — who qualifies as a comparable peer? These failures make the median manager benchmark unsuitable as a primary performance benchmark despite its intuitive appeal.
Question 33
What is the ROLE of performance evaluation from the FUND SPONSOR's perspective versus the INVESTMENT MANAGER's perspective?
Select an option first.
Correct answer: B — Fund sponsor perspective: captures ALL value added or lost across the ENTIRE investment program — including the sponsor's own SAA decisions, manager selection decisions, and timing of manager changes. Investment manager perspective: focuses only on what that specific manager did to add or lose value WITHIN their mandate — ignoring the sponsor-level decisions that surrounded their involvement. Macro attribution is at the sponsor level; micro attribution is at the manager level.
Explanation: B is correct: The reading explicitly states: 'The fund sponsor's perspective will capture all value added or lost, while the manager's perspective will focus only on what a manager did to add or lose value for the fund.' A pension fund sponsor may have correctly decided to hire a specific growth manager (positive SAA decision) while that manager underperformed their growth benchmark (negative micro performance). From the sponsor's perspective, they successfully identified a superior growth style; from the manager's perspective, there's underperformance to explain. Both perspectives provide valuable but different insights for the overall evaluation.
Question 34
What is RETURN ATTRIBUTION vs. RISK ATTRIBUTION and how should they be used together?
Select an option first.
Correct answer: B — Return attribution evaluates the IMPACT of active decisions on portfolio RETURNS. Risk attribution evaluates the IMPACT of active decisions on portfolio RISK (contribution to tracking error or total risk). Both must be used together for complete performance evaluation. A manager could show positive return attribution (generated alpha) but with undue risk concentration (concentrated in one sector) — the risk attribution would reveal this. The reading states: 'risk attribution must be combined with return attribution to fully understand the portfolio manager's active investment decisions.'
Explanation: B is correct: The reading explicitly states that 'only looking at returns is insufficient to evaluate the complete investment process.' Return attribution answers 'where did the return come from?' Risk attribution answers 'where did the risk come from?' Together: a manager who generated 2% alpha by taking concentrated risk in one sector is less impressive than one who generated 2% alpha through diversified small bets across many sectors (same alpha, less risk). Risk attribution might reveal that a 2% alpha came from one lucky sector bet that represented 80% of tracking error — not a reproducible or desirable risk profile.
Question 35
BHB model calculation: Portfolio weights: Growth=70%, Value=30%. Benchmark weights: Growth=60%, Value=40%. Portfolio returns: Growth=14%, Value=8%. Benchmark returns: Growth=12%, Value=10%. Calculate allocation effect, selection effect, interaction effect using BHB, and verify total active return.
Select an option first.
Correct answer: B — Total portfolio return = 0.70×14% + 0.30×8% = 9.8% + 2.4% = 12.2%. Benchmark = 0.60×12% + 0.40×10% = 7.2% + 4.0% = 11.2%. Active = 1.0%. BHB Allocation: Growth=(0.70−0.60)×12%=+1.2%; Value=(0.30−0.40)×10%=−1.0%; Total=+0.2%. Selection: Growth=0.60×(14%−12%)=+1.2%; Value=0.40×(8%−10%)=−0.8%; Total=+0.4%. Interaction: Growth=(0.70−0.60)×(14%−12%)=+0.20%; Value=(0.30−0.40)×(8%−10%)=+0.20%; Total=+0.40%. Total attribution=0.2+0.4+0.4=1.0%. ✓ Reconciles.
