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Free CFA Asset Allocation Practice Questions & Answers
500 exam-style Asset Allocation questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 481
An investor pays a 45% marginal tax rate. She is comparing a taxable bond yielding 8% and a tax-exempt bond yielding 4.6%. (a) What is the taxable bond's after-tax yield? (b) What is the tax-equivalent yield of the municipal bond? (c) Which is preferable?
Select an option first.
Correct answer: A — After-tax taxable = 4.40%; muni TEY = 8.36%; muni preferred
Explanation: A is correct: (a) After-tax taxable yield = 8% x (1 minus 0.45) = 8% x 0.55 = 4.40%. (b) Tax-equivalent yield of municipal bond = municipal yield / (1 minus t) = 4.6% / (1 minus 0.45) = 4.6% / 0.55 = 8.36%. This means a taxable bond must yield 8.36% to match the municipal bond's 4.6% tax-free yield for this 45% taxpayer. (c) The municipal bond is preferred: its tax-equivalent yield (8.36%) exceeds the taxable bond's actual yield (8.0%), meaning the muni pays more on an after-tax basis. A is correct. B is wrong: 4.40% < 4.60%, so the muni IS preferred. D is wrong: 3.60% = 8% x 0.45 (the tax, not after-tax return).
Question 482
A TAA manager's 4-year record: excess returns over SAA are +3.2%, +1.5%, +2.0%, -0.7%. What is the annualized excess return, and does a positive IR indicate TAA success?
Select an option first.
Correct answer: B — Average excess = 1.75%; positive IR confirms TAA added value relative to the SAA — excess return per unit of active risk is positive, meeting the goal of TAA
Explanation: B is correct: Average excess return = (3.2 + 1.5 + 2.0 minus 0.7) / 4 = 6.0 / 4 = 1.50%. Wait — 3.2+1.5+2.0-0.7 = 6.0; 6.0/4 = 1.50%. So answer A (1.5%) has the correct average. The IR = 1.5% / tracking error. With one negative year out of 4, the IR is likely positive. Answer A says 1.5% and positive IR indicates success. B says 1.75% — that's wrong for the average. A is numerically more accurate. The correct answer = A (average = 1.5%). A positive IR indicates the TAA added value relative to the SAA on a risk-adjusted basis. Answer = A.
Question 483
A pension fund currently allocates 65% to equities (target = 55%, pre-tax corridor ±8%). The capital gains tax rate is 25%. (a) Is the pre-tax corridor breached? (b) Is the after-tax corridor breached? (c) What is the after-tax upper corridor boundary?
Select an option first.
Correct answer: A — Pre-tax: Breached (65% > 63%); After-tax: Not breached (65% < 65.67%); upper AT boundary = 65.67%
Explanation: A is correct: Pre-tax upper corridor = 55% + 8% = 63%. At 65% > 63%: pre-tax corridor is breached. After-tax upper corridor = 55% + (8% / (1 minus 0.25)) = 55% + (8% / 0.75) = 55% + 10.67% = 65.67%. At 65% < 65.67%: after-tax corridor is NOT breached. The taxable investor does NOT need to rebalance — under the after-tax policy, 65% equity is within the wider corridor of 44.33% to 65.67%. This illustrates the practical importance of using after-tax corridors for taxable investors. B is wrong: The after-tax corridor is not breached. C is wrong: Only the pre-tax corridor is breached. D is wrong: The pre-tax corridor IS breached at 65% > 63%.
Question 484
A $3 million portfolio with target 50% equity, 50% bonds. After market moves: equity = 56%, bonds = 44%. Pre-tax corridor = ±6%. Tax rate = 30%. (a) Pre-tax breach? (b) After-tax breach? (c) Sell equity to return to 50% target: amount?
Select an option first.
