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Free CFA Portfolio Management Practice Questions & Answers
1,100 exam-style Portfolio Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 601
Enterprise risk management (ERM) views risk governance from which perspective?
Select an option first.
Correct answer: C — The entire organization — considering all risks holistically across the enterprise
Explanation: ERM takes an integrated, enterprise-wide view of all risks — financial and non-financial. It creates a unified risk framework, risk tolerance, and governance structure. A, B, D are too narrow.
Question 602
Risk tolerance in an investment context refers to:
Select an option first.
Correct answer: B — The amount of risk an investor is willing and able to accept in pursuit of their goals
Explanation: Risk tolerance combines willingness (subjective comfort) and ability (financial capacity) to bear risk. It shapes strategic asset allocation and portfolio construction. A, C, D are wrong.
Question 603
Risk budgeting involves:
Select an option first.
Correct answer: B — Allocating the total portfolio risk allowance across different investments or strategies
Explanation: Risk budgeting distributes the available 'risk budget' (e.g., tracking error, VaR, standard deviation) across different positions, strategies, or asset classes to maximize return for the given risk level. A is a stop-loss. C eliminates risk. D is naive diversification.
Question 604
Financial risks faced by a portfolio or firm include:
Select an option first.
Correct answer: C — Market risk, credit risk, and liquidity risk
Explanation: Financial risks are those arising from financial market activities: price movements (market risk), counterparty defaults (credit risk), and inability to transact at fair prices (liquidity risk). A, B, D are non-financial risks.
Question 605
Non-financial risks include:
Select an option first.
Correct answer: C — Operational risk, model risk, legal risk, and reputational risk
Explanation: Non-financial risks arise from operational failures, human error, legal issues, technology breakdowns, and reputational damage — not from financial market price movements. A and B are financial risks. C correctly identifies non-financial risks.
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Question 606
Value at Risk (VaR) measures:
Select an option first.
Correct answer: B — The minimum loss expected to be exceeded with a given probability over a specified time period
Explanation: VaR(95%, 1-day) means: with 95% confidence, daily losses will not exceed this amount. Equivalently, there is a 5% chance losses exceed VaR. A is wrong — VaR is a threshold, not the maximum loss. C and D are wrong.
Question 607
Self-control bias describes the tendency of investors to:
Select an option first.
Correct answer: B — Fail to act in accordance with their long-term best interests due to short-term desires
Explanation: Self-control bias is the failure to delay gratification — investors spend or trade excessively in the short run at the expense of long-term goals (e.g., insufficient retirement saving, frequent trading). A is overconfidence. C is familiarity. D is herding.
Question 608
The planning step of the portfolio management process includes:
Select an option first.
Correct answer: C — Developing the IPS, understanding the client, and setting objectives and constraints
Explanation: The planning step involves gathering information about the client, developing the IPS, forming capital market expectations, and establishing the strategic asset allocation. B and D are feedback step activities. A is execution step.
Question 609
ESG (Environmental, Social, and Governance) considerations in portfolio construction can influence:
Select an option first.
Correct answer: B — Security selection, risk assessment, and the overall portfolio construction process
Explanation: ESG factors can affect security selection (excluding certain companies), risk assessment (identifying ESG-related risks like regulatory or reputational), and portfolio construction broadly. ESG applies to equities, bonds, alternatives, and all asset classes.
Question 610
Which of the following is a characteristic that distinguishes institutional investors from individual investors?
Select an option first.
Correct answer: C — Institutional investors typically have larger pools of capital, formal governance, and may have liability-driven objectives
Explanation: Institutional investors (pension funds, endowments, insurance companies) have distinct characteristics: large capital pools, formal governance structures, specific liability obligations, and professional management. A reverses typical horizons. B is wrong. D is wrong.
Question 611
Risk shifting in risk management refers to:
Select an option first.