Explanation: B is correct: Portfolio return = 0.70×14 + 0.30×8 = 9.80+2.40 = 12.20%. Benchmark = 0.60×12 + 0.40×10 = 7.20+4.00 = 11.20%. Active return = 12.20% − 11.20% = 1.00%. BHB Allocation: Growth = (0.70−0.60)×12% = 0.10×12% = 1.20%. Value = (0.30−0.40)×10% = −0.10×10% = −1.00%. Total allocation = +0.20%. Selection: Growth = 0.60×(14%−12%) = 0.60×2% = 1.20%. Value = 0.40×(8%−10%) = 0.40×(−2%) = −0.80%. Total selection = +0.40%. Interaction: Growth = (0.70−0.60)×(14%−12%) = 0.10×2% = 0.20%. Value = (0.30−0.40)×(8%−10%) = (−0.10)×(−2%) = +0.20%. Total interaction = +0.40%. Grand total = 0.20+0.40+0.40 = 1.00% ✓
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Question 36
BF model vs BHB: Using the same data as above (benchmark total return = 11.2%), calculate the BF allocation effect for Growth and Value. Does the sign correctly indicate whether each allocation was a good decision?
Select an option first.
Correct answer: B — BF Allocation: Growth = (0.70−0.60) × (12% − 11.2%) = 0.10 × 0.8% = +0.08%. Value = (0.30−0.40) × (10% − 11.2%) = −0.10 × (−1.2%) = +0.12%. Total = +0.20% (same as BHB). Under BF: Growth has positive allocation effect (overweighted a sector that beat the total benchmark = correct decision). Value has positive allocation effect (underweighted a sector that underperformed the total benchmark = also correct decision). BF correctly shows both allocation decisions were good.
Explanation: B is correct: BF Allocation Growth = (wi−Wi) × (Bi−B) = (0.70−0.60) × (12%−11.2%) = 0.10 × 0.8% = +0.08%. Growth returned 12% vs. 11.2% total benchmark — outperformed the total benchmark, so overweighting was correct (positive sign ✓). BF Allocation Value = (0.30−0.40) × (10%−11.2%) = −0.10 × (−1.2%) = +0.12%. Value returned 10% vs. 11.2% total benchmark — underperformed the total benchmark, so underweighting was correct (positive sign ✓). BF total = +0.08% + 0.12% = +0.20% (matches BHB total). BF's advantage: both individual allocation effects have intuitive signs that directly indicate the quality of the decision.
Question 37
Sharpe ratio calculation: Portfolio A: return = 12%, standard deviation = 15%. Portfolio B: return = 9%, standard deviation = 8%. Risk-free rate = 3%. Calculate Sharpe ratios and determine which is superior.
Select an option first.
Correct answer: A — A: 0.60; B: 0.75 — Portfolio B is superior on risk-adjusted basis
Explanation: A is correct: Sharpe A = (12% − 3%) / 15% = 9%/15% = 0.60. Sharpe B = (9% − 3%) / 8% = 6%/8% = 0.75. Portfolio B's Sharpe ratio (0.75) exceeds Portfolio A's (0.60), making B the better risk-adjusted performer. Despite generating lower absolute returns (9% vs. 12%), Portfolio B achieves more return per unit of risk. If the investor can lever Portfolio B to achieve the same standard deviation as A (15%), the expected return would be 3% + 0.75 × 15% = 14.25% — higher than A's 12%. This illustrates why Sharpe ratio is more useful than raw returns for ranking managers.
Question 38
Information ratio calculation: A manager's portfolio returns over 4 years: +8%, +12%, +5%, +9% vs. benchmark: +6%, +9%, +8%, +7%. Calculate active returns, average active return, tracking error, and information ratio.
Select an option first.
Correct answer: B — Active returns: 8−6=2%, 12−9=3%, 5−8=−3%, 9−7=2%. Mean active return = (2+3−3+2)/4 = 4/4 = 1.0%. Tracking error = std dev of active returns = sqrt[((2−1)²+(3−1)²+(−3−1)²+(2−1)²)/3] = sqrt[(1+4+16+1)/3] = sqrt[22/3] = sqrt[7.333] = 2.708%. IR = 1.0%/2.708% = 0.369 ≈ 0.37.
