CFA Program — Portfolio Management

Question 1

A fixed income portfolio manager immunizes a portfolio against interest rate risk relative to a single future liability primarily by:

• A) Matching the portfolio's duration to the liability's investment horizon (duration matching)
• B) Investing entirely in equities
• C) Ignoring the liability's timing entirely
• D) Maximizing the portfolio's convexity without regard to duration

Question 2

In multi-factor models such as the Fama-French three-factor model, the "size" (SMB) factor captures the historical tendency of:

• A) Large-cap stocks to outperform small-cap stocks over the long run
• B) Small-cap stocks to outperform large-cap stocks over the long run, on a risk-adjusted basis
• C) Value stocks to always underperform growth stocks
• D) Bond returns to exceed equity returns

Question 3

A pension fund's surplus (funded status) is defined as:

• A) Plan assets minus plan liabilities (the present value of future benefit obligations)
• B) Total contributions made in the current year only
• C) The plan's total assets, with no reference to liabilities
• D) The number of active plan participants

Question 4

Liability-driven investing (LDI), commonly used by defined benefit pension plans, primarily focuses on:

• A) Maximizing absolute return with no regard to plan liabilities
• B) Structuring the asset portfolio (often emphasizing fixed income) to closely match the interest rate sensitivity and cash flow timing of plan liabilities
• C) Investing exclusively in small-cap equities for growth
• D) Eliminating all fixed income exposure from the portfolio

Question 5

The information ratio measures:

• A) A portfolio's total return divided by its total risk (standard deviation)
• B) A portfolio's active return (relative to a benchmark) divided by its active risk (tracking error)
• C) The correlation between two asset classes
• D) The portfolio manager's years of experience

Question 6

In performance attribution analysis, if a portfolio manager's overweight allocation to a sector that subsequently outperformed the benchmark contributed positively to relative performance, this effect is generally classified as:

• A) Security selection effect
• B) Allocation (sector weighting) effect
• C) Currency effect only
• D) Survivorship bias

Question 7

Which of the following best describes the concept of "manager selection risk" within a broader multi-manager portfolio?

• A) The risk that a specific active manager selected by the investor underperforms their benchmark or peers, distinct from the broader asset allocation or market risk of the overall portfolio.
• B) A risk that applies only to passive index fund investments.
• C) A risk that is always identical in magnitude to overall market risk.
• D) A risk that cannot be managed or mitigated in any way.

Question 8

A pension fund adopts a "dynamic" (rather than static) liability-driven investing approach, adjusting its asset allocation as the plan's funded status improves. As funded status increases toward fully funded, the plan would generally:

• A) Immediately terminate the pension plan once fully funded.
• B) Gradually shift toward a more liability-matching (typically higher fixed-income) allocation, reducing risk-taking as the surplus available to absorb losses shrinks relative to the improved funded position.
• C) Always increase equity allocation as funded status improves, regardless of risk considerations.
• D) Maintain an identical asset allocation regardless of changes in funded status.

Question 9

Which of the following best describes the primary purpose of stress testing a portfolio using historical or hypothetical extreme market scenarios?

• A) Replacing the need for any other form of risk management entirely.
• B) A technique used exclusively for evaluating fixed-income portfolios.
• C) Assessing how the portfolio would likely perform under severe but plausible adverse conditions, which may not be well captured by standard risk measures based on normal historical volatility.
• D) Guaranteeing the portfolio will never experience a loss in any future scenario.

Question 10

A portfolio manager's Sharpe ratio has improved significantly over the past year, driven primarily by a large reduction in the portfolio's standard deviation, with little change in absolute returns. An analyst evaluating this improvement should consider:

• A) The Sharpe ratio improvement is always meaningful and requires no further investigation.
• B) Standard deviation has no relevance to evaluating the Sharpe ratio.
• C) The manager must have taken on significantly more risk to achieve this result.
• D) Whether the reduced volatility reflects a genuine, sustainable change in the portfolio's risk profile or a temporary market condition (such as unusually low overall market volatility) that may not persist.

Question 11

Which of the following best describes the primary distinction between "risk budgeting" and simple capital allocation in portfolio construction?

• A) Risk budgeting explicitly allocates a portfolio's total acceptable risk across strategies or asset classes, which may differ meaningfully from a simple allocation based purely on dollar (capital) amounts, since different assets carry different risk per dollar invested.
• B) Risk budgeting and capital allocation always produce identical portfolio weights in every case.
• C) Risk budgeting applies only to portfolios with no fixed income exposure.
• D) Capital allocation always results in a more diversified portfolio than risk budgeting.

