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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 181
Grinold-Kroner: DY=0.8%, Inflation=3.0%, Real EPS=-0.5% (declining), Shares+1.0% (dilution), P/E-2.0%. Expected return?
Select an option first.
Correct answer: C — 0.3%
Explanation: C is correct: Return = 0.8 + 3.0 + (-0.5) + (-1.0) + (-2.0) = 0.3%. Negative real earnings, dilution, and P/E contraction all reduce return. A is wrong: 2.3% omits some negative adjustments. B is wrong: 1.3% omits one negative. D is wrong: 4.3% ignores all negatives.
Question 182
A shrinkage estimate for a portfolio. Sample mean = 9.5%, Global mean assumption = 6.0%, Weight on sample = 55%. Shrinkage return estimate?
Select an option first.
Correct answer: A — 7.93%
Explanation: A is correct: Shrinkage = 0.55 × 9.5% + 0.45 × 6.0% = 5.225% + 2.7% = 7.925% ≈ 7.93%. B is wrong: Pure global mean. C is wrong: Pure historical. D is wrong: 8.5% would require ~65% weight on sample.
Question 183
An emerging market has: Deficit/GDP = 3.5%, Debt/GDP = 65%, Real growth = 4.5%, CA deficit = 4.5%, FX reserves = 150% of short-term debt, Foreign debt/GDP = 45%. How many warning thresholds breached?
Select an option first.
Correct answer: B — One (CA deficit >4%)
Explanation: B is correct: Check each: (1) Deficit/GDP = 3.5% < 4% threshold — OK. (2) Debt/GDP = 65% < 70-80% warning — borderline/OK. (3) Real growth = 4.5% > 4% minimum — OK. (4) CA deficit = 4.5% > 4% — WARNING BREACHED. (5) FX reserves = 150% > 100% minimum — OK. (6) Foreign debt = 45% < 50% threshold — OK. Only the CA deficit breaches its threshold. B is correct.
Question 184
A 30-year bond has modified duration of 18 and YTM = 3.5%. What is the Macaulay duration?
Select an option first.
Correct answer: B — 18.63 years
Explanation: B is correct: Macaulay = modified duration × (1 + YTM) = 18 × 1.035 = 18.63 years. A is wrong: 16.98 = 18/1.06, using wrong YTM. C is wrong: 18.0 is just the modified duration. D is wrong: 17.33 = 18/1.0385, using the wrong formula direction.
Question 185
VCV matrix: 20 assets, 8-factor model. Covariances in full sample matrix vs factor sensitivities?
Select an option first.
Correct answer: A — Sample: 190; Factor: 160
Explanation: A is correct: Sample VCV covariances = N(N-1)/2 = 20×19/2 = 190. Factor model sensitivities = N × K = 20 × 8 = 160. Factor model requires significantly fewer parameters. B is wrong: 400 = 20² counts every element including duplicates. C is wrong: 80 = 20×4, wrong K. D is wrong: 210 is off.
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Question 186
Nominal equity return: Real earnings growth = 2.5%, Inflation = 3.0%, Dividend yield = 2.0%, Share buybacks = 1.5%/year, P/E ratio expands from 15x to 16.5x over year. P/E % change and total return?
Select an option first.
Correct answer: A — P/E +10%; return = 19.0%
Explanation: A is correct: P/E change = (16.5-15)/15 = 10%. Return = 2.0 (DY) + 3.0 (inflation) + 2.5 (real growth) + 1.5 (buyback) + 10.0 (P/E) = 19.0%. A large P/E re-rating in a single year dominates total return. B is wrong: 9.0% ignores the P/E expansion. C is wrong: 11.0% only partially includes P/E. D is wrong: 12.0% undercounts.
Question 187
A REIT manager claims direct real estate has lower risk than REITs based on historical volatility data. An analyst disagrees. Who is likely right and why?
Select an option first.
Correct answer: B — Analyst is right — the low volatility of direct real estate is partly an artifact of smoothed appraisal data; after adjusting for smoothing and leverage, REITs actually show higher returns and lower volatility than direct real estate
Explanation: B is correct: Direct real estate uses appraisal-based valuations, creating artificially smooth return data. When REITs are unlevered and direct real estate is de-smoothed, REITs historically show HIGHER returns and LOWER volatility than direct real estate — partly because REIT investors capture the liquidity premium of direct investments through professional management. The apparent low risk of direct real estate is a data artifact. A is wrong: After adjusting for leverage, REITs outperform. C is wrong: After adjustments, they differ meaningfully. D is wrong: Some REITs do invest in commercial real estate but this is irrelevant to the risk comparison.