Correct answer: B — Transferring risks to a third party (e.g., through insurance, derivatives, or hedging)
Explanation: Risk shifting transfers the financial impact of a risk to another party — through insurance (credit risk), hedging with derivatives, or securitization. A is internal reallocation. C is risk-seeking. D is risk reduction, not shifting.
Question 612
The endowment bias describes investors who:
Select an option first.
Correct answer: B — Place higher value on assets they already own than on equivalent assets they do not own
Explanation: Endowment bias (or status quo bias variant) means investors overvalue what they already own — making them reluctant to sell inherited assets, legacy holdings, or concentrated positions even when diversification would be better. A is recency bias. C and D are wrong.
Question 613
Which of the following describes a bubble in financial markets?
Select an option first.
Correct answer: B — A period in which asset prices become detached from fundamental values, driven by excessive optimism and speculation
Explanation: Asset bubbles occur when prices rise far above intrinsic values, fueled by momentum, herding, and speculation. Eventually the bubble bursts when reality prevails. A is a crash/bear market. C is a yield curve shape. D is a healthy, efficient market.
Question 614
The momentum anomaly in markets refers to the tendency for:
Select an option first.
Correct answer: B — Assets that have recently performed well to continue outperforming in the near term
Explanation: The momentum effect is a well-documented market anomaly where recent winners tend to continue outperforming and recent losers continue underperforming over intermediate horizons (3–12 months). A contradicts momentum. C describes the low-volatility anomaly. D is reversal.
Question 615
An investor needs $50,000 in 2 years for a down payment. The portfolio currently has $45,000 liquid and $80,000 illiquid. What is the minimum required liquid amount to meet the liquidity constraint?
Select an option first.
Correct answer: B — $50,000
Explanation: The liquidity constraint requires having at least $50,000 in liquid assets to meet the goal. Currently $45,000 is liquid — $5,000 short. The investor needs to either save more or liquidate $5,000 of the illiquid assets. B is the minimum required.
Question 616
A portfolio has 60% equities ($600,000) and 40% bonds ($400,000). Equities rise 20%, bonds rise 5%. What is the new equity weight?
Select an option first.
Correct answer: A — 63.2%
Explanation: New equity = $720,000; New bonds = $420,000; Total = $1,140,000. Equity weight = 720/1140 = 63.16% ≈ 63.2%. B, C, D are wrong.
Question 617
To rebalance the portfolio above back to 60% equity and 40% bonds (total $1,140,000), the investor should sell approximately how much equity?
Select an option first.
Correct answer: A — $36,000
Explanation: Target equity = 60% × $1,140,000 = $684,000. Current equity = $720,000. Sell equity = $720,000 − $684,000 = $36,000. B, C, D are wrong.
Question 618
An investor has a nominal return target of 8% and expects inflation of 3%. What is the required real return?
Select an option first.
Correct answer: B — 4.85%
Explanation: Real return = (1 + nominal)/(1 + inflation) − 1 = (1.08/1.03) − 1 = 1.04854 − 1 = 4.85%. A uses simple subtraction (approximate). C adds instead of divides. D is just inflation.
Question 619
A portfolio has VaR of $200,000 at the 95% confidence level over 1 day. This means:
Select an option first.
Correct answer: B — Losses exceeding $200,000 are expected on 5% of trading days
Explanation: VaR(95%, 1-day) = $200,000 means in 5% of days (1 in 20), losses are expected to exceed $200,000. A, C, D misinterpret VaR — it is a threshold, not an exact prediction or maximum loss.
Question 620
A portfolio generates a return of 11% with a standard deviation of 18%. The benchmark returns 9% with a standard deviation of 14%. The risk-free rate is 3%. Which portfolio has a higher Sharpe ratio?
Select an option first.
Correct answer: A — The portfolio (Sharpe = 0.44)
Explanation: Portfolio Sharpe = (11−3)/18 = 8/18 = 0.444. Benchmark Sharpe = (9−3)/14 = 6/14 = 0.429. Portfolio Sharpe > Benchmark Sharpe. A is correct. B is the benchmark. C is wrong. D is wrong — Sharpe uses standard deviation, not beta.
