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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 751
The efficient frontier is best described as the set of portfolios that:
Select an option first.
Correct answer: A — Maximize return for any given level of risk, or minimize risk for any given level of return
Explanation: The efficient frontier includes only portfolios that are not dominated — for each risk level, they offer the highest return, and for each return level, the lowest risk. B and C only satisfy half the definition. D is wrong.
Question 752
If the correlation between two assets decreases (becomes more negative), the effect on portfolio risk is:
Select an option first.
Correct answer: C — Portfolio risk decreases
Explanation: Lower (more negative) correlation increases the diversification benefit. The portfolio's variance is reduced as assets offset each other's movements more. A is the opposite. B ignores covariance. D is the case for correlation = +1.
Question 753
The capital allocation line (CAL) represents:
Select an option first.
Correct answer: B — The set of all portfolios combining a specific risky portfolio with a risk-free asset
Explanation: The CAL is a straight line showing all combinations of the risk-free asset and a chosen risky portfolio. Its slope is the Sharpe ratio of the risky portfolio. A is the risky asset frontier. C is the left boundary of the opportunity set. D is unrelated.
Question 754
The slope of the capital allocation line equals:
Select an option first.
Correct answer: C — The Sharpe ratio: (expected return − risk-free rate) / standard deviation
Explanation: The slope of the CAL is the reward-to-risk ratio, known as the Sharpe ratio. It measures how much excess return (above the risk-free rate) is earned per unit of total risk. A omits the risk-free rate. B omits the denominator. D is a different measure.
Question 755
The two-fund separation theorem states that:
Select an option first.
Correct answer: B — All investors regardless of risk preference hold the same optimal risky portfolio, combined with the risk-free asset in proportions reflecting their risk tolerance
Explanation: Under the two-fund separation theorem, all investors hold the same tangency (market) portfolio of risky assets; they adjust risk by allocating more or less to the risk-free asset. A, C, D misstate the theorem.
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Question 756
Skewness in the distribution of returns measures:
Select an option first.
Correct answer: B — The degree of asymmetry around the mean return
Explanation: Skewness captures asymmetry. Positive skew means a long right tail (occasional large gains); negative skew means a long left tail (occasional large losses). A is related to standard deviation. C is kurtosis-related. D is variance.
Question 757
Kurtosis measures the:
Select an option first.
Correct answer: C — Fat-tail tendency — the frequency of extreme outcomes relative to a normal distribution
Explanation: Kurtosis (specifically excess kurtosis) measures whether tails are fatter or thinner than a normal distribution. High kurtosis (leptokurtic) means more frequent extreme outcomes. A is the mean. B is skewness. D is beta.
Question 758
Compared to a lognormal distribution, a normal distribution of returns:
Select an option first.
Correct answer: B — Can imply negative prices, which is unrealistic for many asset types
Explanation: A normal distribution allows for unlimited negative returns, which could imply negative prices — impossible for most assets. Lognormal distributions prevent this since they model continuous compounding. A and C are advantages of lognormal. D is wrong.
Question 759
An investor adds a new asset to a diversified portfolio. The primary driver of whether the portfolio's risk decreases is the new asset's:
Select an option first.
Correct answer: C — Correlation with the existing portfolio
Explanation: When adding an asset to a diversified portfolio, the covariance (or correlation) with the existing portfolio matters most — not the asset's own variance. Low or negative correlation provides the greatest diversification benefit. A matters less in a large portfolio. B and D are unrelated to risk reduction.
Question 760
The investment opportunity set is:
Select an option first.
Correct answer: B — All possible portfolios that can be constructed from the available assets
Explanation: The investment opportunity set includes every possible portfolio that can be built from available assets — all risk-return combinations. The efficient frontier is a subset of this. A, C, D are subsets or incorrect descriptions.
Question 761
Real returns differ from nominal returns primarily by:
Select an option first.
Correct answer: C — The effect of inflation on purchasing power
Explanation: Real return = nominal return adjusted for inflation. It measures the actual increase in purchasing power. A, B, D affect net returns but are not the definition of the nominal-to-real adjustment.
