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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 1021
Which ratio compares a portfolio's excess return to the active risk (tracking error) taken?
Select an option first.
Correct answer: C — Information ratio
Explanation: Information ratio = (Portfolio return − Benchmark return) / Tracking error. It measures performance per unit of active risk. Sharpe (A) uses total risk vs. Rf. Treynor (B) uses systematic risk. M² (D) is a return-based measure.
Question 1022
A portfolio has a Treynor ratio of 0.12 and beta of 1.2. The risk-free rate is 3%. What is the portfolio return?
Select an option first.
Correct answer: A — 17.4%
Explanation: Treynor = (Rp−Rf)/β → 0.12 = (Rp−3)/1.2 → Rp−3 = 0.144 = 14.4%... wait: 0.12 × 1.2 = 0.144 = 14.4% excess. Rp = 3+14.4 = 17.4%. A is correct. But wait: Treynor ratio is excess return per unit of beta. If expressed as decimal: 0.12×1.2 = 14.4% excess → Rp=17.4%. A is correct.
Question 1023
The security market line shifts upward when:
Select an option first.
Correct answer: B — The risk-free rate or market risk premium increases, causing all required returns to rise
Explanation: An increase in Rf or the market risk premium (Rm−Rf) shifts the entire SML upward, increasing required returns for all assets. Changes in individual betas (A) shift only that stock's point on the SML. C and D affect risk but not the SML level directly.
Question 1024
Which of the following is the most direct measure of a portfolio manager's skill at security selection?
Select an option first.
Correct answer: C — Jensen's alpha
Explanation: Jensen's alpha measures the return above (or below) what is explainable by systematic risk (beta). A positive alpha indicates the manager added value through security selection or timing beyond market exposure. A measures market exposure. B ignores risk. D measures total risk.
Question 1025
Rf=5%, Rm=13%, β=1.4. CAPM expected return is:
Select an option first.
Correct answer: A — 16.2%
Explanation: E(R) = 5+1.4×(13−5) = 5+1.4×8 = 5+11.2 = 16.2%. B would add 2%. C is market return. D is wrong.
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Question 1026
A stock returned 18% last year. Rf=4%, Rm=12%, β=1.25. What is Jensen's alpha?
Select an option first.
Correct answer: A — 4.0%
Explanation: CAPM = 4+1.25×8 = 4+10 = 14%. Alpha = 18-14 = +4%. B, C, D are wrong.
Question 1027
Portfolio P returned 22%, standard deviation=35%, beta=1.5. Rf=4%, Rm=12%. Sharpe ratio:
Select an option first.
Correct answer: A — 0.514
Explanation: Sharpe = (22-4)/35 = 18/35 = 0.514. B uses Treynor concept. C is close but uses different divisor. D is wrong.
Question 1028
Same portfolio: Treynor ratio =
Select an option first.
Correct answer: A — 12.0%
Explanation: Treynor = (22-4)/1.5 = 18/1.5 = 12.0% (or 0.12 in decimal). A is the percentage form. C is decimal form. The conventional expression is 0.12 as a ratio, but as % = 12.0%.
Question 1029
A stock has σ=40%, market σ=20%, R²=0.25. What is the stock's beta?
Select an option first.
Correct answer: B — 1.00
Explanation: R² = β²σm²/σi² → 0.25 = β²×400/1600 = β²×0.25 → β² = 1.0 → β = 1.0. A, C, D are wrong.
Question 1030
A stock has beta 1.8. Market falls 5%. Expected stock return (relative to market) is:
Select an option first.
Correct answer: A — Falls 9%
Explanation: Expected move = β × market move = 1.8 × (−5%) = −9%. High-beta stocks amplify market moves. B is market return. C misuses beta. D halves the answer.
Question 1031
Portfolio A (return=11%, β=1.0) vs Market (return=10%, β=1.0). Same beta. Which has better Jensen's alpha?
Select an option first.
