CFA Program — Portfolio Management

Question 1

An investor's strategic asset allocation is best described as:

• A) A short-term tactical response to daily market news
• B) A long-term target mix of asset classes based on the investor's objectives, risk tolerance, and time horizon
• C) The selection of individual stocks within an equity portfolio
• D) A guarantee of a specific investment return

Question 2

According to modern portfolio theory, combining assets with less than perfect positive correlation in a portfolio will generally:

• A) Increase overall portfolio risk beyond the weighted average of individual asset risks
• B) Reduce overall portfolio risk below the weighted average of individual asset risks, through diversification
• C) Have no effect on portfolio risk
• D) Guarantee higher portfolio returns

Question 3

The Capital Asset Pricing Model (CAPM) describes the expected return of an asset as a function of:

• A) The asset's total standard deviation only
• B) The risk-free rate, the asset's beta, and the expected market risk premium
• C) The asset's price-to-earnings ratio
• D) The company's total revenue

Question 4

A stock has a beta of 1.5. If the risk-free rate is 3% and the expected market return is 9%, what is the stock's expected return according to CAPM?

• A) 9.0%
• B) 12.0%
• C) 13.5%
• D) 15.0%

Question 5

Which type of risk can be eliminated through diversification across a large number of securities?

• A) Systematic risk
• B) Market risk
• C) Unsystematic (idiosyncratic) risk
• D) Inflation risk

Question 6

The Sharpe ratio measures:

• A) A portfolio's total return divided by its beta
• B) A portfolio's excess return over the risk-free rate, per unit of total risk (standard deviation)
• C) A portfolio's dividend yield relative to its price
• D) The correlation between a portfolio and the market index

Question 7

According to Modern Portfolio Theory, combining two assets that are less than perfectly positively correlated in a portfolio will generally:

• A) Have no effect on portfolio risk whatsoever.
• B) Guarantee a higher expected return regardless of the assets' individual returns.
• C) Reduce the overall portfolio risk (standard deviation) below a simple weighted average of the individual assets' risks.
• D) Always increase overall portfolio risk above the weighted average.

Question 8

A portfolio consists of 60% invested in an asset with an expected return of 10% and 40% invested in an asset with an expected return of 6%. The portfolio's expected return is closest to:

• A) 7.0%
• B) 8.4%
• C) 8.0%
• D) 9.0%

Question 9

A pension fund's investment policy statement specifies a required rate of return needed to meet its future obligations. This required return is best described as reflecting the fund's:

• A) Return objective, one of the core components of an investment policy statement alongside risk tolerance and constraints.
• B) Risk tolerance exclusively, with no relationship to return.
• C) Legal jurisdiction only.
• D) Tax status exclusively.

Question 10

Which of the following best describes "passive" portfolio management, as distinguished from "active" management?

• A) Making frequent trades based on the manager's independent judgment about mispriced securities.
• B) Investing exclusively in a single individual stock.
• C) A strategy that guarantees outperformance of the benchmark.
• D) Constructing a portfolio to track a specified benchmark or index, rather than attempting to outperform it through security selection or market timing.

Question 11

A portfolio's "tracking error" measures:

• A) The correlation between two entirely unrelated portfolios.
• B) The number of trades executed within the portfolio in a given period.
• C) The standard deviation of the difference between the portfolio's returns and its benchmark's returns.
• D) The total return of the portfolio in absolute terms.

Question 12

Which of the following best describes the concept of "rebalancing" a portfolio?

• A) Randomly changing the portfolio's holdings without any specific target.
• B) Periodically adjusting portfolio holdings back toward target asset allocation weights, which may drift due to differing asset class performance.
• C) Selling all portfolio holdings permanently and holding only cash.
• D) A one-time action taken only when a portfolio is first created.

Question 13

Which of the following best describes "downside deviation" as a risk measure, compared to standard deviation?

