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Free Questions › CFA › Portfolio Management
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 631
An investor learns that a stock's fundamentals have deteriorated significantly but delays selling because they do not want to realize the loss. This is most likely an example of:
Select an option first.
Correct answer: C — Loss aversion and the disposition effect
Explanation: Holding a losing position to avoid realizing the loss is the classic disposition effect, driven by loss aversion. The investor gives the loss more psychological weight than a rational analysis would justify. A involves overestimating ability. B involves filtering information. D involves separate mental 'buckets.'
Question 632
A client has $2 million in assets, needs $80,000/year for living expenses, and has a 25-year horizon. What is the minimum required nominal annual return to sustain withdrawals (approximately)?
Select an option first.
Correct answer: A — 4%
Explanation: $80,000 / $2,000,000 = 4%. If the portfolio earns at least 4% nominal, withdrawals can be sustained indefinitely (ignoring inflation). With inflation, the required return would be higher. B, C, D provide growth above needs.
Question 633
A portfolio with $600,000 in stocks and $400,000 in bonds (total $1,000,000) has a target of 60/40. Stocks gain 10% to $660,000 and bonds stay at $400,000 (total $1,060,000). How much stock must be sold to rebalance?
Select an option first.
Correct answer: A — $24,000
Explanation: Target stocks = 60% × $1,060,000 = $636,000. Current stocks = $660,000. Sell = $660,000 − $636,000 = $24,000. B, C, D are wrong.
Question 634
A 'unique circumstances' constraint in an IPS would most likely include:
Select an option first.
Correct answer: C — Ethical restrictions or a preference to avoid certain industries
Explanation: Unique circumstances capture special investor-specific factors like ethical investing restrictions, concentrated stock positions, family business exposure, or religious considerations. A is return objective. B is a tax constraint. D is a time horizon constraint.
Question 635
Which type of institutional investor typically has the most stringent liquidity requirements?
Select an option first.
Correct answer: D — Bank with short-term deposit liabilities
Explanation: Banks must meet depositor withdrawal demands on short notice — requiring highly liquid assets. Endowment funds (A) have long horizons with limited liquidity needs. Pension funds (B) have long liability durations. Insurance companies (C) have varied but generally moderate liquidity needs.
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Question 636
Which pooled investment vehicle is structured to mimic specific index returns with low fees?
Select an option first.
Correct answer: C — Index fund (passive mutual fund or ETF)
Explanation: Index funds and passive ETFs are designed to track a specific benchmark index with minimal trading and low fees. Hedge funds (A) and active mutual funds (B) try to outperform. Private equity (D) is illiquid and has a different structure entirely.
Question 637
In behavioral finance, the 'hot-hand fallacy' refers to:
Select an option first.
Correct answer: B — Belief that a streak of successes in investing or performance will continue, even when outcomes are random
Explanation: Hot-hand fallacy (a form of representativeness) is the belief that a winning streak will continue. In investing, this leads to chasing recent winners (performance chasing). A is the gambler's fallacy. C and D are not biases.
Question 638
Cognitive dissonance in investing describes:
Select an option first.
Correct answer: B — The mental discomfort when new information conflicts with existing beliefs, often resolved by ignoring the new data
Explanation: Cognitive dissonance causes investors to rationalize, dismiss, or ignore new information that contradicts their current holdings or beliefs. This reinforces poor decisions. A is what investors should do but often don't. C and D are rational behaviors.
Question 639
An investor has a $5 million portfolio and wants VaR not to exceed $250,000 at 95% confidence. The manager calculates a daily VaR of $300,000. What must happen?
Select an option first.
Correct answer: B — Reduce portfolio risk until VaR falls to or below $250,000
Explanation: The portfolio's VaR ($300,000) exceeds the stated tolerance ($250,000). Risk must be reduced — either by reducing position sizes, increasing diversification, or adding hedges. A violates the constraint. C and D increase risk, worsening the problem.
Question 640
Which of the following describes a 'passive' investment strategy?
Select an option first.