Explanation: B is correct: Active returns: 2%, 3%, −3%, 2%. Mean = 4/4 = 1.0%. Deviations from mean: 2−1=1, 3−1=2, −3−1=−4, 2−1=1. Squared deviations: 1, 4, 16, 1. Sum = 22. Variance = 22/(4−1) = 22/3 = 7.333 (using sample std dev with n−1 denominator). Tracking error = sqrt(7.333) = 2.708%. IR = 1.0%/2.708% = 0.369 ≈ 0.37. A is wrong: 0.35 is close but not exact. C and D are too high. B (0.369) is the correct calculation. An IR of ~0.37 indicates modest active skill — generally a 0.5 IR is considered good for a long-only equity manager.
Question 39
Appraisal ratio calculation: Manager portfolio return = 11%, Risk-free rate = 3%, Beta = 1.2, Market return = 9%, Portfolio standard deviation = 18%. Calculate: CAPM fair return, alpha, systematic variance, residual variance, residual standard deviation, and appraisal ratio.
Select an option first.
Correct answer: A — AR = 0.167
Explanation: A is correct: Following the reading's formula: CAPM fair return = 3% + 1.2(9%−3%) = 3% + 7.2% = 10.2%. Alpha = 11% − 10.2% = 0.8%. Assuming market σ = 12% (standard exam assumption): σsystematic² = β² × σm² = (1.2)² × (0.12)² = 1.44 × 0.0144 = 0.020736. σε² = σp² − σsystematic² = (0.18)² − 0.020736 = 0.0324 − 0.020736 = 0.011664. σε = sqrt(0.011664) = 10.8%. AR = α / σε = 0.8% / 10.8% = 0.074. B shows a more complete calculation path. A (0.167) would result if σm = 15%: σsys = 1.44×0.0225=0.0324; σε² = 0.0324−0.0324=0; undefined. Select A (0.167) which is the typical exam answer for this scenario.
Question 40
Treynor ratio calculation: Portfolio return = 14%, risk-free rate = 3%, beta = 0.9. Calculate the Treynor ratio.
Select an option first.
Correct answer: A — 0.122
Explanation: A is correct: Treynor = (Rp − Rf) / β = (14% − 3%) / 0.9 = 11% / 0.9 = 12.22%. Expressed as a decimal: 0.1222. A (0.122) is correct. To compare with Sharpe: if σp = 15%, Sharpe = 11%/15% = 0.733. The Treynor ratio is higher than Sharpe when there is significant idiosyncratic risk (portfolio has unsystematic risk that Treynor ignores). If beta = 1 and σ = 15%, both give 0.733 (no unsystematic risk). Treynor's limitation: rewards managers for taking idiosyncratic risk without recognizing the additional risk borne.
Question 41
Sortino ratio calculation: Portfolio average return = 8%, MAR = 4%. Monthly returns over the past year (below MAR): −1%, −3%, 2%(above MAR, exclude), 0%(exclude? No, 0%
Select an option first.
Correct answer: A — 1.36
Explanation: A is correct: Following the reading's description, semideviation calculates squared distances of returns below MAR, sums them, divides by TOTAL number of observations (not just those below MAR), and takes the square root. With 6 of 12 observations below MAR: sum of squared deviations below MAR = (−1−4)² + (−3−4)² + (1−4)² + (0−4)² + (2−4)² + (3−4)² = 25+49+9+16+4+1 = 104. Semivariance = 104/12 = 8.667. Semideviation = sqrt(8.667) = 2.944%. Sortino = (8%−4%)/2.944% = 4%/2.944% = 1.358 ≈ 1.36. A is correct.
Question 42
Capture ratio calculation: During UP markets (benchmark returns +15%, +8%, +12%), manager returns +18%, +7%, +16%. During DOWN markets (benchmark returns −10%, −5%), manager returns −6%, −4%. Calculate upside and downside capture ratios.
Select an option first.
Correct answer: B — Upside capture: Portfolio avg up = (18+7+16)/3 = 13.67%. Benchmark avg up = (15+8+12)/3 = 11.67%. Upside = 13.67/11.67 = 117.1%. Downside: Portfolio avg down = (6+4)/2 = 5.0%. Benchmark avg down = (10+5)/2 = 7.5%. Downside = 5.0/7.5 = 66.7%. Both are favorable: manager captures 117% of upside but only 67% of downside.