• A) Downside deviation cannot be calculated for any investment.
• B) Downside deviation measures only the volatility of returns below a specified minimum acceptable return (or the mean), ignoring upside volatility, which some investors view as more relevant since they are primarily concerned with losses.
• C) Downside deviation and standard deviation are calculated identically in all cases.
• D) Downside deviation measures only the volatility of returns above the mean.

Question 14

Which of the following best describes the concept of the "efficient frontier"?

• A) The set of all portfolios with a beta of exactly 1.0.
• B) A theoretical concept with no practical application in portfolio construction.
• C) The set of portfolios that offer the highest expected return for each level of risk, or equivalently, the lowest risk for each level of expected return.
• D) A single portfolio guaranteed to outperform all others regardless of risk.

Question 15

Which of the following best describes the primary purpose of an asset-liability management (ALM) approach used by institutions such as pension funds or insurance companies?

• A) A strategy used exclusively by individual retail investors, not institutions.
• B) Aligning investment strategy and asset allocation with the specific characteristics (timing, size, and nature) of the institution's future liabilities.
• C) Maximizing short-term trading profits with no consideration of future obligations.
• D) Eliminating the need for any actuarial or liability projections.

Question 16

A portfolio manager's use of "factor investing," targeting specific characteristics such as value, momentum, or quality, is most closely associated with which broader investment approach?

• A) An approach that relies entirely on the manager's subjective, undisclosed intuition.
• B) An approach used exclusively for fixed income portfolios.
• C) A rules-based, systematic approach that sits between traditional passive indexing and fully discretionary active management.
• D) A purely passive approach identical to holding a market-cap-weighted index.

Question 17

Which of the following best describes "diversifiable" (unsystematic) risk?

• A) Risk that affects the entire market and cannot be reduced through diversification.
• B) A type of risk that only affects government bonds.
• C) Risk that is always exactly equal to a portfolio's beta.
• D) Risk specific to an individual company or industry that can be substantially reduced by holding a well-diversified portfolio.

Question 18

Which of the following best describes the "risk tolerance" component of an investment policy statement?

• A) An assessment of the investor's willingness and financial ability to accept fluctuations in portfolio value in pursuit of their return objectives.
• B) A fixed, universal standard identical for every investor regardless of circumstances.
• C) A measure exclusively of the investor's current age.
• D) A component that has no bearing on asset allocation decisions.

Question 19

According to the Capital Asset Pricing Model (CAPM), the expected return of a stock equals:

• A) The risk-free rate plus a premium for total risk
• B) The risk-free rate plus beta times the market risk premium
• C) The market return times the stock's beta
• D) The risk-free rate plus the Sharpe ratio

Question 20

Portfolio A has a return of 12% and standard deviation of 18%. Portfolio B has a return of 10% and standard deviation of 12%. The risk-free rate is 3%. Which portfolio has the higher Sharpe ratio?

• A) Portfolio A: 0.50
• B) Portfolio B: 0.58
• C) Both have the same Sharpe ratio
• D) Portfolio A: 0.67

Question 21

An investor holds a portfolio of two assets with a correlation of −1.0. The portfolio's minimum variance is achieved when the standard deviation equals:

• A) The average of the two assets' standard deviations
• B) Zero
• C) The lower of the two assets' standard deviations
• D) The geometric mean of the two standard deviations

Question 22

The Investment Policy Statement (IPS) for a pension fund should address all of the following EXCEPT:

• A) Return objectives
• B) Risk tolerance
• C) Names of specific securities to hold
• D) Time horizon and liquidity needs

Question 23

Which of the following best describes systematic (market) risk?

• A) Risk that can be eliminated through diversification
• B) Risk specific to an individual company
• C) Risk that cannot be diversified away, affecting all securities
• D) Operational risk arising from internal processes

Question 24

Under the Capital Market Line (CML), all efficient portfolios:

• A) Plot on the security market line
• B) Are combinations of the risk-free asset and the market portfolio
• C) Have the same Sharpe ratio as individual assets
• D) Have zero correlation with the market

Question 25

According to Modern Portfolio Theory, the "efficient frontier" represents:

• A) A single portfolio that guarantees the highest possible return regardless of risk.
• B) The set of all possible portfolios with negative expected returns.
• C) A line representing only risk-free assets.
• D) The set of portfolios offering the highest expected return for each level of risk (or, equivalently, the lowest risk for each level of expected return).