Correct answer: B — Portfolio A (alpha=1%)
Explanation: Alpha_A = 11% − CAPM. Alpha_Market = 10% − CAPM. Since they have the same beta, same CAPM expected return. Portfolio A earns 1% more → alpha_A is 1% higher than alpha_Market. B is correct. Note: we need Rf to compute exact alpha values, but Portfolio A has 1% better alpha than the market.
Question 1032
The 'market model' is also known as:
Select an option first.
Correct answer: B — The single-index model
Explanation: The market model (single-index model) regresses a stock's excess returns against the market's excess returns: Ri = αi + βiRm + εi. It is a simplification that uses one factor (the market). A and C use multiple factors. D is APT.
Question 1033
Which performance measure would most penalize a manager who took a lot of unsystematic risk that was poorly rewarded?
Select an option first.
Correct answer: C — Sharpe ratio (penalizes total risk — systematic + unsystematic)
Explanation: Sharpe ratio uses total standard deviation — it penalizes unsystematic risk just as much as systematic risk. A manager with high unsystematic risk earns no premium for it, so a high σ denominator reduces the Sharpe ratio. A and B only adjust for systematic risk. D focuses on benchmark-relative.
Question 1034
A stock has a covariance with the market of 0.048. Market variance is 0.04. Beta is:
Select an option first.
Correct answer: A — 1.2
Explanation: β = Cov(i,m)/Var(m) = 0.048/0.04 = 1.2. B, C, D are wrong.
Question 1035
Using the same data: if σi=30%, what is the correlation between the stock and the market (σm=20%)?
Select an option first.
Correct answer: A — 0.80
Explanation: ρ = β × σm/σi = 1.2 × 20/30 = 1.2 × 0.667 = 0.80. B is ρ². C implies β=1.5. D is wrong.
Question 1036
Which of the following is most likely a result of holding an undiversified portfolio under CAPM?
Select an option first.
Correct answer: C — The same expected return as a diversified portfolio with the same beta but with unnecessary unsystematic risk
Explanation: CAPM prices only beta. An undiversified portfolio with the same beta as a diversified one earns the same CAPM expected return — but bears extra unsystematic risk with no compensation. This is suboptimal. A and D are wrong. B is wrong.
Question 1037
Alpha in CAPM can be positive over time for a manager because:
Select an option first.
Correct answer: B — Information asymmetry or skill allows identification of mispriced securities before prices adjust
Explanation: Positive alpha can persist if a manager has genuine skill or information edge to identify and exploit mispricings before the market corrects. This is consistent with mild forms of market inefficiency. A contradicts the average-outcome principle. C is too dismissive. D is empirically wrong.
Question 1038
The Sharpe ratio of the market is (Rm−Rf)/σm. If Rm=12%, Rf=3%, σm=20%, it equals:
Select an option first.
Correct answer: A — 0.45
Explanation: (12−3)/20 = 9/20 = 0.45. B, C, D are wrong.
Question 1039
Portfolio Z: return=10%, σ=15%, Rf=3%. Portfolio market: return=12%, σ=20%, Rf=3%. Which has higher Sharpe ratio?
Select an option first.
Correct answer: B — Portfolio Z (Sharpe=0.467)
Explanation: Sharpe_Z = (10−3)/15 = 7/15 = 0.467. Sharpe_market = (12−3)/20 = 0.45. Portfolio Z has higher Sharpe despite lower absolute return. B is correct.
Question 1040
An analyst notes that Stock W has a beta of 1.5 but its Sharpe ratio equals the market's Sharpe ratio. This implies Stock W:
Select an option first.
Correct answer: D — Has negative alpha
Explanation: On the CML, only efficient portfolios (combinations of Rf and market) share the same Sharpe ratio as the market. A stock with β=1.5 and same Sharpe would need to be on the CML, which means Rf+1.5×MRP return with σ such that Sharpe equals market's. But since it's an individual stock, it likely has unsystematic risk, making its total σ higher relative to return. This implies negative alpha — it's plotting below the SML for its systematic risk. D is the most defensible answer.
Question 1041
The Capital Market Line and the Security Market Line have the same y-intercept. This intercept equals:
Select an option first.