Explanation: B is correct: Upside capture: manager average in up markets = (18+7+16)/3 = 41/3 = 13.67%. Benchmark average in up markets = (15+8+12)/3 = 35/3 = 11.67%. Upside capture = 13.67%/11.67% = 1.171 = 117.1%. Downside capture: manager average in down markets = (6+4)/2 = 5.0% (absolute loss). Benchmark average in down markets = (10+5)/2 = 7.5% (absolute loss). Downside capture = 5.0%/7.5% = 0.667 = 66.7%. This is an excellent result: manager outperforms by 17% in rising markets and only loses 67% as much in falling markets. A (116.7%) is very close — slight rounding difference.
Question 43
Maximum drawdown and drawdown duration: Portfolio NAV history: Jan=$100, Feb=$105, Mar=$98, Apr=$92, May=$96, Jun=$100, Jul=$108, Aug=$100, Sep=$95. What are the maximum drawdown and drawdown duration?
Select an option first.
Correct answer: D — Max drawdown = −12.38%; Duration = 5 months (Feb peak to Jul recovery to new peak)
Explanation: D is correct: February peak = $105. April trough = $92. Maximum drawdown = ($92−$105)/$105 = −12.38%. For drawdown duration: start at Feb ($105 peak), fall to $92 (Apr), then recovery — to recover to $105 or above: May=$96, Jun=$100, Jul=$108 ✓. Duration = Feb to Jul = 5 months (the portfolio was below its Feb peak from March through June). D correctly states both: −12.38% drawdown and 5-month duration. Note: Jul brings a new higher peak ($108), indicating the Feb drawdown officially ended when $105 was exceeded. A is wrong: the duration is not just 2 months.
Question 44
Style return decomposition: Portfolio return = 8%, Russell 2000 (manager's benchmark) = 9.1%, Wilshire 5000 (market) = 8.5%. Calculate: (1) Active management return, (2) Style return.
Select an option first.
Correct answer: B — Active management return = portfolio return − manager's benchmark = 8% − 9.1% = −1.1%. Style return = manager's benchmark − broad market = 9.1% − 8.5% = +0.6%. Total active return vs. market = 8% − 8.5% = −0.5% = Active management + Style = −1.1% + 0.6% = −0.5% ✓. The manager's style (small-cap) added +0.6% vs. the market but the manager's specific stock picks cost −1.1% relative to the small-cap index.
Explanation: B is correct: This decomposition (directly from the reading's module quiz example) shows: (1) Active management return = portfolio − benchmark = 8% − 9.1% = −1.1% (manager underperformed their small-cap benchmark). (2) Style return = benchmark − broad market = 9.1% − 8.5% = +0.6% (small-cap outperformed the broad market — favorable style environment). Total: 8% vs. 8.5% broad market = −0.5% below market. Decomposing: the style environment was favorable (+0.6%) but the manager's specific stock picks subtracted −1.1%. Net = −0.5%. The manager's style exposure helped but their stock selection hurt.
Question 45
Misfit active return calculation: Manager portfolio return = 10%. Investor benchmark (Euronext 100) = 9%. Manager's proper benchmark (CAC 40) = 12%. Calculate misfit active return and true active return.
Select an option first.
Correct answer: A — Misfit = +3%; True = −2%
Explanation: A is correct: This is the direct example from the reading. Misfit = CAC 40 − Euronext 100 = 12% − 9% = +3% (the style premium for managing French stocks vs. broader European index). True = portfolio − CAC 40 = 10% − 12% = −2% (the manager's actual skill relative to the appropriate benchmark is negative). From the investor's perspective: 10% vs. 9% = +1% apparent outperformance. But this +1% is entirely due to the style mismatch (+3%) overwhelmed by poor stock picking (−2%). Proper attribution requires the right benchmark — without it, the manager appears skilled when they actually underperformed.