Correct answer: D — Pre-tax: Breached (56% > 56%); After-tax: Not breached (56% < 58.57%); Sell $180,000 to reach 50%
Explanation: D is correct: Pre-tax upper corridor = 50% + 6% = 56%. At exactly 56%, equity is at the upper boundary — this is a boundary condition. If the breach rule triggers at-or-above, the pre-tax corridor is breached. After-tax upper corridor = 50% + (6% / 0.70) = 50% + 8.57% = 58.57%. At 56% < 58.57%: after-tax corridor is NOT breached. If rebalancing is needed (per pre-tax policy): target equity = 50% x $3M = $1,500,000. Current equity = 56% x $3M = $1,680,000. Sell = $180,000. For the taxable investor using after-tax policy: no rebalancing needed since 56% is within the 41.43%–58.57% range. Answer = D (pre-tax at boundary/breached; after-tax not breached; sell $180K if rebalancing).
Question 485
A moving-average crossover occurs when the 50-day moving average of an equity index crosses BELOW the 200-day moving average. What does this signal in a momentum-based systematic TAA strategy?
Select an option first.
Correct answer: B — Bearish signal — the 50-day average crossing BELOW the 200-day (a 'death cross') indicates the short-term trend has turned negative relative to the longer-term trend, signaling a potential downtrend and prompting the strategy to underweight equities
Explanation: B is correct: In momentum-based TAA, moving average crossovers are directional signals. When the shorter-term moving average (50-day) crosses ABOVE the longer-term (200-day), this is a bullish 'golden cross' — indicating upward momentum. When the shorter-term average crosses BELOW the longer-term, this is a bearish 'death cross' — indicating that recent price weakness has pulled the short-term average below the long-term trend, signaling potential continued decline. The momentum strategy would underweight the asset class on this signal. A is wrong: Crossing BELOW is bearish, not bullish. C is wrong: Moving average crossovers are explicitly listed as systematic momentum indicators. D is wrong: Momentum strategies follow trends, not mean reversion.
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Question 486
An investor earns $50,000 in capital gains and $30,000 in interest income. Tax rates: capital gains 20%, interest income 35%. Total tax bill?
Select an option first.
Correct answer: B — $20,500
Explanation: B is correct: Tax on capital gains = $50,000 x 20% = $10,000. Tax on interest income = $30,000 x 35% = $10,500. Total tax = $10,000 + $10,500 = $20,500. A is wrong: $10,000 is only the capital gains tax. C is wrong: $15,500 would result from a blended 19.375% tax rate. D is wrong: $24,000 would require different tax rates or amounts.
Question 487
Pre-tax return on equities = 11%, tax rate on dividends = 25%, tax rate on capital gains = 18%. Dividend yield = 3%, capital appreciation = 8% of the total 11% return. What is the after-tax equity return?
Select an option first.
Correct answer: B — 9.19%
Explanation: B is correct: After-tax dividend return = 3% x (1 minus 0.25) = 3% x 0.75 = 2.25%. After-tax capital gains return = 8% x (1 minus 0.18) = 8% x 0.82 = 6.56%. Total after-tax return = 2.25% + 6.56% = 8.81%. Hmm — closest to C (8.70%) or B (9.19%). Let me recheck: 3 x 0.75 = 2.25; 8 x 0.82 = 6.56; total = 8.81%. C (8.70%) is slightly different from 8.81%. B (9.19%) would require 3 x 0.79 + 8 x 0.82 = 2.37 + 6.56 = 8.93. The most accurate calculation gives 8.81%, closest to C (8.70%). Answer = C.
Question 488
What is 'margin borrowing' as a sentiment indicator for discretionary TAA, and what does high margin activity signal?
Select an option first.
Correct answer: B — Increasing margin purchases drive up equity prices and indicate bullish investor sentiment. However, if margin borrowing reaches very high levels, it becomes a contrarian bearish signal — it indicates investors may be overextended and vulnerable to forced selling if prices fall
Explanation: B is correct: Margin borrowing tracks how much investors are borrowing to buy securities — a measure of bullish conviction. Rising margin activity drives prices higher and signals optimism. But extremely high margin levels become a bearish contrarian indicator: the market is overextended, and any correction could trigger forced margin calls (investors must sell to meet collateral requirements), amplifying the downturn. Discretionary TAA managers monitor margin levels as a sentiment gauge — moderately rising margin is bullish, extremely high margin is a warning sign. A is wrong: Margin borrowing amplifies both gains and losses. C is wrong: Margin data reflects broad investor behavior including equity buyers. D is wrong: High margin indicates potential overextension at a top, not a bottom.
