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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 931
An investor holds a $1 million portfolio. She adds a $200,000 position in an asset with ρ=0 with the existing portfolio. The weight of the new asset is:
Select an option first.
Correct answer: A — 16.7%
Explanation: Weight = $200,000 / ($1,000,000 + $200,000) = $200,000 / $1,200,000 = 16.67% ≈ 16.7%. B uses old total. C and D are wrong.
Question 932
The efficient frontier assumes that investors can identify the 'true' expected returns and variances of all assets. In practice, the main challenge is:
Select an option first.
Correct answer: B — True expected returns and covariances are unknown and must be estimated from noisy historical data
Explanation: Mean-variance optimization is highly sensitive to input assumptions. Since true parameters are unknown, estimates from historical data introduce error, leading to unstable or extreme portfolio weights. This is the primary practical limitation of the framework.
Question 933
An investor puts 100% in the risk-free asset. Expected return = Rf = 5%, σ = 0%. What is their Sharpe ratio?
Select an option first.
Correct answer: A — Undefined (0/0)
Explanation: Sharpe=(Rp−Rf)/σp = (5−5)/0 = 0/0 — undefined. The risk-free asset itself cannot be evaluated by Sharpe ratio since σ=0. B, C, D are wrong.
Question 934
A portfolio has returns of 8%, 12%, 6%, 14%, 10%. The variance (using population formula) is:
Select an option first.
Correct answer: A — 8.0 (%²)
Explanation: Mean = (8+12+6+14+10)/5 = 50/5 = 10%. Deviations: −2, 2, −4, 4, 0. Squared: 4, 4, 16, 16, 0. Sum=40. Variance=40/5=8.0(%²). B, C, D are wrong.
Question 935
The Capital Asset Pricing Model (CAPM) assumes which of the following?
Select an option first.
Correct answer: B — There are no transaction costs, taxes, or restrictions on short selling
Explanation: CAPM assumptions include: frictionless markets (no taxes, transactions costs), unlimited short selling, all investors can borrow/lend at the risk-free rate, and homogeneous expectations. A, C, D violate CAPM assumptions.
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Question 936
Under CAPM, the market portfolio is:
Select an option first.
Correct answer: C — The value-weighted portfolio of all risky assets in the economy
Explanation: The theoretical CAPM market portfolio is a value-weighted combination of ALL risky assets in the economy (stocks, bonds, real estate, human capital, etc.). In practice, a broad stock index is used as a proxy. A is an approximation. B and D are wrong.
Question 937
Beta (β) in the CAPM measures:
Select an option first.
Correct answer: B — An asset's systematic risk relative to the market portfolio
Explanation: Beta measures how much of the market's risk (systematic) an asset carries, relative to the market. β = Cov(Ri, Rm)/Var(Rm). It is NOT total risk (A), NOT correlation (C, though related), and NOT standard deviation ratio (D) — that would be σi/σm.
Question 938
An asset with a beta of 1.5 is expected to:
Select an option first.
Correct answer: B — Move 1.5% for every 1% move in the market portfolio
Explanation: Beta of 1.5 means the asset's return is expected to move 1.5% for every 1% move in the market. It is more volatile than the market (β > 1). A involves the risk-free rate, not the market. C describes relative standard deviation. D is wrong.
Question 939
The Security Market Line (SML) shows the relationship between:
Select an option first.
Correct answer: B — Systematic risk (beta) and expected return
Explanation: The SML plots expected return on the y-axis against beta on the x-axis. Any correctly priced asset lies on the SML under CAPM. A describes the Capital Market Line (CML). C and D are unrelated.
Question 940
The difference between the Capital Market Line (CML) and the Security Market Line (SML) is:
Select an option first.
Correct answer: C — The CML uses total risk (standard deviation) on the x-axis; the SML uses systematic risk (beta)
Explanation: CML: x-axis = standard deviation (total risk), applies to efficient portfolios. SML: x-axis = beta (systematic risk), applies to all assets and portfolios. A and D swap the definitions. B is wrong.
Question 941
If a stock plots above the Security Market Line, it is:
Select an option first.
Correct answer: C — Underpriced — its expected return is higher than required for its beta level
Explanation: Above the SML means the stock's actual expected return exceeds what CAPM requires for its beta — a positive alpha. This signals undervaluation (buy signal). Fairly priced assets lie on the SML (A). Overpriced assets fall below (B). D is wrong.
Question 942
Jensen's alpha measures:
Select an option first.
Correct answer: B — The excess return of a portfolio above what the CAPM predicts given its beta
Explanation: Jensen's alpha = Actual return − CAPM expected return = Rp − [Rf + β(Rm − Rf)]. Positive alpha indicates the manager generated return beyond what beta exposure alone would predict. A is just the return. C is Sharpe ratio. D is Treynor ratio.
Question 943
The Sharpe ratio is defined as:
Select an option first.
Correct answer: B — (Portfolio return − Risk-free rate) / Portfolio standard deviation
Explanation: Sharpe ratio = (Rp − Rf) / σp. It measures excess return per unit of TOTAL risk. A uses benchmark return (that's the information ratio concept). C is the Treynor ratio. D is wrong.
Question 944
The Treynor ratio differs from the Sharpe ratio in that the Treynor ratio uses:
Select an option first.
Correct answer: B — Beta in the denominator instead of standard deviation
Explanation: Treynor ratio = (Rp − Rf) / βp. It measures excess return per unit of SYSTEMATIC risk (beta). Sharpe uses total risk. A describes Sharpe. C is active return. D is wrong.
Question 945
Which performance measure is most appropriate for evaluating a portfolio that represents only a portion of an investor's total wealth?
Select an option first.