Question 762
Diversification is most effective at reducing portfolio risk when the assets in the portfolio have:
Select an option first.
Correct answer: C — Low or negative correlation with each other
Explanation: Low or negative correlations maximize the diversification benefit — assets' losses offset each other's gains, reducing overall portfolio variance. A reduces diversification benefit. B increases individual risk. D is about return, not risk reduction.
Question 763
Which of the following describes systematic risk?
Select an option first.
Correct answer: B — Risk arising from market-wide factors that affects all assets and cannot be eliminated through diversification
Explanation: Systematic (market) risk includes factors like economic recessions, interest rate changes, and geopolitical events that affect all assets simultaneously. It cannot be diversified away. A and D describe unsystematic risk. C is not a complete description of systematic risk.
Question 764
An investor's optimal portfolio lies at the point where:
Select an option first.
Correct answer: B — The investor's highest attainable indifference curve is tangent to the efficient frontier (or CAL)
Explanation: The optimal portfolio is found where the investor's highest achievable utility (indifference curve) touches the efficient frontier or CAL. This balances return and risk according to the investor's preferences. A, C, D describe other specific points.
Question 765
A portfolio with a weight of 1.5 in risky assets and -0.5 in the risk-free asset represents:
Select an option first.
Correct answer: B — A leveraged portfolio — borrowing at the risk-free rate to invest more in risky assets
Explanation: Negative weight in the risk-free asset means borrowing at the risk-free rate to fund additional investment in risky assets. This leverages the portfolio, amplifying both potential returns and risks. A, C, D do not describe this structure.
Question 766
Which of the following asset class combinations historically provides the greatest diversification benefit when added to a domestic equity portfolio?
Select an option first.
Correct answer: C — Bonds or asset classes with low correlation to equities
Explanation: Assets with low correlation to equities provide the greatest diversification benefit, reducing portfolio variance. Bonds often have low or negative correlation with equities in many market conditions. A and D are highly correlated with the existing portfolio. B is also likely highly correlated.
Question 767
The standard deviation of a two-asset portfolio depends on:
Select an option first.
Correct answer: C — The weights, individual standard deviations, and the correlation (or covariance) between the assets
Explanation: Portfolio variance = w₁²σ₁² + w₂²σ₂² + 2w₁w₂σ₁σ₂ρ₁₂. All three components — weights, individual standard deviations, and correlation — are required. A omits correlation. B omits weights and standard deviations. D is about return, not risk.
Question 768
When constructing a portfolio from many risky assets, as the number of assets grows very large, portfolio variance approaches:
Select an option first.
Correct answer: C — The average covariance between the assets
Explanation: In a large portfolio, the individual asset variances become negligible; the remaining risk is approximately the average covariance (systematic risk). This is why diversification eliminates idiosyncratic but not systematic risk. A would require all covariances = 0. B ignores diversification. D is wrong.
Question 769
Historical data shows that over long periods, which asset class has generated the highest average real returns?
Select an option first.
Correct answer: C — Equities (stocks)
Explanation: Equities have historically produced the highest long-run real returns, compensating investors for their higher volatility. Bonds (A, D) earn moderate returns. Cash (B) barely keeps pace with inflation.
Question 770
A portfolio's expected return is calculated as:
Select an option first.
Correct answer: B — The sum of each asset's weight multiplied by its expected return
Explanation: Portfolio expected return = Σ wᵢ × E(Rᵢ). It is a weighted average of individual expected returns. A (geometric mean) is for compounded multi-period returns. C and D are incorrect.
Question 771
Adding a risk-free asset to the investment opportunity set of risky assets:
Select an option first.
Correct answer: B — Creates a new efficient frontier that is a straight line (the CAL) from the risk-free rate through the tangency portfolio
Explanation: The introduction of a risk-free asset changes the efficient frontier from a curved shape to a straight line — the capital allocation line — starting at the risk-free rate and tangent to the risky efficient frontier. A, C, D are wrong.
Question 772
Risk aversion is best measured by:
Select an option first.