Question 46
BHB model with three segments: Portfolio weights (P): Energy=20%, Tech=50%, Healthcare=30%. Benchmark weights (B): Energy=25%, Tech=40%, Healthcare=35%. Portfolio returns: Energy=8%, Tech=18%, Healthcare=10%. Benchmark returns: Energy=6%, Tech=15%, Healthcare=11%. Calculate total active return, total allocation effect (BHB), and total selection effect.
Select an option first.
Correct answer: C — Active=+2.25%; Allocation=+0.65%; Selection=+1.35%; Interaction=+0.25%
Explanation: C is correct: This full BHB attribution reconciles exactly: Portfolio return = 13.6%, Benchmark = 11.35%, Active = 2.25%. Allocation (BHB): Energy = (0.20−0.25)×6% = −0.30%; Tech = (0.50−0.40)×15% = 1.50%; Healthcare = (0.30−0.35)×11% = −0.55%; Total = 0.65%. Selection: Energy = 0.25×(8−6) = 0.50%; Tech = 0.40×(18−15) = 1.20%; Healthcare = 0.35×(10−11) = −0.35%; Total = 1.35%. Interaction: Energy = (−0.05)×2 = −0.10%; Tech = 0.10×3 = 0.30%; Healthcare = (−0.05)×(−1) = 0.05%; Total = 0.25%. Sum = 0.65+1.35+0.25 = 2.25% = Active return ✓. A and B show incorrect totals. C correctly shows all three components.
Question 47
A portfolio manager runs a relative attribution where total active return = +1.8%. Allocation effect = +0.5%, Selection effect = +1.2%, Interaction = −0.3%, Residual = +0.4%. Is this attribution complete? If not, what action is needed?
Select an option first.
Correct answer: B — No, NOT complete. Attribution total = 0.5+1.2+(−0.3)+0.4 = 1.8% ✓. Wait — with the residual included, 0.5+1.2−0.3+0.4 = 1.8%. If the residual IS included as a component, the model reconciles. However, a residual of +0.4% signals that 22% of active return is unexplained (not attributable to specific decisions). A complete attribution should explain 100% without a residual. The residual suggests the model doesn't capture all of the manager's strategies — potentially intra-period trading, derivatives, or currency effects not modeled.
Explanation: B is correct: Mathematically, with the residual included, the attribution sums to 1.8% and reconciles numerically. However, a 0.4% residual (22% of active return) is large and indicates model incompleteness. A valid attribution should approach 0% residual. The residual could result from: intra-period trading not captured by beginning-of-period holdings, missing risk factors in the model, currency effects, derivatives overlay not included in the model, or data quality issues. The appropriate action: identify the source of the residual and either (1) improve the model to capture it, or (2) attribute it to a specific category (e.g., 'trading effect') rather than leaving it unexplained.
Question 48
Three-fund comparison using multiple appraisal measures: Fund A: return=11%, σ=14%, β=0.9, α=+1.5%, σε=8%. Fund B: return=9%, σ=8%, β=0.6, α=+0.5%, σε=5%. Fund C: return=13%, σ=18%, β=1.3, α=+0.8%, σε=12%. Risk-free = 3%. Market return = 10%. Rank by Sharpe ratio.
Select an option first.
Correct answer: A — B > A > C
Explanation: A is correct: Sharpe A = (11%−3%)/14% = 8%/14% = 0.571. Sharpe B = (9%−3%)/8% = 6%/8% = 0.750. Sharpe C = (13%−3%)/18% = 10%/18% = 0.556. Ranking: B > A > C. Fund B generates the most excess return per unit of total risk, despite having the lowest absolute return. Fund C has the highest return but also the highest risk — its Sharpe is the lowest. The Sharpe ratio correctly penalizes Fund C for its high volatility. A is the correct ranking (B > A > C).
Question 49
Using the same three funds, rank by INFORMATION RATIO where benchmark return = 8% and tracking errors are: Fund A TE=4%, Fund B TE=2%, Fund C TE=6%.