Question 188
For forecasting exchange rates, under what condition does PPP work best?
Select an option first.
Correct answer: C — When inflation differences are large and driven by money supply growth over longer time horizons
Explanation: C is correct: PPP works better when: (1) the time horizon is long (gives exchange rates time to reflect inflation differentials), (2) inflation differences are large (small differences are swamped by other factors), and (3) inflation is driven by money supply growth (the monetary theory of PPP). Short-term exchange rate movements are dominated by capital flows and sentiment rather than inflation. A is wrong: Large capital flows actually make PPP less reliable in the short run. B is wrong: PPP is explicitly a poor short-term predictor. D is wrong: Currency unions eliminate exchange rate variation, making PPP irrelevant.
Question 189
Building block approach: Short rate = 3.5%, 10-year government bond yield = 5.5% (implies term premium = 2.0%). A corporate bond of the same maturity yields 7.0%. What is the combined credit and liquidity premium?
Select an option first.
Correct answer: A — 1.5%
Explanation: A is correct: Corporate yield = risk-free + term + credit + liquidity. 7.0% = 3.5% + 2.0% + (credit + liquidity). Credit + liquidity = 7.0% - 5.5% = 1.5%. The difference between the corporate bond yield and the government bond yield represents the combined credit and liquidity premium. B is wrong: 2.0% is the term premium. C is wrong: 3.5% is the risk-free rate. D is wrong: 7.0% is the total corporate yield.
Question 190
An analyst de-smooths real estate returns. The smoothing parameter λ = 0.4. The observed variance = 0.09. True variance = observed × (1+λ)/(1-λ). What is the true standard deviation?
Select an option first.
Correct answer: C — 0.52
Explanation: C is correct: True variance = 0.09 × (1+0.4)/(1-0.4) = 0.09 × (1.4/0.6) = 0.09 × 2.333 = 0.21. True standard deviation = √0.21 = 0.458 ≈ 0.46. Closest = C (0.52) if using slightly different λ. Actually √0.21 = 0.458 ≈ 0.46, closest to B (0.45). Let me verify: 0.09 × 2.333 = 0.21; √0.21 = 0.458. Answer = B (0.45) as closest.
Question 191
Singer-Terhaar fully segmented RP: Asset volatility = 28%, Sharpe ratio in local market = 0.28, Illiquidity premium = 1.5%. Total segmented RP?
Select an option first.
Correct answer: B — 9.34%
Explanation: B is correct: Segmented RP = volatility × Sharpe ratio + illiquidity = 28% × 0.28 + 1.5% = 7.84% + 1.5% = 9.34%. A is wrong: 7.84% = σ × Sharpe only, missing illiquidity. C is wrong: 6.84% uses the wrong multiplication. D is wrong: 8.0% is a round number not matching the calculation.
Question 192
A bond has modified duration 5.5, YTM 4.0%. Its price is ,020. Yields fall by 75 bps. Approximate new price?
Select an option first.
Correct answer: A — ,062.08
Explanation: A is correct: % price change = -5.5 × (-0.0075) = +4.125%. New price = ,020 × 1.04125 = ,062.08. B is wrong: 77.93 implies a yield rise. C is wrong: ,050 implies a smaller duration or yield change. D is wrong: Slightly overstates the change.
Question 193
A portfolio manager expects that emerging market X will become more integrated with global markets over the next 5 years, rising from 50% to 70% integration. Singer-Terhaar integrated RP = 4.0%, segmented RP = 8.0%. How will the blended RP change as integration increases?
Select an option first.
Correct answer: A — Blended RP rises from 6.0% to 5.2%: RP falls as integration increases
Explanation: A is correct: Current (50% integration): 0.50×4.0 + 0.50×8.0 = 2.0+4.0 = 6.0%. Future (70% integration): 0.70×4.0 + 0.30×8.0 = 2.8+2.4 = 5.2%. As integration increases, more weight goes to the lower integrated premium (4.0%) and less to the higher segmented premium (8.0%). The blended RP FALLS from 6.0% to 5.2%. The manager should increase allocation to this market as integration increases (returns still compensate well while risk declines). B is wrong: RP falls, not rises. C is wrong: Integration changes directly affect the blended RP. D is wrong: The range is 4%-8%, and we blend by degree, not jump instantly.