Correct answer: C — Holding a portfolio that mirrors a market index with minimal turnover
Explanation: Passive investing replicates market index returns with minimal trading, research, and cost. A and D are active (fundamental stock selection). B is active (tactical allocation). C is the definition of passive.
Question 641
The 'feedback' step in the portfolio management process includes:
Select an option first.
Correct answer: D — Monitoring performance, rebalancing, and updating the IPS as needed
Explanation: The feedback step involves measuring actual performance against benchmarks, adjusting for changes in client circumstances or market conditions, and updating the IPS and portfolio accordingly. A and B are planning. C is execution.
Question 642
An investor claims high risk tolerance but their financial situation (large mortgage, upcoming tuition payments, low emergency savings) suggests low risk capacity. The appropriate risk level for portfolio construction is:
Select an option first.
Correct answer: C — Based on the lower of the two — financial capacity determines the maximum risk level
Explanation: When willingness (subjective) exceeds ability (objective), the objective financial constraint prevails. Exceeding the ability to bear risk could cause the investor to abandon the plan during downturns. C is the correct principle. A ignores financial reality. B could be too conservative if ability is adequate. D is not the standard practice.
Question 643
Which of the following is a potential benefit of including alternative assets (real estate, commodities, private equity) in a portfolio?
Select an option first.
Correct answer: B — They can improve diversification by providing returns with low correlation to traditional assets
Explanation: Alternative assets often have low correlation with stocks and bonds, providing diversification benefits that can reduce portfolio risk or improve the risk-return tradeoff. A is too strong. C is impossible. D is the opposite — alternatives are typically illiquid.
Question 644
The concept of 'risk budgeting' is most closely related to:
Select an option first.
Correct answer: B — Allocating shares of total portfolio risk across asset classes or strategies to maximize return per unit of risk
Explanation: Risk budgeting assigns the total risk 'budget' (e.g., VaR, tracking error, or standard deviation) to different parts of the portfolio based on expected returns and correlations. Goal: maximize expected portfolio return per unit of risk. A is a stop-loss. C and D are unrelated.
Question 645
An investor is placing an irrational amount of importance on recent market events when forming expectations. This bias is called:
Select an option first.
Correct answer: C — Recency bias
Explanation: Recency bias (or availability bias in some frameworks) means giving too much weight to recent events or data. Investors expect recent trends to continue indefinitely. A fixates on an anchor. B is slow to update. D is overestimating skill.
Question 646
Status quo bias in portfolio management leads investors to:
Select an option first.
Correct answer: B — Hold their current portfolio unchanged even when changes are optimal
Explanation: Status quo bias is the preference for the current state of affairs — inaction even when action would improve outcomes. Investors with this bias avoid selling, rebalancing, or making necessary adjustments. A is rational action. C is goal-oriented. D is panic behavior.
Question 647
Which of the following is most likely to help overcome behavioral biases in portfolio management?
Select an option first.
Correct answer: C — Establishing a disciplined, rules-based investment process and pre-commitment strategies
Explanation: Disciplined, systematic processes (e.g., IPS, checklists, pre-commitment rules) help counteract biases by reducing the role of emotion and intuition. A and B reinforce biases. D worsens decision quality.
Question 648
An endowment fund has $100 million in assets and annual spending of $5 million. The spending rate is:
Select an option first.
Correct answer: A — 5.0%
Explanation: Spending rate = Annual spending / Total assets = $5M / $100M = 5%. This is typical for large endowments (the '5% rule'). B, C, D are wrong.
Question 649
An investor needs $100,000 in 5 years. If the expected return is 8% per year, approximately how much must be invested today?
Select an option first.
Correct answer: A — $68,058
Explanation: PV = $100,000 / (1.08)⁵ = $100,000 / 1.4693 = $68,058. B would use 6.4% (lower rate). C and D are wrong.
Question 650
A portfolio manager tracks error relative to a benchmark. If the portfolio's active return (excess over benchmark) averages 2% and tracking error is 4%, the information ratio is:
Select an option first.