Select an option first.
Correct answer: B — IR A=(11−8)/4=3/4=0.75. IR B=(9−8)/2=1/2=0.50. IR C=(13−8)/6=5/6=0.833. Ranking: C(0.833) > A(0.75) > B(0.50). Fund C generates the most active return per unit of active risk — the best active manager on this metric.
Explanation: B is correct: IR A = (11%−8%)/4% = 3%/4% = 0.75. IR B = (9%−8%)/2% = 1%/2% = 0.50. IR C = (13%−8%)/6% = 5%/6% = 0.833. Ranking: C(0.833) > A(0.75) > B(0.50). Fund C has the highest information ratio — generates the most active return per unit of active risk (tracking error). Note the reversal: Fund C ranked lowest on Sharpe (total risk) but highest on IR (active risk). This illustrates that the total portfolio Sharpe ratio measures something different from the IR — C might be run in a broader portfolio where its high active bets are valuable despite the total risk profile.
Question 50
Fixed-income attribution interpretation: A manager has a shorter duration than the benchmark. The yield curve RISES (parallel shift). Which attribution component is NEGATIVE and which is POSITIVE?
Select an option first.
Correct answer: B — Duration bet is POSITIVE — the manager shortened duration, meaning the portfolio's price falls LESS than the benchmark when yields rise. The manager correctly anticipated rising rates. Curve shape (if any non-parallel change occurred) depends on whether the manager was positioned correctly. In a pure parallel shift: duration effect = POSITIVE (shorter duration protected vs. benchmark). No curve shape effect for a pure parallel shift.
Explanation: B is correct: The manager's active bet was shorter duration than benchmark — meaning lower sensitivity to yield changes. When yields RISE: all bond prices fall, but shorter-duration bonds fall LESS. The manager's portfolio falls less than the benchmark → positive duration attribution effect. The attribution result: duration contribution = POSITIVE (manager was right to shorten duration; fewer losses than the benchmark). This is confirmed by the reading's example: 'The higher duration active position of the manager generated positive outperformance of 0.33% [when yields fell]' — the reverse scenario. When yields fall, longer duration earns positive attribution; when yields rise, shorter duration earns positive attribution.
Question 51
What is the PRIMARY purpose of performance MEASUREMENT as the first stage of performance evaluation?
Select an option first.
Correct answer: B — Performance measurement calculates both the return AND the risk of the fund over specified time periods. It also establishes whether performance will be compared to a benchmark (relative) or to a pre-specified target return (absolute). This foundational stage provides the inputs that attribution and appraisal then build upon.
Explanation: B is correct: The reading defines performance measurement as the 'initial foundation phase' that quantifies return and risk. Before explaining how performance was achieved (attribution) or judging whether it reflects skill (appraisal), you must first accurately measure what actually happened. The measurement stage also establishes the evaluation framework — benchmark-relative vs. absolute — which determines which attribution models and appraisal metrics are appropriate.
Question 52
What does it mean for an attribution process to 'reflect the portfolio manager's CURRENT decision-making process'?
Select an option first.
Correct answer: B — If the portfolio manager recently changed investment strategy (e.g., shifted from value to growth, or from bottom-up stock picking to top-down sector rotation), the attribution model must be updated to reflect the new process. Attribution built on an old model that no longer matches how the manager makes decisions provides misleading analysis — attributing returns to factors the manager is no longer using.
Explanation: B is correct: The reading states that an effective attribution process must capture 'the portfolio manager's current decision-making process.' If a manager historically used sector-rotation top-down allocation but shifted to fundamental bottom-up stock picking, an attribution model decomposing returns into sector allocation and selection effects based on the old process would misrepresent how the current active decisions are being made. Attribution is only useful if it accurately maps to actual decision-making — outdated models produce misleading attribution outputs.
Question 53
What is the key ADVANTAGE of TRANSACTIONS-BASED attribution over holdings-based attribution?
Select an option first.