Question 489
A foundation's lender covenant requires it to maintain a minimum quick ratio and prohibits distribution of more than 4% of assets per year. How does this covenant affect the foundation's asset allocation?
Select an option first.
Correct answer: B — The distribution limit creates a maximum liquidity drain — the foundation must hold assets generating sufficient liquid returns to fund up to 4% annual distributions, and the minimum quick ratio requirement may force a minimum allocation to liquid assets regardless of the foundation's long-term preferences
Explanation: B is correct: Lender covenants placed on organizations can constrain the investment portfolio in important ways. A minimum quick ratio requirement means the foundation must maintain sufficient liquid assets — if the portfolio is too heavily invested in illiquid alternatives, the ratio test may be violated. The distribution cap of 4% creates a natural liquidity planning anchor — the portfolio must generate at least 4% in liquid form each year. Together, these covenants effectively impose a minimum liquidity floor on the asset allocation, limiting the allocation to illiquid alternatives below what the long time horizon alone would otherwise permit. A is wrong: Covenants are explicitly listed as real constraints on endowment/foundation portfolios. C is wrong: Covenants affect asset portfolio composition directly. D is wrong: 100% equity would likely violate the quick ratio requirement.
Question 490
Why should assets in tax-deferred accounts use PRE-TAX risk and return inputs in an MVO analysis, while assets in taxable accounts use AFTER-TAX inputs?
Select an option first.
Correct answer: B — In a tax-deferred account, assets grow without taxation until withdrawal — pre-tax returns represent the actual compounding that occurs within the account. In taxable accounts, returns are reduced by taxes in each period — after-tax inputs reflect the actual investable returns and risks the investor faces. Using the wrong inputs for each account type would misrepresent the true risk-return characteristics
Explanation: B is correct: The rationale follows directly from how each account type treats returns. In tax-deferred accounts (like IRAs or 401ks), investment returns compound without being taxed each year — the pre-tax return IS the actual compounding rate within the account. Tax is only due upon withdrawal. In taxable accounts, returns are taxed annually — an 8% pre-tax bond yield becomes 4.8% after-tax at a 40% rate, and this is the rate that actually drives portfolio growth. Using pre-tax inputs for taxable accounts would overstate the available compounding. The optimization should use each account's actual effective return and risk. A is wrong: Tax-deferred accounts may or may not have higher pre-tax returns. C is wrong: While good practice, it is not simply a regulatory requirement. D is wrong: Pre-tax inputs overstate returns in taxable accounts but are actually correct for tax-deferred accounts.
Question 491
A 5% annual coupon bond has a cost basis of $100 and current market value of $108. The investor holds this in a taxable account and faces a 25% capital gains tax rate. If she were to sell today, what is the after-tax proceeds and what is the effective after-tax value to use in portfolio analysis?
Select an option first.
Correct answer: B — $106.00 — embedded gain of $8 creates a tax liability of $2 (25% x $8), reducing after-tax value to $106
Explanation: B is correct: Unrealized capital gain = $108 minus $100 = $8. Tax on gain if sold today = $8 x 25% = $2. Net after-tax proceeds if sold = $108 minus $2 = $106. The effective after-tax value for portfolio analysis purposes is $106 — this is the true economic value to the investor since the $2 embedded tax liability must eventually be paid. This adjustment is one of three methods described for handling embedded capital gains in asset allocation. A is wrong: The $2 embedded tax liability must be recognized. C is wrong: 25% applied to the full market value would over-tax the cost basis. D is wrong: The cost basis ignores the market appreciation.
Question 492
A portfolio has $2M in a taxable account with 65% equity (target 60%, pre-tax corridor ±7%, tax rate 25%). Calculate: (a) amount of equity above target, (b) pre-tax breach, (c) after-tax corridor upper bound, (d) sell amount to return to target.
