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Free CFA Portfolio Construction Practice Questions & Answers
600 exam-style Portfolio Construction questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 601
What is the key LESSON from the R-SWF case study for managing MINORITY EQUITY STAKES in frontier market direct investments?
Select an option first.
Correct answer: B — Key lessons: (1) Negotiate strong governance protections at the time of investment — supermajority requirements for ESG-sensitive decisions, specific covenants around labor and environmental standards, management incentive alignment to ESG metrics; (2) Establish clear monitoring rights (board seats, information rights, site access) beyond just financial reporting; (3) Set predefined exit triggers if governance covenants are violated — creating real consequences for ESG failures rather than just recommendations; (4) Consider requiring majority control if governance and ESG risks are material.
Explanation: B is correct: The Atsui ABC case study reveals that a 35% minority stake with two board seats but no formal governance covenants around ESG practices is insufficient for a frontier market investment in a company with an entrepreneurial founder-controlled structure. The lessons for future direct minority investments: (1) Stronger contractual protections (not just board representation); (2) Explicit ESG performance requirements as conditions of continued investment; (3) Predetermined exit triggers with clear timetables; (4) Management incentive alignment to ESG outcomes, not just financial metrics. Without these protections, the investor has limited practical ability to influence behavior.
Question 602
Calculate the CARBON FOOTPRINT of an institutional portfolio and interpret: Portfolio holds $500M in oil companies (estimated emissions: 100 tonnes CO2e per $M invested) and $300M in renewable energy (estimated emissions: 5 tonnes CO2e per $M invested). Weighted portfolio carbon intensity per $M invested?
Select an option first.
Correct answer: B — ($500M × 100 + $300M × 5) / ($500M + $300M) = ($50,000 + $1,500) / $800M = $51,500 / $800 = 64.4 tonnes CO2e per $M invested
Explanation: B is correct: Portfolio carbon intensity = weighted average intensity = [(500×100) + (300×5)] / (500+300) = [50,000 + 1,500] / 800 = 51,500/800 = 64.375 ≈ 64.4 tonnes CO2e per $M invested. A ($62.5) is close but incorrect calculation. The reading discusses carbon emissions as a key ESG metric and TCFD disclosure element. Calculating portfolio-level carbon intensity helps institutional investors: (1) measure alignment with Paris Agreement targets; (2) compare against benchmarks; (3) identify the highest-emitting positions for engagement or divestment. The renewable energy allocation (5 tonnes/$M) dramatically reduces portfolio intensity vs. the oil allocation (100 tonnes/$M).
Question 603
What does the reading identify as the PRIMARY purpose of the R-SWF ERM framework?
Select an option first.
Correct answer: B — 'Enterprise risk management is a top-down approach in which an organization decides which risks to take and which to avoid or transfer to achieve its purpose and objectives.' The primary purpose is to OPTIMIZE risk and return decisions — taking the right AMOUNT of risk in the right AREAS to achieve the institution's long-term investment objectives, not to minimize risk per se.
Explanation: B is correct: The reading explicitly states the ERM objective: 'The objective is not to minimize or eliminate risk but instead to optimize the compensation for taking the risk (i.e., take the right level of risk for the institution).' For R-SWF (a savings fund), this means: taking return-generating risk (long-term equity, alternatives, frontier market investments) in amounts that maximize expected long-term wealth creation, while managing tail risks (that could permanently impair capital) and operational risks (that don't compensate with return). Risk elimination would also eliminate return — ERM seeks the optimal balance.
Question 604
How does the reading define 'ESG risk' in the ERM context and provide an example of how it manifests financially?
Select an option first.
Correct answer: B — ESG risk encompasses environmental, social, and governance factors that can create financial losses or opportunity costs for institutional investors. Example of financial manifestation: ABC's waste dumping (environmental violation) → attracts scientific and public attention → potential regulatory fines + mandatory cleanup costs + consumer boycotts + reputational damage to R-SWF → these financial consequences may vastly exceed the cost savings from the waste dumping itself. ESG risks materialize as financial risks through regulatory, reputational, and operational channels.
Explanation: B is correct: The reading integrates ESG risk into the ERM framework alongside market, credit, liquidity, and operational risks — precisely because ESG failures have documented financial consequences. The Atsui ABC case study quantifies this implicitly: waste dumping savings (small, temporary) vs. potential cleanup costs + fines + reputational damage + exit costs (large, potentially permanent). This financial framing of ESG risk — 'ESG failures impose financial costs that can exceed the apparent savings from ESG shortcuts' — is the key argument for ESG integration in institutional risk management.
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Question 605
R-SWF calculates portfolio-level VaR at 95% confidence, 1-day, as $150M on its $56B portfolio. Express this as a percentage and as annualized VaR (assume 252 trading days).
Select an option first.
Correct answer: B — Daily VaR % = $150M / $56,000M = 0.268%. Annualized using square root of time: Annual VaR = 0.268% × sqrt(252) = 0.268% × 15.87 = 4.25%. This means there is a 5% probability (1 in 20 trading days) that R-SWF loses more than $150M (0.268%) in a single day. Annualized, there's a 5% probability of annual losses exceeding 4.25% of portfolio value in the tail of the distribution.
Explanation: B is correct: Daily VaR % = $150M / $56,000M = 0.00268 = 0.268%. Annualized VaR = 0.268% × sqrt(252) = 0.268% × 15.87 = 4.25%. For the 95% confidence level: on the worst 5% of days, R-SWF loses more than $150M. For the worst 5% of years (using sqrt(252) scaling), losses exceed 4.25% of the $56B portfolio = approximately $2.38B. Note: The square root of time scaling assumes i.i.d. returns — this is an approximation. C is wrong: decimal misplacement. D is wrong: the square root rule is explicitly used for this purpose in practice.
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