Correct answer: C — Treynor ratio
Explanation: When a portfolio is one component of a larger portfolio, the relevant risk measure is beta (systematic risk), not total risk. The Treynor ratio (excess return per unit of beta) is therefore most appropriate. Sharpe (A) and M² (D) use total risk, better for evaluating entire portfolios.
Question 946
The M-squared (M²) measure adjusts a portfolio's performance to:
Select an option first.
Correct answer: C — Match the market's total risk level, allowing direct comparison with the market return
Explanation: M² adjusts the portfolio to have the same standard deviation as the market (by mixing with the risk-free asset). This creates a risk-adjusted return that can be directly compared to the market return. If M² > Rm, the portfolio outperformed. A, B, D are wrong.
Question 947
A single-index model decomposes a stock's return into:
Select an option first.
Correct answer: A — Systematic and unsystematic components, where systematic return is linked to the market index
Explanation: The single-index (market) model: Ri = αi + βiRm + εi. The systematic part is βiRm (market-linked); the unsystematic part is εi (firm-specific). B, C, D are incomplete or wrong.
Question 948
Under CAPM, expected return is a function of:
Select an option first.
Correct answer: C — Beta multiplied by the market risk premium, plus the risk-free rate
Explanation: CAPM: E(Ri) = Rf + βi[E(Rm) − Rf]. Only systematic risk (beta) is rewarded because investors can diversify away unsystematic risk. A uses total risk (CML does this, not SML). B alone is incomplete. D uses historical returns.
Question 949
If the risk-free rate is 3%, the market return is 10%, and a stock's beta is 1.2, its CAPM expected return is:
Select an option first.
Correct answer: A — 11.4%
Explanation: E(R) = 3% + 1.2×(10%−3%) = 3% + 1.2×7% = 3% + 8.4% = 11.4%. B would be 3+1.2×7.83%. C and D are wrong.
Question 950
A stock has a CAPM expected return of 10% but the analyst forecasts a return of 13%. The stock's alpha is:
Select an option first.
Correct answer: A — +3%
Explanation: Alpha = Actual/forecast return − CAPM expected return = 13% − 10% = +3%. Positive alpha suggests undervaluation — the stock is expected to outperform. B is the wrong sign. C means fairly valued. D is just the forecast.
Question 951
The market risk premium is defined as:
Select an option first.
Correct answer: B — The market return minus the risk-free rate
Explanation: Market risk premium = E(Rm) − Rf. It is the extra return investors demand for bearing systematic market risk above the risk-free rate. A and C are components, not the premium. D is a credit spread.
Question 952
The beta of the overall market portfolio is:
Select an option first.
Correct answer: C — 1.0
Explanation: By definition, the market portfolio has a beta of 1.0 relative to itself. Everything is measured relative to the market, so the market's sensitivity to itself is 1. A (beta=0) is the risk-free asset. B and D are wrong.
Question 953
The beta of a risk-free asset is:
Select an option first.
Correct answer: C
Explanation: The risk-free asset has zero correlation and zero covariance with the market portfolio. Since beta = Cov(Ri,Rm)/Var(Rm) = 0/Var(Rm) = 0. A is the market beta. B is wrong. D is wrong.
Question 954
Which of the following is NOT an assumption of CAPM?
Select an option first.
Correct answer: C — Asset returns follow a lognormal distribution
Explanation: CAPM does not specify a lognormal distribution — it assumes returns are normally distributed (or that investors have mean-variance preferences). A, B, D are all standard CAPM assumptions. C is an additional assumption of some option pricing models, not CAPM.
Question 955
The security characteristic line (SCL) is a regression of:
Select an option first.
Correct answer: B — Individual stock returns against market returns
Explanation: The SCL plots the stock's excess return against the market's excess return. Its slope is beta (systematic risk) and its intercept is alpha. This is the empirical application of the single-index model. A, C, D are wrong.
Question 956
Which of the following best describes the 'extensions to CAPM' such as multi-factor models?
Select an option first.
Correct answer: B — They recognize that multiple systematic risk factors (beyond just market beta) may explain asset returns
Explanation: Multi-factor models (Fama-French, APT) expand beyond CAPM by including additional systematic risk factors (size, value, momentum, etc.) that may explain cross-sectional return differences. A, C, D are wrong.
Question 957
A limitation of the CAPM is that:
Select an option first.
Correct answer: B — Beta is an unobservable forward-looking quantity that must be estimated from historical data and may not be stable
Explanation: CAPM's main practical limitations: beta must be estimated from historical data (may not be stable), the market portfolio is unobservable, and the model relies on unrealistic assumptions. A is wrong — CAPM does estimate expected returns. C and D are not primary limitations.
Question 958
The Sharpe ratio is most appropriate for evaluating which type of portfolio?
Select an option first.
Correct answer: B — A well-diversified portfolio that represents the investor's entire wealth
Explanation: Sharpe ratio uses total risk (standard deviation) in the denominator, making it appropriate when the portfolio is the investor's entire investment. When the portfolio is one component of a larger portfolio, Treynor ratio (using beta) is more appropriate. C and D are too restrictive.
Question 959
Arbitrage Pricing Theory (APT) differs from CAPM in that APT:
Select an option first.
Correct answer: D — Uses multiple macroeconomic factors to explain asset returns
Explanation: APT is a multi-factor model — expected return is driven by multiple risk factors (e.g., GDP growth, inflation, interest rates). CAPM uses only one factor (market beta). B is actually a feature of APT. A describes CAPM. C is assumed by both.
Question 960
If the risk-free rate is 4%, market expected return is 11%, and beta is 0.8, the CAPM expected return is:
Select an option first.
Correct answer: A — 9.6%
Explanation: E(R) = 4% + 0.8×(11%−4%) = 4% + 0.8×7% = 4% + 5.6% = 9.6%. B would use beta 0.88. C is market return. D is wrong.
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