Question 621
The execution step of the portfolio management process includes:
Select an option first.
Correct answer: C — Translating the strategic asset allocation into specific security selections and executing trades
Explanation: The execution step involves security analysis and selection (within each asset class) and placing trades to implement the portfolio. A and B are planning step. D is the feedback step.
Question 622
Conservatism bias refers to the tendency to:
Select an option first.
Correct answer: B — Update beliefs too slowly in response to new information
Explanation: Conservatism bias (a belief perseverance bias) means investors hold too firmly to prior views and are slow to revise them when contradictory evidence emerges. A is overconfidence. C is risk aversion. D is overreaction.
Question 623
Representativeness bias occurs when investors:
Select an option first.
Correct answer: A — Classify assets based on superficial similarities rather than fundamental analysis
Explanation: Representativeness leads investors to judge probability by resemblance to stereotypes (e.g., assuming a company with recent strong earnings is a 'great' long-term investment). It causes overreaction to recent trends. B is disposition effect. C is herding. D is model reliance.
Question 624
Framing bias occurs when the same information presented in different ways leads to:
Select an option first.
Correct answer: B — Different investment decisions based purely on how options are presented
Explanation: Framing effects cause investors to respond differently to the same facts depending on how they are framed (e.g., 90% survival rate vs. 10% mortality rate). This leads to irrational inconsistency. A is rational behavior. C and D are correct behaviors.
Question 625
Herding behavior in financial markets describes:
Select an option first.
Correct answer: C — Investors mimicking the actions of others, often ignoring their own analysis
Explanation: Herding occurs when investors follow the crowd rather than their own analysis, often amplifying market trends. It is a form of social influence that can contribute to bubbles and crashes. A and D are wrong. B is independent but coincidental convergence (not herding).
Question 626
Confirmation bias leads investors to:
Select an option first.
Correct answer: B — Seek out and give more weight to information that confirms their existing beliefs
Explanation: Confirmation bias makes investors selectively gather and interpret information in ways that reinforce their prior beliefs. This leads to overconfidence and underestimation of risks. A is rational updating. C is overreaction. D is decision paralysis.
Question 627
The risk management framework of an organization typically includes:
Select an option first.
Correct answer: B — A risk governance structure, risk identification, risk measurement, risk modification, and monitoring processes
Explanation: A comprehensive risk management framework covers: governance (who is responsible), identification (what risks exist), measurement (how much), modification (how to manage them), and monitoring. A is too narrow. C is unrelated. D excludes non-financial risks.
Question 628
Which of the following risk modification strategies involves paying someone else to bear a risk?
Select an option first.
Correct answer: D — Risk transfer (e.g., buying insurance or hedging)
Explanation: Risk transfer shifts the financial impact of a risk to a third party. Insurance, derivatives hedging, and securitization are examples. A eliminates the risky activity. B keeps the risk internally. C reduces the probability of the risk occurring.
Question 629
A pension fund invests primarily in long-duration bonds to match its long-term liabilities. This approach is called:
Select an option first.
Correct answer: B — Liability-driven investing (LDI)
Explanation: Liability-driven investing aligns the portfolio's asset duration and cash flows with the pension fund's liability structure, minimizing the risk of a funding shortfall. A is general long-term allocation. C is short-term opportunistic adjustments. D is about risk allocation.
Question 630
Which of the following statements about the value anomaly is most accurate?
Select an option first.
Correct answer: B — Value stocks have historically outperformed growth stocks over long periods
Explanation: Value stocks (cheap relative to fundamentals) have historically outperformed growth stocks over long periods — the value premium. Whether this is a risk premium or a behavioral anomaly is debated. A reverses history. C contradicts empirical evidence. D is one explanation but not fully proven.
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