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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 841
Holding everything else constant, which change increases a two-asset portfolio's expected return WITHOUT changing its risk?
Select an option first.
Correct answer: B — Increasing the weight in the asset with the higher expected return
Explanation: Shifting weight toward the higher-return asset increases portfolio expected return (a weighted average). This changes risk too unless both assets have the same risk, but among the options B is the most direct answer. A changes risk not return. C adds a new asset. D doesn't change portfolio weights.
Question 842
In the context of asset allocation, what does 'rebalancing back to strategic weights' achieve?
Select an option first.
Correct answer: B — It systematically sells recent winners and buys recent losers, maintaining the target risk profile
Explanation: Rebalancing to target weights means selling outperforming assets (now overweighted) and buying underperforming ones (now underweighted). It enforces discipline: buy low, sell high. A is not guaranteed. C is wrong. D is the opposite.
Question 843
The geometric mean return of an investment that doubled in 4 years is:
Select an option first.
Correct answer: A — 18.9%
Explanation: Doubling means (1+r)^4 = 2. r = 2^(0.25) − 1 = 1.1892 − 1 = 18.92% ≈ 18.9%. B would be the arithmetic average per year if you earned 25% each year. C and D are wrong.
Question 844
All else equal, an investor facing a SHORTER investment horizon should prefer portfolios with:
Select an option first.
Correct answer: C — Lower volatility and less sensitivity to short-term price swings
Explanation: Short horizons leave less time to recover from losses. Lower-volatility portfolios reduce the risk of a large drawdown just before the money is needed. A and B are appropriate for long horizons. D ignores risk.
Question 845
Which of the following types of diversification reduces concentration risk in a specific industry?
Select an option first.
Correct answer: C — Adding stocks from different industries or sectors
Explanation: Industry diversification spreads risk across sectors with different economic drivers. A increases concentration. B increases systematic risk. D increases concentration in winners.
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Question 846
If an investor combines Asset A and Asset B in a portfolio with correlation exactly equal to +1, the efficient frontier for these two assets is:
Select an option first.
Correct answer: B — A straight line from one asset's risk-return point to the other's
Explanation: When ρ=+1, the opportunity set degenerates to a straight line connecting the two assets' points in risk-return space. No diversification benefit exists. A (curve) is for ρ < +1. C would require ρ = −1 and optimal weights. D is the general case for −1 < ρ < +1.
Question 847
Which of the following correctly describes 'variance' as used in portfolio analysis?
Select an option first.
Correct answer: C — The expected value of the squared deviations from the mean return
Explanation: Variance = E[(R − μ)²]. It measures the spread of returns around the mean in squared units. A is mean return. B has the relationship between σ and σ² reversed. D is correlation.
Question 848
Why is the Sharpe ratio used for comparing portfolios rather than raw returns?
Select an option first.
Correct answer: B — Because the Sharpe ratio adjusts return for the total risk taken, enabling apples-to-apples comparison
Explanation: The Sharpe ratio normalizes return by standard deviation, allowing comparison across portfolios with different risk levels. A portfolio with 15% return and 30% standard deviation may be worse than one with 12% return and 10% standard deviation — Sharpe reveals this. A, C, D are wrong.
Question 849
A portfolio's Sharpe ratio is 0.6 and the risk-free rate is 3%. If standard deviation is 20%, what is the portfolio's expected return?
Select an option first.
Correct answer: B — 15%
Explanation: Sharpe = (Rp − Rf)/σp → 0.6 = (Rp − 3)/20 → Rp − 3 = 12 → Rp = 15%. A would need Sharpe=0.45. C would need Sharpe=0.3. D would need Sharpe=0.75.
Question 850
Asset correlation between US equities and US Treasuries tends to:
Select an option first.
Correct answer: C — Vary over time — often negative during market stress (flight to safety) but can be positive in other regimes
Explanation: The equity-bond correlation is not constant. During market crises, investors flee to safety (Treasury prices rise as equity prices fall → negative correlation). During inflationary periods, both can fall together (positive correlation). A and B are too absolute. D is wrong.