Correct answer: B — 0.50
Explanation: Information ratio = Active return / Tracking error = 2% / 4% = 0.50. A would need active return=1%. C uses the denominator as active return. D is wrong.
Question 651
Which of the following is the BEST example of a tax-related constraint in an IPS?
Select an option first.
Correct answer: B — Capital gains should be deferred or minimized where possible
Explanation: Tax constraints address how the portfolio manages tax liability — deferring gains, using tax-loss harvesting, preferring tax-exempt securities, etc. A is a liquidity constraint. C is a return objective. D is risk tolerance.
Question 652
Which of the following investors would LEAST likely have a constraint on short selling?
Select an option first.
Correct answer: C — A hedge fund pursuing a long-short equity strategy
Explanation: Hedge funds commonly engage in short selling as a core strategy. Retail mutual funds (A) typically cannot short. Endowments (B) often have mandates against shorting. Pension funds (D) face regulatory restrictions. C has the fewest short-selling constraints.
Question 653
An investor with a 30-year horizon and stable income should allocate relatively more to:
Select an option first.
Correct answer: C — Long-duration bonds and equities
Explanation: A 30-year horizon allows the investor to tolerate short-term volatility and invest in growth assets (equities) and long-duration bonds. These typically offer higher long-run returns. A, B, D are too conservative for a 30-year horizon with stable income.
Question 654
A 'core-satellite' portfolio strategy involves:
Select an option first.
Correct answer: B — Holding a passive core (tracking the market) combined with active satellite positions for potential alpha
Explanation: Core-satellite combines passive investing (low-cost index funds as the core) with active positions (satellites) that aim to outperform. This balances cost efficiency with active management. A uses only passive. C and D misstate the strategy.
Question 655
Which of the following best describes 'factor investing'?
Select an option first.
Correct answer: C — Systematically tilting a portfolio toward characteristics (factors) that have historically earned risk premiums
Explanation: Factor investing (smart beta) systematically targets documented risk premiums like value, size, quality, momentum, and low volatility. It is more structured than stock picking and more targeted than pure passive. A is pure passive. B is fundamental active. D is random.
Question 656
Which of the following best describes the role of capital market expectations in portfolio construction?
Select an option first.
Correct answer: B — They are forecasts of risk, return, and correlations for asset classes, used to determine the optimal strategic asset allocation
Explanation: Capital market expectations (CME) are long-run forecasts for asset class returns, risks, and correlations. They feed into the optimization process that determines the strategic asset allocation. A, C, D are wrong.
Question 657
Which of the following hedge fund strategies involves taking long positions in stocks expected to rise and short positions in stocks expected to fall?
Select an option first.
Correct answer: B — Long/short equity
Explanation: Long/short equity hedge funds buy (go long) undervalued stocks and short overvalued ones, aiming to profit from relative performance while reducing market exposure. A bets on macroeconomic trends. C exploits merger announcements. D trades futures based on trend-following.
Question 658
Which statement about private equity funds is most accurate?
Select an option first.
Correct answer: C — Private equity funds typically have long lock-up periods and target returns above public market equivalents
Explanation: Private equity funds invest in private companies with long hold periods (5-10+ years) and illiquidity. They target high returns to compensate for illiquidity risk and leverage. A, B, D are wrong.
Question 659
An investor is worried about overfitting in quantitative models. This is a concern related to:
Select an option first.
Correct answer: B — Model risk — the risk that a model performs well in-sample but fails out-of-sample
Explanation: Overfitting is a model risk: the model captures historical noise rather than true patterns, failing to generalize to new data. It is a non-financial risk in the framework. A is a behavioral bias. C and D are financial risks.
Question 660
A high information ratio for an active manager indicates:
Select an option first.
Correct answer: B — The manager delivers high active return per unit of active risk (tracking error) — consistent alpha generation
Explanation: Information ratio = Active return / Tracking error. A high IR means the manager generates active return efficiently, taking minimal active risk for each unit of excess return earned. A, C, D are wrong.
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