Question 12

An analyst constructs a multi-factor risk model incorporating value, momentum, quality, and size factors to analyze a portfolio's sources of active risk relative to its benchmark. This type of analysis is generally referred to as:

• A) A technique with no practical application in institutional portfolio management.
• B) Risk attribution (or factor-based risk decomposition)
• C) Simple historical performance charting with no decomposition.
• D) A method used exclusively for fixed-income portfolios.

Question 13

An institutional investor is constructing a portfolio using the Black-Litterman model rather than standard mean-variance optimization. Which of the following best describes a key advantage of this approach?

• A) It guarantees higher realized returns than any other portfolio construction approach.
• B) It can only be applied to fixed-income portfolios.
• C) It starts from market-implied equilibrium returns and blends them with the investor's own specific views, producing more intuitive and stable portfolio weights than unconstrained mean-variance optimization, which is highly sensitive to small changes in expected return inputs.
• D) It eliminates the need for any estimate of asset covariances.

Question 14

Which of the following best describes the primary purpose of a portfolio "rebalancing policy" (e.g., calendar-based or percentage-range-based rebalancing)?

• A) A policy applicable only to portfolios with no strategic asset allocation targets.
• B) Maintaining the portfolio's risk and return characteristics in line with the investor's strategic asset allocation targets by systematically trimming outperforming asset classes and adding to underperforming ones as market movements cause actual weights to drift from targets.
• C) Maximizing trading activity and transaction costs regardless of any benefit.
• D) Permanently locking in the portfolio's initial weights with no future adjustments ever made.

Question 15

Which of the following best describes a key limitation of using standard deviation as the sole risk measure when evaluating a hedge fund or alternative investment strategy with a non-normal return distribution?

• A) Standard deviation is only applicable to fixed-income securities.
• B) Standard deviation cannot be calculated for any alternative investment strategy.
• C) Standard deviation treats upside and downside deviations symmetrically and does not capture tail risk or skewness, which can understate the true downside risk of strategies with negatively skewed or fat-tailed return distributions.
• D) Standard deviation always overstates the risk of strategies with normally distributed returns.

Question 16

Which of the following best describes the primary distinction between strategic asset allocation (SAA) and tactical asset allocation (TAA)?

• A) SAA and TAA are identical concepts with no meaningful distinction.
• B) TAA always refers to a permanent, one-time change to the long-term target allocation.
• C) SAA is always revised on a daily basis, while TAA is fixed for the life of the portfolio.
• D) SAA reflects the long-term target allocation based on an investor's objectives, constraints, and long-run capital market expectations, while TAA involves deliberate, typically shorter-term deviations from the SAA targets based on current market views.

Question 17

A pension fund with a well-defined stream of future liability payments is evaluating a liability-driven investing (LDI) approach. Which of the following best describes the primary objective of LDI?

• A) Structuring the asset portfolio, particularly its interest rate sensitivity, to closely track and hedge changes in the value of the fund's liabilities, reducing the risk of a funding shortfall due to interest rate movements.
• B) Maximizing absolute portfolio return with no consideration of the liability structure.
• C) Investing exclusively in equities to maximize long-term growth potential.
• D) Eliminating all interest rate exposure from both assets and liabilities simultaneously.

Question 18

Which of the following best describes the primary purpose of a "risk parity" portfolio construction approach?

• A) A strategy that ignores risk entirely and focuses only on expected return maximization.
• B) Allocating capital such that each asset class or risk factor contributes an equal share of the portfolio's total risk, rather than allocating equal dollar amounts, since asset classes differ substantially in volatility.
• C) Allocating equal dollar amounts to every asset class regardless of volatility differences.
• D) Concentrating the portfolio entirely in the single lowest-volatility asset class.

Question 19

Which of the following best describes the liability-driven investing (LDI) framework for a pension fund?

• A) Maximizing total return regardless of the liability profile
• B) Structuring assets to hedge the interest rate sensitivity of the pension liabilities
• C) Investing exclusively in bonds to avoid equity market risk
• D) Matching asset duration to the equity risk premium

Question 20

In an active equity strategy using the 130/30 approach, the manager:

• A) Holds 130% in equities and 30% in bonds for diversification
• B) Takes 130% long positions and 30% short positions, resulting in 100% net market exposure
• C) Uses 30% leverage to amplify returns above the benchmark
• D) Holds 130% in investment-grade bonds and 30% in high-yield bonds

Question 21

A portfolio manager's information coefficient (IC) is 0.08 and her investment universe includes 150 independent opportunities per year. Her expected information ratio is closest to:

• A) 0.98
• B) 0.80
• C) 0.64
• D) 1.20

Question 22

Which of the following best describes the information ratio (IR)?