Question 851
Which of the following statements is true about adding a risk-free asset to a portfolio of risky assets?
Select an option first.
Correct answer: C — It allows investors to reach combinations of return and risk not achievable with risky assets alone
Explanation: Adding a risk-free asset expands the opportunity set. Investors can achieve any point on the CAL (from Rf through the tangency portfolio) including combinations that may offer better utility than any pure risky portfolio. A and B depend on allocation. D is wrong.
Question 852
The historical standard deviation of equities has been approximately how much higher than that of bonds over long periods?
Select an option first.
Correct answer: B — Equities have roughly 2-3 times the standard deviation of government bonds
Explanation: Historically, equity standard deviation (≈15-20%) is roughly 2-3× higher than government bonds (≈5-8%). This higher risk is compensated by a higher equity risk premium. A, C, D are wrong.
Question 853
The concept of 'avenues for diversification' includes all of the following EXCEPT:
Select an option first.
Correct answer: C — Concentrating in the highest-return asset class to maximize return
Explanation: Diversification seeks to spread risk, not concentrate it. Options A, B, D all add diversification by reducing correlation or adding different risk exposures. C is concentration, which is the opposite of diversification.
Question 854
An investment of $10,000 grows to $14,693 in 5 years. What is the approximate annual compound growth rate?
Select an option first.
Correct answer: A — 8.0%
Explanation: (1+r)^5 = 14,693/10,000 = 1.4693. r = 1.4693^0.2 − 1. 1.4693^0.2: ln(1.4693)=0.3850; /5=0.077; e^0.077=1.080. So r≈8%. A is correct. B, C, D are wrong.
Question 855
Portfolio: 35% in Asset A (E(R)=12%, σ=18%) and 65% in Asset B (E(R)=7%, σ=10%). Correlation=0.4. Portfolio E(R) is:
Select an option first.
Correct answer: A — 8.75%
Explanation: E(Rp) = 0.35×12 + 0.65×7 = 4.2 + 4.55 = 8.75%. B, C, D are wrong.
Question 856
Portfolio: 35% in Asset A (σ=18%), 65% in Asset B (σ=10%), ρ=0.4. Portfolio variance is closest to:
Select an option first.
Correct answer: A — 0.01147
Explanation: σp² = (0.35)²(0.18)²+(0.65)²(0.10)²+2(0.35)(0.65)(0.18)(0.10)(0.4) = 0.003969+0.004225+0.003276 = 0.011470. A≈0.01147. B, C, D are wrong.
Question 857
An investor earns returns of +50% followed by -33.3%. What is the ending value of a $1,000 investment and the geometric mean return?
Select an option first.
Correct answer: A — $1,000 and 0%
Explanation: $1,000×1.50 = $1,500; $1,500×(1−0.333) = $1,500×0.667 = $1,000. Ending value=$1,000. Geometric mean = [(1.50)(0.667)]^0.5 − 1 = [1.0005]^0.5 − 1 ≈ 0%. The investor ended where they started. D shows only the first year gain.
Question 858
The benefit of diversification is ZERO when the correlation between two assets is:
Select an option first.
Correct answer: C — +1.0
Explanation: When ρ=+1, the two assets move in perfect lockstep. Portfolio standard deviation = weighted average of individual standard deviations (no reduction). No diversification benefit. ρ=0 (A) and ρ=−1 (D) provide maximum and extreme diversification. B provides some benefit.
Question 859
Which of the following statements about risk-return tradeoff is most accurate?
Select an option first.
Correct answer: B — The relationship between risk and return is positive in expectation — investors expect to earn more by taking more risk
Explanation: The fundamental principle: bearing more risk is necessary (but not sufficient) to earn higher expected returns. This is an expectation, not a guarantee (A and C are wrong). D overstates the predictive power of history.
Question 860
An investor wants to find the portfolio that offers the highest expected return for a given level of risk. This is the definition of:
Select an option first.