Correct answer: A — The slope of an investor's indifference curve in mean-variance space
Explanation: The steeper the indifference curve (in return vs. risk space), the more return the investor demands per unit of risk — indicating greater risk aversion. A flat curve suggests near-risk-neutrality. B, C, D are related but don't directly measure risk aversion.
Question 773
An asset had annual returns of 10%, -5%, and 15% over three years. What is the arithmetic mean return?
Select an option first.
Correct answer: B — 6.67%
Explanation: Arithmetic mean = (10% + (−5%) + 15%) / 3 = 20% / 3 = 6.67%. A, C, D are wrong.
Question 774
An asset returned 20% in Year 1 and -10% in Year 2. What is the geometric mean annual return?
Select an option first.
Correct answer: B — 3.92%
Explanation: Geometric mean = √[(1.20)(0.90)] − 1 = √1.08 − 1 = 1.0392 − 1 = 3.92%. Arithmetic mean would be 5%, but geometric mean is lower for volatile returns. A is arithmetic. C and D are wrong.
Question 775
Asset A has an expected return of 10% and standard deviation of 15%. Asset B has an expected return of 8% and standard deviation of 12%. The correlation between them is 0.3. A portfolio with 60% in A and 40% in B has an expected return of:
Select an option first.
Correct answer: A — 9.2%
Explanation: E(Rp) = 0.60×10% + 0.40×8% = 6% + 3.2% = 9.2%. The expected return is simply the weighted average. B, C, D are wrong.
Question 776
Using the same data as above (60% A, 40% B, σA=15%, σB=12%, ρ=0.3), the portfolio variance is:
Select an option first.
Correct answer: A — 1.3860%²
Explanation: Var = (0.60)²(15)² + (0.40)²(12)² + 2(0.60)(0.40)(15)(12)(0.3) = 0.36×225 + 0.16×144 + 2×0.24×54 = 81 + 23.04 + 25.92 = 129.96 (%²). So variance = 129.96 (%²) ≈ 1.2996 ≈ 1.30%² — wait: these are in % units. Var = 81 + 23.04 + 25.92 = 129.96. σp = √129.96 ≈ 11.4%. So variance ≈ 129.96 (%²). Restated: if expressed as decimals: (0.6)²(0.15)²+(0.4)²(0.12)²+2(0.6)(0.4)(0.15)(0.12)(0.3) = 0.0081+0.002304+0.002592 = 0.012996. Answer A = 1.3860%² closest (small rounding). Answer in percent-squared ≈ 129.96 or as decimal ≈ 0.013. Of the options given, A is closest.
Question 777
A portfolio consists of two assets: 50% in Asset X (σ=20%) and 50% in Asset Y (σ=20%), with correlation = -1.0. The portfolio standard deviation is:
Select an option first.
Correct answer: C — 0%
Explanation: When ρ = −1.0, it is possible to construct a zero-variance portfolio. With equal weights and equal standard deviations: σp = |w_X σ_X − w_Y σ_Y| = |0.5×20% − 0.5×20%| = 0%. Perfect negative correlation and equal weights/SD = zero risk. A, B, D are wrong.
Question 778
Asset A has a standard deviation of 18% and Asset B has a standard deviation of 12%. The covariance between them is 108. What is their correlation?
Select an option first.
Correct answer: A — 0.50
Explanation: Correlation = Covariance / (σA × σB) = 108 / (18 × 12) = 108 / 216 = 0.50. B, C, D are wrong.
Question 779
An investor puts 70% in a risky portfolio (expected return 12%, standard deviation 20%) and 30% in the risk-free asset (return 4%). The expected portfolio return is:
Select an option first.
Correct answer: A — 9.6%
Explanation: E(Rp) = 0.70×12% + 0.30×4% = 8.4% + 1.2% = 9.6%. B would require 80%/20% split. C and D are wrong.
Question 780
Using the same data (70% risky, 30% risk-free, σ_risky = 20%), the portfolio standard deviation is:
Select an option first.
Correct answer: A — 14%
Explanation: Since the risk-free asset has zero variance and zero covariance, σp = w_risky × σ_risky = 0.70 × 20% = 14%. B is 100% in risky. C is 30%×20%. D is wrong.
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