Question 26

Diversification reduces a portfolio's risk primarily by:

• A) Eliminating all forms of risk, including systematic market risk.
• B) Guaranteeing higher returns than any individual asset in the portfolio.
• C) Combining assets whose returns are not perfectly positively correlated, reducing unsystematic (diversifiable) risk.
• D) Increasing the number of correlated assets that move identically together.

Question 27

A portfolio's Sharpe ratio measures:

• A) The number of securities held in a portfolio.
• B) Excess return per unit of total risk, calculated as (portfolio return minus risk-free rate) divided by portfolio standard deviation.
• C) Total return without any adjustment for risk.
• D) The correlation between two different portfolios.

Question 28

A portfolio has an expected return of 12%, a standard deviation of 15%, and the risk-free rate is 3%. The portfolio's Sharpe ratio is closest to:

• A) 0.60
• B) 0.80
• C) 0.20
• D) 1.20

Question 29

The Capital Market Line (CML) differs from the Security Market Line (SML) in that the CML plots expected return against:

• A) Systematic risk (beta), for any individual security or portfolio.
• B) Company size exclusively.
• C) The number of years an investment has been held.
• D) Total risk (standard deviation), for efficient portfolios combining the risk-free asset and the market portfolio.

Question 30

An investment policy statement (IPS) for an individual client typically documents which of the following?

• A) Only the fee schedule charged by the investment manager.
• B) Nothing related to the client's financial goals.
• C) The client's return objectives, risk tolerance, constraints (such as liquidity needs, time horizon, tax considerations, and legal/regulatory factors), and overall investment strategy.
• D) Only the specific stocks the client currently owns.

Question 31

A portfolio has an expected return of 9%, a standard deviation of 18%, and the risk-free rate is 2%. The portfolio's Sharpe ratio is closest to:

• A) 0.50
• B) 0.07
• C) 0.39
• D) 0.11

Question 32

An investor consistently overestimates the accuracy of his own investment forecasts and trades far more frequently than his actual performance would justify, believing his stock-picking skill is well above average. This behavior is most consistent with which behavioral bias?

• A) Anchoring bias
• B) Loss aversion
• C) Regret aversion
• D) Overconfidence bias, in which investors overestimate their own knowledge, skill, or the precision of their information, often leading to excessive trading and inadequate diversification.

Question 33

On the Markowitz efficient frontier, the "global minimum-variance portfolio" is best described as:

• A) The portfolio with the highest possible expected return among all feasible portfolios.
• B) A portfolio invested entirely in the single least risky individual asset available.
• C) The portfolio, among all feasible combinations of risky assets, that has the lowest possible level of risk (standard deviation), regardless of its expected return.
• D) A portfolio that always earns a guaranteed positive return in every period.

Question 34

A portfolio consists of 60% invested in Asset A, with a standard deviation of 20%, and 40% invested in Asset B, with a standard deviation of 10%. The correlation between Asset A and Asset B is 0.3. The portfolio's standard deviation is closest to:

• A) 16.0%
• B) 13.7%
• C) 20.0%
• D) 10.0%

Question 35

A portfolio earns a return of 13%, while the risk-free rate is 3%, the portfolio's beta is 1.1, and the market return is 11%. The portfolio's Jensen's alpha is closest to:

• A) 1.2%
• B) 2.0%
• C) 0.0%
• D) -1.2%

Question 36

A portfolio has an expected return of 14%, a beta of 1.2, and the risk-free rate is 3%. The portfolio's Treynor ratio is closest to:

• A) 11.7%
• B) 13.2%
• C) 8.3%
• D) 9.2%