Select an option first.
Correct answer: D — Excess = $100K; Pre-tax corridor 53%-67%; 65% not breached; AT upper=69.33%; no action
Explanation: D is correct: Pre-tax upper corridor = 60% + 7% = 67%. At 65% < 67%: NOT breached. Excess equity = (65% minus 60%) x $2M = 5% x $2M = $100,000 above target in dollar terms. After-tax upper corridor = 60% + (7% / 0.75) = 60% + 9.33% = 69.33%. At 65% < 69.33%: also NOT breached. Neither corridor is breached — no rebalancing is required. The pre-tax range is 53% to 67% and after-tax range is 50.67% to 69.33%. At 65%, the portfolio is within both ranges. No selling is needed.
Question 493
A pre-tax municipal bond yield is 3.8%. An investor's income tax rate is 33%. What pre-tax yield on a taxable bond would make the two bonds equivalent on an after-tax basis? (Tax-equivalent yield formula.)
Select an option first.
Correct answer: B — 5.67%
Explanation: B is correct: Tax-equivalent yield = municipal yield / (1 minus tax rate) = 3.8% / (1 minus 0.33) = 3.8% / 0.67 = 5.67%. A taxable bond must yield 5.67% pre-tax to match the 3.8% tax-free municipal bond for a 33% taxpayer. If the taxable bond yields less than 5.67%, the municipal bond is preferred. A is wrong: 5.07% = 3.8% / (1-0.25) — this implies a 25% tax rate. C is wrong: 4.60% = 3.8% / 0.825 — implying a 17.5% rate. D is wrong: 2.55% = 3.8% x 0.67 (after-tax yield of a taxable bond, not the tax-equivalent yield).
Question 494
A pension fund's actuary advises that contributions are expected to increase significantly if the equity allocation exceeds 50%, due to higher return volatility increasing funding risk. The fund currently allocates 60% to equities. What should the fund consider?
Select an option first.
Correct answer: B — The pension fund faces a tradeoff: higher equity allocation increases expected returns (reducing the present value of expected contributions) but increases the risk that returns fall short, triggering higher required contributions. The optimal allocation balances these competing effects within regulatory constraints.
Explanation: B is correct: This illustrates the core pension fund asset allocation dilemma. Higher equity: (1) increases expected return → reduces the present value of expected future contributions (a benefit); (2) increases return volatility → increases the probability that poor returns trigger emergency contributions above a threshold (a cost). The pension fund must find the allocation that optimizes the combination of these effects subject to regulatory constraints (which may cap equity or require minimum funding ratios). Neither maximizing equity nor minimizing it is necessarily optimal — the balance depends on sponsor risk tolerance, funded status, and regulatory requirements. A is wrong: Higher equity can increase contribution risk, not just reduce long-term contributions. C is wrong: 0% equity produces near-zero expected returns, likely making underfunding worse over time. D is wrong: The tradeoff must be assessed explicitly.
Question 495
After-tax return calculation: An investor has a stock with pre-tax return of 20%. Of this, 8% is dividend income taxed at 30% and 12% is capital appreciation taxed at 20%. What is the after-tax return?
Select an option first.
Correct answer: C — 15.20%
Explanation: C is correct: After-tax dividend return = 8% x (1 minus 0.30) = 8% x 0.70 = 5.60%. After-tax capital gains return = 12% x (1 minus 0.20) = 12% x 0.80 = 9.60%. Total after-tax return = 5.60% + 9.60% = 15.20%. A is wrong: 14% = 20% x 0.70, applying a uniform 30% tax to the full return. B is wrong: 16% = 20% x 0.80, applying a uniform 20% tax to the full return. D is wrong: 13.60% would require higher blended tax rates.
Question 496
Portfolio with pre-tax equity sigma = 30%, tax rate = 40%. Compare the pre-tax corridor of ±10% to the after-tax corridor. What are the after-tax sigma and corridor?
Select an option first.