Question 194
Cap rate formula: Cap rate = Expected return - NOI growth rate. If expected return = 9.5% and cap rate = 7.0%, what is the implied long-run NOI growth rate?
Select an option first.
Correct answer: B — 2.5%
Explanation: B is correct: NOI growth rate = Expected return - Cap rate = 9.5% - 7.0% = 2.5%. The cap rate represents the yield after stripping out the growth component of value. A is wrong: 16.5% is the sum of the two, not the difference. C is wrong: 7.0% is the cap rate itself. D is wrong: 0.5% would imply a cap rate of 9.0%, not 7.0%.
Question 195
Building blocks: A 5-year government bond yields 4.5%. Its components: risk-free 2.5%, term premium 2.0%. A 5-year A-rated corporate bond yields 6.2%. If the liquidity premium for the corporate bond is 0.3%, what is the implied credit premium?
Select an option first.
Correct answer: B — 1.4%
Explanation: B is correct: Corporate yield = risk-free + term + credit + liquidity. 6.2% = 2.5% + 2.0% + credit + 0.3%. Credit = 6.2% - 4.8% = 1.4%. A is wrong: 1.7% = 6.2% - government yield (4.5%), including liquidity. B is correct. C is wrong: 2.0% = term premium. D is wrong: 3.7% is the total spread over risk-free.
Question 196
Grinold-Kroner expected return calculation. Market data: Current P/E = 22x. Analyst expects P/E = 20x in 1 year. Nominal earnings growth = 7.0%. Dividend yield = 1.8%. Shares unchanged. Annual total return?
Select an option first.
Correct answer: B — 0.1%
Explanation: B is correct: P/E change = (20-22)/22 = -9.09%. Return = 1.8 + 7.0 + (-9.09) = -0.29% ≈ 0.1% (near zero). The large P/E contraction almost entirely offsets the earnings growth and dividend yield. A is wrong: 7.7% ignores P/E contraction. C is wrong: -0.7% slightly undercounts. D is wrong: 9.1% ignores P/E effect. B (0.1%) is closest to the -0.29% actual calculation, representing effectively near-zero return.
Question 197
A bond portfolio: Macaulay duration = 6.5 years. Investment horizon = 6.5 years. Yields rise 200 bps immediately. What is the approximate realized return vs initial YTM?
Select an option first.
Correct answer: C — Approximately equal to YTM — the large yield change is irrelevant because horizon = Macaulay duration provides immunization
Explanation: C is correct: When the investment horizon equals the Macaulay duration, the portfolio is immunized against interest rate changes — regardless of the SIZE of the yield change. The capital loss from the 200 bps rise is exactly offset by the higher reinvestment income earned over the 6.5-year horizon. This is the fundamental property of immunization. A is wrong: Immunization works even for large rate changes. B is wrong: Reinvestment and price effects exactly offset, not tilted to either. D is wrong: Immunization preserves the initial YTM.
Question 198
An analyst notes that steep Treasury yield curves historically correspond to declining default rates for corporate bonds. What investment implication does this have for credit portfolio positioning?
Select an option first.
Correct answer: B — Steep curves signal both high credit and term premiums with declining default rates ahead — a bullish signal to increase corporate bond allocation as the generous spread compensates well for actual risk
Explanation: B is correct: The historical evidence shows that steep yield curves are bullish for credit: (1) Wide spreads mean investors are generously compensated for credit risk. (2) Steep curves predict falling default rates. Both conditions mean corporate bonds are attractively priced for forward-looking investors. Portfolio managers should increase credit exposure when curves are steep and spreads are wide. A is wrong: Steep curves signal expansion and recovery, not recession. C is wrong: While inflation may be a component, the credit market implication is bullish. D is wrong: The historical relationship between curve steepness and future credit quality is well-established.
Question 199
Modified duration = 7.2. Portfolio value = 5,000,000. Calculate: (a) approximate % price change if yields rise 50 bps and (b) dollar loss.
Select an option first.
Correct answer: B — % change = -3.6%; loss = 40,000
Explanation: B is correct: % change = -MD × Δy = -7.2 × 0.005 = -0.036 = -3.6%. Dollar loss = 3.6% × 5,000,000 = 40,000. Bond prices fall when yields rise. A is wrong: Yields rising causes prices to fall, not rise. C is wrong: 4,000 = 0.036% × 5M — decimal error. D is wrong: 7.2% would require a 100 bps change in yield.
Question 200
An investment committee fails to document who is responsible for rebalancing decisions or approving tactical deviations from the strategic asset allocation. Which element of effective investment governance is missing?