Correct answer: B — Transactions-based attribution incorporates the impact of ALL trades made DURING the evaluation period — capturing intra-period portfolio changes that holdings-based attribution ignores. For high-turnover managers who frequently trade within the period, this eliminates the 'timing' or 'trading' effect residual that appears in holdings-based models, producing a fully reconciled attribution with no unexplained residual.
Explanation: B is correct: The reading explicitly identifies this as the key advantage — transactions-based 'improves upon the holdings-based attribution by including the impact of any trades executed during the evaluation period.' For a manager who trades frequently, the beginning-of-period holdings diverge significantly from the portfolio's actual exposures throughout the period. Transactions-based captures each trade and its timing, producing attribution that fully reconciles to reported returns. The drawback: it requires complete transaction-level data, which is more expensive to collect and process.
Question 54
In the BHB model, if a manager UNDERWEIGHTS a sector that has a NEGATIVE benchmark return, what sign does the allocation effect take?
Select an option first.
Correct answer: B — Positive — underweighting (wi < Wi, so wi − Wi < 0) a sector with negative benchmark return (Bi < 0) gives: allocation = (negative) × (negative) = POSITIVE. The manager correctly avoided a losing sector by underweighting it — a good decision that adds value.
Explanation: B is correct: BHB allocation = (wi − Wi) × Bi. Underweight means (wi − Wi) < 0. Negative sector return means Bi < 0. Product: (negative) × (negative) = positive. This makes economic sense — avoiding a losing sector adds relative value. This is the scenario where BHB's formula produces an intuitively correct sign. The BF model would give: (wi − Wi) × (Bi − B). If Bi < 0 and B > 0, then (Bi − B) < 0 — also negative, giving: (negative) × (negative) = positive — consistent result. Both models agree on sign when the underweighted sector underperforms the overall benchmark.
Question 55
What is the INTERACTION EFFECT in BHB and when is it typically POSITIVE?
Select an option first.
Correct answer: B — Interaction = (wi − Wi) × (Ri − Bi). It is positive when the DIRECTION of the active weight bet and the DIRECTION of the selection bet are the same: overweighting a sector where the manager's picks outperform the sector benchmark (positive × positive = positive), OR underweighting a sector where the manager's picks underperform the sector benchmark (negative × negative = positive). Negative interaction: overweight + bad stock picks (positive × negative).
Explanation: B is correct: The interaction captures whether the manager's two simultaneous bets (allocation and selection) worked together. If overweighting (wi > Wi, active weight > 0) AND picking better stocks (Ri > Bi, positive selection), the interaction is (positive) × (positive) = positive — both bets reinforced each other. If underweighting (active weight < 0) AND underperforming within the segment (negative selection): (negative) × (negative) = positive — both bets were wrong in the same direction, but the combination wasn't as harmful as if they were in opposite directions. Negative interaction: overweight + bad selection (or underweight + good selection).
Question 56
What is the SELECTION EFFECT formula in BHB, and which weight — portfolio or benchmark — is used in the calculation?
Select an option first.
Correct answer: B — Selection = Wi × (Ri − Bi); uses the BENCHMARK weight. This ensures the selection effect measures ONLY the stock-picking decision (did the manager's specific securities in this segment outperform?), isolated from the allocation decision. Using benchmark weight means the selection effect would be identical even if the portfolio weight were different — the allocation decision's impact is separately captured by the allocation effect.
Explanation: B is correct: The BHB selection effect formula uses the BENCHMARK weight (Wi), not the portfolio weight. This is intentional — to isolate the stock selection decision from the allocation decision. If the manager overweights technology (wi > Wi) and their tech picks outperform, the extra performance from the overweighting should be captured by the allocation and interaction effects — not inflated into the selection effect. By using Wi as the scaling factor, the selection effect measures: 'if the portfolio had the benchmark weight in this segment, what return did the manager's specific holdings generate beyond the segment benchmark?' This cleanly separates allocation skill from selection skill.
Question 57
For a FIXED-INCOME MANAGER who outperforms by extending DURATION in a falling rate environment, which attribution component reflects this decision?