• A) Excess return over the risk-free rate divided by total volatility
• B) Active return divided by tracking error
• C) Jensen's alpha divided by systematic risk (beta)
• D) Sharpe ratio minus the benchmark Sharpe ratio

Question 23

A defined benefit pension plan has a duration of liabilities of 15 years and currently has assets equally split between equities (duration ≈ 0) and bonds (duration 10 years). The funded status surplus/deficit changes most when:

• A) Credit spreads widen
• B) Interest rates fall significantly
• C) Equity markets decline
• D) Inflation rises unexpectedly

Question 24

The Black-Litterman model improves on mean-variance optimization primarily by:

• A) Using historical returns instead of expected returns
• B) Combining market equilibrium returns with investor views to produce more stable expected return inputs
• C) Eliminating the need for a covariance matrix
• D) Maximizing the Sharpe ratio directly without constraint

Question 25

An investor with a high degree of "loss aversion," a concept from behavioral finance, is most likely to:

• A) Feel the pain of a loss more intensely than the pleasure of an equivalent-sized gain, potentially leading to suboptimal decisions such as holding losing investments too long.
• B) Feel entirely neutral about gains and losses of any size.
• C) Always make perfectly rational investment decisions regardless of past outcomes.
• D) Feel more pleasure from a gain than pain from an equivalent loss.

Question 26

A portfolio manager evaluates performance using the Treynor ratio rather than the Sharpe ratio. The Treynor ratio is most appropriate when:

• A) Total risk and systematic risk are always identical for every portfolio.
• B) Evaluating a portfolio that is one of several holdings within a larger, well-diversified overall portfolio, since Treynor uses systematic risk (beta) rather than total risk.
• C) The portfolio being evaluated represents an investor's entire total wealth with no other holdings.
• D) The portfolio has no exposure to systematic risk whatsoever.

Question 27

A pension fund conducts an asset-liability management (ALM) study. The primary purpose of this analysis is to:

• A) Align the fund's investment strategy and asset allocation with the characteristics (such as timing and size) of its future liabilities.
• B) Determine the fund's asset allocation without any reference to its liabilities.
• C) Guarantee the fund will never experience a funding shortfall.
• D) Eliminate the need for any actuarial assumptions.

Question 28

The information ratio measures a portfolio manager's:

• A) Total return with no adjustment for risk of any kind.
• B) Correlation with the risk-free asset exclusively.
• C) The total number of securities held in the portfolio.
• D) Active return (portfolio return minus benchmark return) per unit of active risk (tracking error).

Question 29

A manager pursuing a "core-satellite" portfolio construction approach typically combines:

• A) A single security representing the entire portfolio.
• B) Only fixed income securities, with no equity exposure of any kind.
• C) A large, low-cost, broadly diversified "core" holding (often passively managed) with smaller "satellite" positions in actively managed or specialized strategies intended to add incremental excess return.
• D) Exclusively actively managed holdings with no passive component whatsoever.

Question 30

Which of the following best describes "risk budgeting" in portfolio management?

• A) A guarantee that the portfolio will never experience losses.
• B) Allocating a portfolio's total acceptable risk across different asset classes, strategies, or managers, rather than allocating solely based on capital amounts.
• C) Allocating capital without any consideration of risk whatsoever.
• D) A process used exclusively for allocating cash among savings accounts.

Question 31

A portfolio consists of 60% invested in Asset A (expected return 8%, standard deviation 12%) and 40% invested in Asset B (expected return 12%, standard deviation 20%). The correlation between the returns of Asset A and Asset B is 0.30. The portfolio's expected return and standard deviation are closest to:

• A) Expected return = 9.6%; standard deviation = 16.80%, which correctly calculates the expected return but incorrectly computes standard deviation as a simple weighted average of the two individual asset standard deviations (0.6x12%+0.4x20%), ignoring the correlation and variance formula entirely.
• B) Expected return = 10.0%; standard deviation = 12.26%, which incorrectly calculates expected return as a simple unweighted average of the two asset returns (8%+12%)/2 rather than using the correct portfolio weights.
• C) Expected return = 9.6%; standard deviation = 12.26%. Expected return = (0.60 x 8%) + (0.40 x 12%) = 4.8% + 4.8% = 9.6%. Variance = (0.60^2 x 0.12^2) + (0.40^2 x 0.20^2) + (2 x 0.60 x 0.40 x 0.12 x 0.20 x 0.30) = 0.005184 + 0.0064 + 0.003456 = 0.01504; standard deviation = sqrt(0.01504) = 12.26%.
• D) Expected return = 9.6%; standard deviation = 14.42%, which incorrectly omits the covariance (correlation) cross-term entirely from the portfolio variance formula, using only the sum of the two weighted individual variances.