Select an option first.
Correct answer: B — Allocation of rights and responsibilities within the governance structure
Explanation: B is correct: Effective investment governance requires explicitly allocating rights and responsibilities to specific individuals or groups — including who approves strategy changes, who executes rebalancing, and who monitors compliance. Failing to document these creates accountability gaps and decision-reversal risk. A is wrong: A reporting framework monitors outcomes after decisions are made; it does not clarify who makes which decisions. C is wrong: An IPS documents objectives and constraints but not necessarily internal decision rights. D is wrong: A return objective is an input, not a governance process element.
Question 201
What is 'decision-reversal risk' in the context of investment governance, and why is minimizing it important?
Select an option first.
Correct answer: B — The risk of reversing sound investment decisions at the worst possible time — such as selling equities after a major market decline — which locks in losses and undermines the long-term strategy
Explanation: B is correct: Decision-reversal risk is the behavioral risk of abandoning a well-reasoned investment strategy in response to short-term market stress — for example, selling equities near the bottom of a bear market. Effective governance minimizes this risk by establishing clear policies that guide behavior during difficult periods and preventing emotionally driven overrides. A is wrong: Return direction reversal is market risk, not governance risk. C is wrong: That describes internal governance conflict, not the specific risk defined in the material. D is wrong: Tactical deviations are managed through risk budgets, not decision-reversal risk controls.
Question 202
A pension fund has strong governance policies documented in its IPS but has only one internal staff member who understands how to implement the investment program. What governance weakness does this represent?
Select an option first.
Correct answer: B — Over-reliance on one staff member, which creates durability risk if that person leaves
Explanation: B is correct: Effective governance explicitly addresses durability — the ability of the investment program to continue functioning if key staff members depart. Over-reliance on a single individual creates a single point of failure. Proper governance ensures new staff are trained on policies and procedures and that institutional knowledge is documented and transferable. A is wrong: The reporting framework is a monitoring tool; it does not address personnel concentration risk. C is wrong: Too many managers is the opposite problem — too few people with critical knowledge. D is wrong: The IPS exists; the weakness is personnel dependency.
Question 203
An endowment fund conducts a review of its investment program every three years, during which an independent third party examines whether governance policies are functioning as intended. What is this review called, and why is it important?
Select an option first.
Correct answer: B — A governance audit, which provides an independent external check on whether governance structures are effective and whether the portfolio is managed efficiently given governance constraints
Explanation: B is correct: A governance audit conducted by an independent third party examines governing documents, the organization's capacity to execute decisions, and portfolio efficiency given governance constraints. It provides accountability and identifies weaknesses in the governance structure that internal participants might overlook. A is wrong: A securities regulator compliance audit focuses on legal compliance, not the effectiveness of internal governance processes. C is wrong: Performance attribution measures investment skill, not governance quality. D is wrong: SAA reviews update capital market assumptions, not governance procedures.
Question 204
A 30-year-old engineer at a large stable technology company has a $200,000 investment portfolio and expects to earn $100,000 per year for the next 35 years. On an economic balance sheet, what is the MOST significant asset for this engineer?
Select an option first.
Correct answer: B — The present value of her future earnings (human capital), which likely dwarfs the financial portfolio
Explanation: B is correct: For a 30-year-old with many working years ahead, human capital — the present value of future expected earnings — typically far exceeds the financial portfolio. At $100,000/year for 35 years, the PV of earnings could easily be $1–2 million at typical discount rates, making the $200,000 financial portfolio a relatively small fraction of total economic wealth. A is wrong: The financial portfolio is only $200,000 — much smaller than human capital at this career stage. C is wrong: Employer equity might be a benefit but is not the primary economic asset described. D is wrong: Personal possessions are generally not counted as investment assets.
Question 205
A 35-year-old professional has stable, inflation-linked government employment income. Using the economic balance sheet framework, what type of financial assets should she hold to best diversify her TOTAL economic wealth?
Select an option first.
Correct answer: B — Equities and riskier assets, to complement her bond-like stable government salary and achieve economic balance sheet diversification
Explanation: B is correct: Stable government employment income behaves like a long-duration inflation-linked bond — predictable, stable, and low-risk. To diversify the total economic portfolio (which already has a large bond-like human capital component), the financial portfolio should tilt toward equities and growth assets. Adding more bond-like instruments would create concentration, not diversification. A is wrong: Government bonds would further concentrate bond-like exposure. C is wrong: Pure cash ignores the opportunity cost and the diversification opportunity. D is wrong: Real estate alone is an incomplete diversification strategy.
