Free CAIA Level II Risk and Risk Management Practice Questions
Risk and risk management on CAIA Level II covers alpha-beta separation, delta hedging, cross-asset benchmarking, Value-at-Risk for managed futures, return smoothing and unsmoothing for private assets, and cybersecurity risk management.
A is correct. Active return is defined as the portfolio's return minus the benchmark return. It captures the total value added or subtracted by the manager relative to the chosen benchmark, encompassing both security selection and allocation effects.
Question 2
Medium
Omitted factor bias in single-factor performance attribution occurs when:
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Correct Answer: D
Solution
D is correct. Omitted factor bias arises when a performance model excludes systematic risk factors that the manager is actually exposed to. Returns earned from those omitted factor exposures are misclassified as alpha, making the manager appear to generate skill-based returns when in fact they are earning systematic risk premiums.
Question 3
Hard
During an annual 're-underwriting' onsite review of an external hedge fund manager, which of the following practices is LEAST consistent with industry best practice as described for annual data collection?
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Correct Answer: C
Solution
C is correct. A core valuation-policy principle is that fair-value determination should be insulated from the investment team to avoid conflicts of interest, with valuation activities contained within back-office and external service-provider personnel. Allowing the investment-side onsite reviewer to set Level 3 marks compromises that separation. Separate investment and operational onsite meetings, periodic mandate and agreement renewals, and refreshed third-party background checks (commonly every three years) are all standard annual practices.
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