Question 32

A portfolio manager's actively managed portfolio has generated an annualized active return (portfolio return minus benchmark return) of 2.5%, with an annualized tracking error (standard deviation of active returns) of 4.0%. The portfolio's information ratio is closest to:

• A) 1.60, which incorrectly inverts the calculation, dividing tracking error by active return (4.0%/2.5%) rather than active return by tracking error.
• B) 6.50, which incorrectly adds the active return and tracking error together (2.5% + 4.0%) rather than dividing one by the other.
• C) 10.00, which incorrectly multiplies active return by tracking error (2.5% x 4.0%, then scaled incorrectly) rather than dividing active return by tracking error.
• D) 0.625, calculated as Information ratio = Active return / Tracking error = 2.5% / 4.0% = 0.625.

Question 33

A $5,000,000 portfolio has an expected annual return of 8% and an annual return standard deviation of 18%, and returns are assumed to be normally distributed. Using the parametric (variance-covariance) method and a 5% one-tailed confidence level (z-value of approximately 1.645), the portfolio's 1-year 5% value at risk (VaR) is closest to:

• A) $900,000, which incorrectly calculates VaR using only the standard deviation term (5,000,000 x 0.18) and omits both the z-value scaling factor and the expected return adjustment.
• B) $1,480,500, which incorrectly adds the expected return to the z-scaled standard deviation term (1.645 x 18% + 8%) rather than subtracting it.
• C) $1,080,500, calculated as VaR% = (z x standard deviation) - expected return = (1.645 x 18%) - 8% = 29.61% - 8% = 21.61%. VaR (dollar) = Portfolio value x VaR% = $5,000,000 x 0.2161 = $1,080,500, representing the estimated maximum loss (at the 5% confidence level) over one year.
• D) $8,225,000, which incorrectly multiplies the full z-value x standard deviation percentage (29.61%) as if it were greater than 100%, or otherwise misapplies the VaR percentage to the portfolio value with a scaling/decimal error.

Question 34

A portfolio has an annualized return of 11% and a beta of 1.2. The risk-free rate is 3%, and the market's expected return is 9%. Using the capital asset pricing model (CAPM) to determine the portfolio's expected (required) return, the portfolio's Jensen's alpha is closest to:

• A) 2.00%, which incorrectly calculates alpha as the simple difference between the portfolio's actual return and the market return (11% - 9%), ignoring the portfolio's beta entirely.
• B) 0.80%, calculated as CAPM expected return = Risk-free rate + Beta x (Market return - Risk-free rate) = 3% + 1.2 x (9% - 3%) = 3% + 7.2% = 10.2%. Jensen's alpha = Actual return - CAPM expected return = 11% - 10.2% = 0.80%.
• C) 8.00%, which incorrectly calculates alpha as the portfolio's excess return over the risk-free rate (11% - 3%), without incorporating the CAPM-based expected return calculation using beta.
• D) -0.80%, which incorrectly reverses the sign of alpha, understating the CAPM expected return calculation such that it exceeds, rather than falls short of, the portfolio's actual realized return.

Question 35

A portfolio has an annualized return of 11%, a beta of 1.2 relative to its benchmark, and the risk-free rate is 3%. The portfolio's Treynor ratio is closest to:

• A) 6.67%, calculated as Treynor ratio = (Portfolio return - Risk-free rate) / Beta = (0.11 - 0.03) / 1.2 = 0.08 / 1.2 = 0.0667, or 6.67%.
• B) 9.60%, which incorrectly multiplies the excess return by beta (0.08 x 1.2) rather than dividing the excess return by beta.
• C) 8.00%, which correctly calculates the excess return (11% - 3%) but incorrectly fails to divide by the portfolio's beta of 1.2, omitting the final step of the Treynor ratio calculation.
• D) 3.33%, which incorrectly divides the portfolio's full return (11%) by beta before subtracting the risk-free rate, rather than first subtracting the risk-free rate and then dividing by beta.

Question 36

Portfolio X has an annualized return of 11% and a standard deviation of 15%. Portfolio Y has an annualized return of 9% and a standard deviation of 10%. The risk-free rate is 3%. Based on the Sharpe ratio, which portfolio provided superior risk-adjusted performance?

• A) Portfolio X, because it has a higher raw return of 11% compared to Portfolio Y's 9%, without considering the higher level of total risk taken to achieve that return.
• B) The two portfolios have identical risk-adjusted performance, since their Sharpe ratios round to a similar order of magnitude even though the underlying calculations produce meaningfully different values.
• C) Portfolio X, because its Sharpe ratio of (11%-3%)/15% = 0.80 exceeds Portfolio Y's Sharpe ratio of (9%-3%)/10% = 0.60, based on an incorrect Sharpe ratio calculation for Portfolio X.
• D) Portfolio Y, since its Sharpe ratio of (9% - 3%)/10% = 0.60 exceeds Portfolio X's Sharpe ratio of (11% - 3%)/15% = 0.533, indicating Portfolio Y generated more excess return per unit of total risk (standard deviation), despite its lower absolute return.