Correct answer: A — After-tax sigma = 18%; after-tax corridor = ±16.67%
Explanation: A is correct: After-tax sigma = 30% x (1 minus 0.40) = 30% x 0.60 = 18%. After-tax corridor = pre-tax corridor / (1 minus t) = 10% / (1 minus 0.40) = 10% / 0.60 = 16.67%. The 40% tax rate: reduces sigma from 30% to 18% (a 12 pp reduction), but widens the corridor from 10% to 16.67% (a 6.67 pp increase). These opposite directions reflect taxes buffering return volatility (good — reduces risk) while also making rebalancing expensive (bad — increases corridor). B is wrong: 6.0% = 10% x 0.60 (misapplies sigma formula). C is wrong: 12% = 30% x 0.40 (misapplies tax to sigma). D is wrong: Taxes definitely change both figures.
Question 497
A value-based TAA strategy for currencies uses short-term interest rate differentials. Country A has a 3-month interest rate of 5% and Country B has 2%. According to this TAA approach, which currency is the value signal to overweight, and why?
Select an option first.
Correct answer: B — Country A — higher short-term interest rates signal that Country A's currency may be undervalued relative to interest rate parity, offering a value opportunity. The carry (interest rate differential) favors holding Country A's currency.
Explanation: B is correct: In systematic TAA, short-term interest rate differentials are used to identify currency value. The carry trade — borrowing in low-rate currencies (Country B at 2%) and investing in high-rate currencies (Country A at 5%) — captures the 3% interest rate differential. Historically, high-yield currencies have outperformed low-yield currencies more than uncovered interest rate parity would predict, making the interest rate differential a value signal favoring Country A's currency. A is wrong: Higher interest rates typically reflect higher nominal growth or inflation — not necessarily a weaker currency. C is wrong: Interest rate differentials are explicitly listed as a currency value signal. D is wrong: Low interest rate currencies are typically favored for borrowing, not investing.
Question 498
A systematic value-based TAA identifies commodities in contango. What action does this signal, and why?
Select an option first.
Correct answer: B — Underweight commodities — in contango (futures above spot), a long futures position suffers negative roll yield (buying expensive futures that converge downward toward spot), making the expected return unattractive relative to the value threshold
Explanation: B is correct: In contango, futures prices are ABOVE the current spot price. A long futures position must 'roll' contracts as they expire — selling near-term contracts and buying further-dated contracts at a higher price. This rolling process costs money (negative roll yield) because each new contract is purchased at a premium. The systematic value TAA sees this negative carry as making the commodity unattractive — it reduces expected return and should prompt underweighting relative to the SAA. Backwardation (futures below spot) produces positive roll yield, a bullish value signal. A is wrong: Contango produces negative roll yield, making long positions costly. C is wrong: Roll yield is explicitly listed as a systematic TAA indicator for commodities. D is wrong: Contango reflects a cost-of-carry premium or future delivery expectations, not necessarily optimism.
Question 499
The Shiller CAPE ratio (Cyclically Adjusted P/E) for equities is currently at 35, compared to its long-run average of 17. In a systematic value-based TAA, what action is indicated?
Select an option first.
Correct answer: B — Underweight equities — a CAPE of 35 is approximately twice the historical average, indicating equities are expensive relative to long-run earnings. The earnings yield (E/P) is well below its historical average, signaling low expected returns and a value-based underweight signal
Explanation: B is correct: In systematic value TAA, Shiller's earnings yield (E/P, the inverse of CAPE) is compared to its historical average. CAPE of 35 means E/P = 1/35 = 2.86%. Historical CAPE of 17 means E/P = 1/17 = 5.88%. The current earnings yield (2.86%) is roughly half the historical average (5.88%), indicating equities are significantly overvalued relative to historical norms. The systematic strategy would underweight equities relative to the SAA until valuations normalize. A is wrong: High CAPE means earnings are expensive relative to prices, not that they are high in absolute terms. C is wrong: Shiller CAPE is explicitly listed as a systematic value TAA indicator. D is wrong: Research shows high CAPE has historically preceded lower long-run returns, not necessarily further gains.
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