Correct answer: C — The risk-free rate
Explanation: Both the CML and SML start at the risk-free rate on the y-axis (when standard deviation = 0 for CML, and when β = 0 for SML). The y-intercept = Rf. A, B, D are wrong.
Question 1042
Which of the following would cause the Security Market Line to become flatter?
Select an option first.
Correct answer: B — A decrease in the market risk premium
Explanation: The SML slope = market risk premium = (Rm−Rf). If this decreases (investors require less compensation for market risk, or Rm falls), the SML becomes flatter. A shifts the SML up but changes the slope only if Rm moves by less. C steepens (demands more return for risk). D increases required return.
Question 1043
A portfolio has M² = 11% and the market return = 10%. The portfolio's risk-adjusted performance:
Select an option first.
Correct answer: C — Outperformed the market by 1% on a risk-adjusted basis
Explanation: M² > market return indicates risk-adjusted outperformance. At the same risk level as the market, the portfolio would have earned 11% vs. market 10% — a 1% advantage. A is wrong. B reverses. D is wrong.
Question 1044
Two stocks have the same expected return but different betas (β1=0.8, β2=1.2). Under CAPM, this means:
Select an option first.
Correct answer: C — Stock 1 is underpriced (positive alpha) since it offers the same return with lower systematic risk
Explanation: Under CAPM, the stock with lower beta should have a lower required return. If both stocks have the same actual return but β1 < β2, then Stock 1 is earning more than its CAPM required return (positive alpha) — it is undervalued. Stock 2 earns less than its CAPM required return (negative alpha). C is correct.
Question 1045
Jensen's alpha for a market index fund tracking its benchmark perfectly is:
Select an option first.
Correct answer: C — Zero (before fees)
Explanation: An index fund with β=1 that tracks perfectly earns exactly the market return. CAPM: E(Rm) = Rf + 1×(Rm−Rf) = Rm. Actual return = Rm. Alpha = Rm − Rm = 0. Before fees, alpha = 0. After fees, alpha = −fees. A, B, D are wrong.
Question 1046
Which of the following correctly describes the relationship between Jensen's alpha and the security market line?
Select an option first.
Correct answer: A — Alpha is the distance above or below the security market line
Explanation: On a beta vs. return plot (SML), alpha is the vertical distance from the SML. Above = positive alpha (undervalued). Below = negative alpha (overvalued). B is wrong — y-intercept is Rf. C would mean all securities are correctly priced. D is wrong.
Question 1047
A manager with a positive alpha may still be inferior to the market if:
Select an option first.
Correct answer: C — The alpha was achieved with extremely high total risk, resulting in a lower Sharpe ratio than the market
Explanation: Positive alpha means outperformance for its beta level. But if the manager took enormous total risk (high σ) to achieve it, the Sharpe ratio (return/total risk) could be below the market's. Overall risk-adjusted performance could still be inferior. A contradicts this. B is one scenario. D alone doesn't indicate inferior performance.
Question 1048
A manager earned a return of 14%. The benchmark returned 11%. The tracking error (standard deviation of active returns) over the period was 5%. The information ratio is:
Select an option first.
Correct answer: A — 0.60
Explanation: Information ratio = (14−11)/5 = 3/5 = 0.60. B would need active return=1.4%. C would need active return=2%. D would need TE=2.14%.
Question 1049
Which of the following correctly states the formula for the Capital Asset Pricing Model?
Select an option first.
Correct answer: B — E(Ri) = Rf + βi × [E(Rm) − Rf]
Explanation: CAPM: E(Ri) = Rf + βi[E(Rm)−Rf]. The asset's required return = risk-free rate + beta × market risk premium. A, C, D are incorrect formulas.
Question 1050
Under CAPM, a portfolio manager who achieves positive alpha has:
Select an option first.
Correct answer: B — Earned return above what is explained by the portfolio's beta exposure alone
Explanation: Alpha = actual return − CAPM expected return. Positive alpha means the manager earned more than beta alone would predict — through superior security selection or timing. A is market timing. C reduces β, not creates alpha. D is risk management.
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