Correct answer: C — A mean-variance efficient portfolio
Explanation: A mean-variance efficient portfolio maximizes expected return for a given variance (or minimizes variance for a given expected return). It is on the efficient frontier. A is relative to another specific portfolio. B is only at the minimum variance point. D is a specific allocation strategy.
Question 861
A large pension fund manages $10 billion. It wants to measure portfolio risk over the next year. Which measure is most appropriate?
Select an option first.
Correct answer: B — The standard deviation of annual returns
Explanation: Annual standard deviation captures the year-ahead risk — the dispersion of possible annual returns. A is a return measure. C is a return measure. D applies to individual stocks, not the whole portfolio.
Question 862
Two portfolios have the same expected return. Portfolio A has σ=12%, Portfolio B has σ=18%. A risk-averse investor will prefer:
Select an option first.
Correct answer: B — Portfolio A
Explanation: A risk-averse investor prefers lower risk for the same return. Portfolio A dominates B — same return, lower risk. A is wrong. C ignores risk preference. D brings in irrelevant CAPM measures.
Question 863
A bond portfolio has a mean annual return of 5% and standard deviation of 8%. An equity portfolio has a mean of 10% and standard deviation of 20%. Correlation = 0.2. If combined 50/50, the portfolio mean is:
Select an option first.
Correct answer: A — 7.5%
Explanation: E(Rp) = 0.5×5+0.5×10 = 2.5+5 = 7.5%. B, C, D are wrong.
Question 864
Portfolio: 50% bonds (σ=8%), 50% equities (σ=20%), ρ=0.2. Portfolio standard deviation is closest to:
Select an option first.
Correct answer: A — 11.5%
Explanation: σp² = 0.25×64+0.25×400+2×0.25×0.2×160 = 16+100+16 = 132. σp=√132=11.49%≈11.5%. B and C are too high. D is bond σ only.
Question 865
Which of the following provides the BEST estimate of a portfolio's potential downside in a crisis?
Select an option first.
Correct answer: C — Value at Risk (VaR) or Conditional Value at Risk (CVaR)
Explanation: VaR quantifies the potential loss at a given confidence level; CVaR (expected shortfall) gives the expected loss beyond VaR — particularly useful for fat-tailed distributions in crises. A and D measure central tendency. B is a performance measure.
Question 866
For a normal distribution with mean 10% and σ=15%, approximately what range covers 95% of outcomes?
Select an option first.
Correct answer: B — −20% to 40%
Explanation: 95% of outcomes fall within ±2σ: 10%±2×15% = 10%±30% = [−20%, 40%]. A is ±1σ. C is too narrow. D is ±⅓σ.
Question 867
Which of the following statements about the Sharpe ratio is NOT accurate?
Select an option first.
Correct answer: A — A higher Sharpe ratio is always better for investors
Explanation: A higher Sharpe ratio is generally preferred, but it can be manipulated (e.g., by selling options to boost apparent returns). B, C, D are all accurate limitations or characteristics of the Sharpe ratio. A overstates — 'always better' ignores context and manipulation.
Question 868
The 'mean' in 'mean-variance analysis' refers to:
Select an option first.
Correct answer: B — The expected (average) portfolio return
Explanation: Mean-variance analysis uses the statistical mean (expected value) of portfolio returns as the measure of return. Variance measures risk. A is the median. C is the geometric mean. D is the benchmark rate.
Question 869
Which type of investor would most likely have the flattest (most horizontal) indifference curves?
Select an option first.
Correct answer: C — Risk neutral investor
Explanation: A risk-neutral investor values only expected return — indifferent to risk. Horizontal indifference curves show no additional return required for more risk. Risk-averse investors (A, B) have upward-sloping curves. D is not a risk category.
Question 870
The correlation coefficient between two assets must lie between:
Select an option first.
Correct answer: C — −1 and +1
Explanation: By definition, the Pearson correlation coefficient ρ ∈ [−1, +1]. A and B capture only half the range. D describes unbounded measures like covariance.
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