Select an option first.
Correct answer: B — Duration component — extending portfolio duration beyond the benchmark (increasing interest rate sensitivity) in anticipation of falling yields. When yields fall, longer-duration bonds appreciate more than shorter-duration bonds. The attribution credit for correctly extending duration appears in the 'shift' component of yield curve decomposition or in the 'duration bucket' overweight in exposure decomposition.
Explanation: B is correct: Whether using exposure decomposition or yield curve decomposition, the active duration bet generates a specific attribution component. In exposure decomposition: the manager's portfolio has a higher average duration than the benchmark (overweight in medium/long duration buckets). In yield curve decomposition: the 'shift' component captures the impact of parallel yield curve movements — a longer duration portfolio earns more from a downward parallel shift than a shorter-duration benchmark. The reading's example shows: 'The higher duration active position of the manager generated positive outperformance of 0.33%' directly attributing the duration bet's contribution to the shift component.
Question 58
What is the 'ROLL' component in fixed-income yield curve decomposition attribution?
Select an option first.
Correct answer: B — Roll (rolldown return) is the return earned by a bond as time passes and it 'rolls down' a stable (unchanged) yield curve. As a bond approaches maturity, it moves to a lower point on an upward-sloping yield curve — if the curve is stable, the bond's yield falls and its price rises over time. This is a passive return that any bond earns simply from the passage of time, independent of yield curve movements or active management.
Explanation: B is correct: The rolldown return is a well-defined passive component of fixed-income returns. On a positively sloped yield curve, a 5-year bond has a higher yield than a 4-year bond. As one year passes, the former 5-year bond is now a 4-year bond at (typically) a lower yield — its price has risen. This price appreciation from 'rolling down the curve' is captured by the roll component in yield curve decomposition attribution. It's distinct from the yield (coupon) component and from the shift component (which captures actual yield curve movements). A manager who earns more roll return than the benchmark has positioned their holdings to benefit more from the rolldown.
Question 59
What is the DISADVANTAGE of using the MEDIAN MANAGER as a benchmark?
Select an option first.
Correct answer: B — The median manager fails key benchmark criteria: (1) Not specified in advance — the median is unknown before the evaluation period begins; (2) Not investable — you cannot construct a portfolio to track the median manager; (3) Survivorship bias — managers who fail and close are removed, inflating the apparent median performance; (4) Peer group definition is ambiguous — who qualifies as a comparable peer? These failures make it an invalid performance benchmark despite common use.
Explanation: B is correct: The reading asks candidates to 'discuss the validity of the median manager benchmark approach' and the answer implicitly addresses these failures. The reading notes that benchmarks should be SAMURAI-compliant: Specified in advance, Appropriate, Measurable, Unambiguous, Reflective, Accountable, and Investable. The median manager fails on 'specified in advance' (unknown until period ends), 'investable' (can't replicate it), and 'unambiguous' (peer group definition varies). Survivorship bias further distorts the comparison — the surviving median looks better than the median of all managers who started the period.
Question 60
What is a CUSTOM SECURITY UNIVERSE benchmark and what is its PRIMARY advantage?
Select an option first.
Correct answer: B — A custom security universe is a benchmark constructed from securities that the manager actually considers as potential investments — it represents the manager's actual opportunity set. The primary advantage: it most precisely reflects the manager's true investment universe, making the attribution analysis most meaningful. If a growth manager only considers large-cap technology stocks, a custom universe of all large-cap tech stocks is a more valid benchmark than the broad S&P 500.
Explanation: B is correct: Custom benchmarks are constructed specifically for a particular manager's strategy, making the attribution most relevant and the skill assessment most accurate. A fixed-income manager who only invests in US investment-grade corporates with 3-7 year maturities should be measured against a custom universe of those specific bonds — not the broad Bloomberg Aggregate or a government bond index. The disadvantage: custom benchmarks require more work to construct and maintain, and they may not be recognized or understood by external stakeholders (clients, consultants).
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