Free CFA Level II Portfolio Management Practice Questions

B is correct. A creation unit is a large, standardized block of ETF shares (typically 25,000 to 100,000 shares, though the exact size varies by ETF) that serves as the unit of exchange in the creation/redemption process. Only authorized participants (APs) — typically large broker-dealers or market makers — can create or redeem shares in creation unit increments by exchanging the underlying securities (or cash) with the ETF issuer.

C is incorrect because individual investors cannot create ETF shares. They buy and sell existing shares on the secondary market (exchange). The creation process is reserved for authorized participants and occurs in large blocks, not single shares.

A is incorrect because the total number of ETF shares outstanding is not fixed — it changes continuously as APs create new shares or redeem existing ones. This open-ended structure is a key feature that keeps the ETF's market price close to its NAV.

A is correct. The alpha has a t-statistic of 1.88 and a p-value of 0.065, which means it is not statistically significant at the conventional 5% significance level (which requires a t-statistic above approximately 2.0 or a p-value below 0.05). This means we cannot reject the null hypothesis that the true alpha is zero. The positive alpha could simply be due to random variation rather than genuine manager skill.

B is incorrect because a positive alpha alone does not constitute evidence of manager skill. Statistical significance must be established first. With a p-value of 0.065, the alpha is not significant at the 5% level, so we cannot confidently conclude the manager adds value.

C is incorrect because while 0.15% monthly (approximately 1.80% annualized) might appear economically meaningful, the lack of statistical significance means we cannot be confident that the true alpha is different from zero. Economic significance is moot if the estimate is not statistically reliable.

B is correct. The fund has a market beta of 1.08 (above-market risk) and a significant HML loading of 0.58 (strong value tilt), both of which are statistically significant. This means a substantial portion of the fund's returns can be attributed to systematic factor exposures — taking more market risk and tilting toward value stocks. Since the alpha is not statistically significant (t = 1.88, p = 0.065), the evidence suggests the manager is not generating returns from stock selection skill but rather from factor exposures that could be replicated more cheaply with passive factor-tilted strategies.

Choice A is incorrect because a high R-squared does not mean the fund tracks its benchmark closely. It means the three-factor model explains 92% of the variation in the fund's returns. The fund could deviate substantially from a market-cap-weighted benchmark while still having high R-squared if those deviations are well-explained by SMB and HML factors.

Choice C is incorrect because a Durbin-Watson statistic of 1.89 is close to 2.0, which indicates no significant serial correlation in the residuals. Values near 2.0 suggest the regression residuals are not autocorrelated, which supports the validity of the regression results.