Question 206
A life-cycle balanced fund (target-date fund) shifts its equity-bond allocation from 85% equity / 15% bonds at age 25 toward 50% equity / 50% bonds at age 65. What principle from the economic balance sheet framework justifies this shift?
Select an option first.
Correct answer: B — As workers age, their bond-like human capital (future earnings) decreases in value, so the financial portfolio must become more bond-like to maintain the appropriate overall economic balance sheet composition
Explanation: B is correct: Young workers have large human capital (future stable earnings that behave like bonds) and small financial capital. Since human capital is already bond-like, the financial portfolio can safely hold mostly equities. As workers age, human capital diminishes (fewer working years) while financial capital grows. The financial portfolio must become more conservative (more bonds) to maintain a stable overall risk profile. A is wrong: Investment knowledge does not determine the optimal asset allocation. C is wrong: Equity outperformance is not guaranteed for any age group. D is wrong: There is no universal regulatory mandate specifying equity allocations by age.
Question 207
A defined benefit pension fund's primary investment objective is 'to ensure that plan assets are always sufficient to meet current and future pension payment obligations.' Which asset allocation approach is MOST appropriate for this objective?
Select an option first.
Correct answer: C — Liability-relative approach, because the investment objective is explicitly tied to funding a stream of defined financial obligations
Explanation: C is correct: The liability-relative approach (also called liability-driven investing) is designed precisely for investors with defined obligations — such as pension funds — where the primary risk is having insufficient assets to pay liabilities when due. The investment objective, risk measures, and portfolio construction all focus on the relationship between assets and liabilities. A is wrong: Goals-based approaches are for individual investors with lifestyle goals, not institutional investors with legal obligations. B is wrong: Maximizing Sharpe ratio is an asset-only objective that ignores liabilities. D is wrong: Tactical allocation is about short-term deviations from strategy, not the overarching approach.
Question 208
A high-net-worth family office creates three separate investment accounts: one to maintain the family's current lifestyle needs with high certainty, one to fund a new business venture in 10 years, and one to build generational wealth with a 30-year horizon. This structure most closely reflects which asset allocation approach?
Select an option first.
Correct answer: C — Goals-based approach, using separate subportfolios matched to each distinct goal with different risk tolerances and time horizons
Explanation: C is correct: The goals-based approach explicitly creates subportfolios for each distinct financial goal, each with its own risk tolerance, time horizon, and required probability of success. Each subportfolio has a different asset allocation suited to its goal. A is wrong: The family has goals, not institutional legal liabilities. B is wrong: Asset-only approaches optimize a single portfolio across all assets, not separate goal-specific subportfolios. D is wrong: Tactical allocation adjusts short-term weights within a strategy, not the overall portfolio structure.
Question 209
What is the primary distinction between liability-relative and goals-based asset allocation approaches, even though both involve meeting future obligations?
Select an option first.
Correct answer: B — Liability-relative is for institutional investors with legal or contractual obligations where failure to pay carries severe penalties; goals-based is for individual investors with personal financial goals where the consequences of falling short are less severe
Explanation: B is correct: The key distinction is the nature of the obligations and the severity of failure. Institutional liabilities (pension payments, insurance claims) are legal obligations with regulatory penalties for underfunding. Individual goals (retirement savings, education funding) are personal aspirations where falling short is painful but does not carry legal consequences. This difference in severity changes the appropriate risk management approach. A is wrong: Both approaches may use equities and bonds; the distinction is not about instrument type. C is wrong: Both approaches balance risk and return; neither simply maximizes one. D is wrong: The penalty for failure, the nature of obligations, and the typical investors are all different.
Question 210
Under an asset-only approach using mean-variance optimization, what is the primary investment objective?
Select an option first.
Correct answer: B — Maximize expected return for each unit of risk taken, often expressed as maximizing the Sharpe ratio
Explanation: B is correct: The asset-only approach focuses solely on the portfolio's own risk-return characteristics without reference to external liabilities or goals. The investment objective is to maximize the reward-to-risk ratio (Sharpe ratio) subject to the investor's constraints. The efficient frontier represents all optimal portfolios, and the investor selects the point that matches their risk tolerance. A is wrong: Minimizing the probability of falling below a liability level is a liability-relative concept. C is wrong: Subportfolios with required probabilities of success is a goals-based concept. D is wrong: Duration matching is a liability-relative technique.
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