You’re on a roll
Create a free account to save your CFA progress, track your accuracy by topic, and pick up right where you left off.
Free Questions › CFA › Specialized Pathway - Portfolio Management
Free CFA Specialized Pathway - Portfolio Management Practice Questions & Answers
250 exam-style Specialized Pathway - 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 61
An activist investor typically acquires what SIZE of initial stake in a target company?
Select an option first.
Correct answer: C — A significant but minority stake (typically less than 10% of voting rights)
Explanation: C is correct. The reading states: 'Buying an initial stake in the target company (typically less than 10% of voting rights).' The quiz confirms: 'Activist investors do not take controlling majority stakes (greater than 50%) in companies they invest in. They usually take a significant but minority position of less than 10% and look to garner support from other shareholders in a proxy contest to enforce the value-enhancing changes they want to occur.' Taking a majority stake (A) would require a takeover premium. The small stake allows activists to then build coalitions.
Question 62
Which of the following is a DEFENSIVE MEASURE used by company management to resist an activist investor's proposed changes?
Select an option first.
Correct answer: B — A poison pill clause allowing existing shareholders to purchase more shares at a discount, diluting the activist's stake
Explanation: B is correct. The reading explicitly lists poison pill clauses as management defenses: they 'allow existing shareholders to purchase more shares in the target company at a discount, diluting the stake of the activist.' Other defenses include multi-class share structures (granting founders multiple votes) and staggered board provisions (partial board re-election each year). A (launching a media campaign) is actually a tactic used BY activists, not management. C (buying back at a premium) is not listed. D is not a defensive measure.
Question 63
Empirical research on activist investing shows which of the following outcomes?
Select an option first.
Correct answer: B — Activism leads to improvements in growth, profitability, and corporate governance but also results in higher debt levels
Explanation: B is correct. The reading states: 'Studies show that activism does lead to improvements in growth, profitability, and corporate governance; however, it also leads to higher debt levels.' On performance, 'the added performance of activist funds has been modest with hedge fund data showing Sharpe ratios slightly above the broad stock market.' Stock price outperformance is strongest on the announcement day with only modest continuation. A is wrong — profitability improves. C is wrong — Sharpe ratios are only slightly above the market.
Question 64
Target companies in activist investing campaigns MOST LIKELY feature:
Select an option first.
Correct answer: B — Slower earnings and revenue growth, negative share price momentum, and weak corporate governance
Explanation: B is correct. The reading states: 'Target companies tend to feature slower earnings and revenue growth than the market, negative share price momentum, and weak corporate governance. This poor track record is evidence that changes need to be made and makes it more likely the activist will garner support from other disgruntled shareholders in a proxy contest.' Companies with poor performance and governance are more vulnerable to activism because other shareholders are already dissatisfied and likely to support change.
Question 65
Pairs trading profits from which market behavior?
Select an option first.
Correct answer: B — Mean reversion in the price ratio of two historically correlated securities after a temporary divergence
Explanation: B is correct. The reading describes pairs trading as a strategy that 'identifies two securities in the same industry that are historically highly correlated with each other and aims to profit from taking advantage of a temporary breakdown in this relationship. The strategy buys the underperforming security while shorting the outperforming securities. The strategy profits from mean reversion if the long (previous underperform) now outperforms.' The key assumption is that the divergence is TEMPORARY and prices will revert.
Get the full CFA question bank — free
Drop your email and we'll send you fresh CFA practice questions, fully worked solutions and exam-deadline reminders. No spam — unsubscribe in one click.
Want to save your score and take a full mock exam? Create a free account →
Question 66
In a SHARE-FOR-SHARE merger (1:1 exchange ratio), a risk arbitrage strategy would MOST LIKELY:
Select an option first.
Correct answer: C — Buy the target company's shares and short sell the acquirer's shares in proportion to the exchange ratio
Explanation: C is correct. The reading states: 'In a share-for-share transaction, the risk arb manager will simultaneously short sell the shares of the acquirer and purchase the shares of the target company in the same ratio as the proposed share exchange of the deal.' If the exchange ratio is 1:1, the manager buys 1 share of target for each 1 share of acquirer shorted. This locks in the spread between the current target price and the implied acquisition price, which is realized when the deal closes. B has the directions reversed.
Question 67
A pairs trading strategy generates a SELL SIGNAL when the log ratio of two stock prices is:
Select an option first.
Correct answer: B — More than two standard deviations ABOVE its moving average
Explanation: B is correct. The reading states: 'This spread is deemed to be high when it is more than two standard deviations above its moving average... The strategy would sell the spread when it is high, and buy the spread when it is low looking to profit from mean reversion.' When the spread is unusually high (the numerator stock is expensive relative to the denominator), the strategy sells the spread — shorting the outperformer and buying the underperformer, expecting mean reversion back to the normal ratio.
Question 68
Why would pairs trading be INAPPROPRIATE for Baron PLC (whose correlation with its sector peer has permanently broken down due to fundamental business changes)?
Select an option first.
Correct answer: B — The strategy relies on mean reversion, which is not appropriate when the correlation breakdown is fundamental and long-term rather than temporary
Explanation: B is correct. The reading notes: 'The breakdown in the historical correlation of Baron to its competitor appears to be based on fundamental changes in the management and strategy of Baron. It is not appropriate to assume mean reversion to the past relationship and mean reversion is the underlying assumption in a pairs trade.' Pairs trading only works when the divergence is temporary and mean reversion is expected. When a fundamental change drives the divergence (new management, restructuring), the historical relationship may not return, making mean reversion an invalid assumption.
Question 69
Market microstructure-based arbitrage strategies are MOST likely implemented using:
Select an option first.
Correct answer: B — High-frequency trading to capture mispricing opportunities lasting only milliseconds
Explanation: B is correct. The reading states: 'Market microstructure-based arbitrage strategies take advantage of mispricing opportunities occurring due to imbalances in supply and demand that are expected to only last for a few milliseconds. Investors with the tools to analyze the limit order book of an exchange, and the capability for high-frequency trading are in a position to capture such opportunities.' These are fleeting, microsecond opportunities requiring automated, high-speed execution. Fundamental analysis (A) operates on much longer time horizons. Pairs trading (C) and dividend capture (D) are different strategies.
Question 70
The GROWTH TRAP in active equity investing occurs when:
Select an option first.
Correct answer: B — Favorable future growth prospects are already fully or over-reflected in the stock price, so even above-average growth disappoints
Explanation: B is correct. The reading explains: 'A growth trap where the favorable future growth prospects are already reflected, or over-reflected, in the price. For example, the market price could reflect very aggressive growth of 15% and the price could decline if only above-average growth of 12% is realized. The trap is that growth stocks generally trade at a high P/E and even modest shortfalls in growth can lead to significant declines in P/E and stock price.' Even genuine growth companies can be bad investments if their growth is already priced in.
Question 71
SURVIVORSHIP BIAS in quantitative backtesting makes strategies appear MORE attractive than they are because:
Select an option first.
Correct answer: B — Back-tests exclude companies that failed, went bankrupt, or were delisted, thus excluding their poor returns from the historical sample
Explanation: B is correct. The reading defines survivorship bias: 'If back-tests are only applied to existing companies, then they will overlook companies that have failed in the past, and this will make the strategy look better than it actually is.' Companies that went bankrupt had very poor returns that are excluded from the backtesting database. A strategy that avoided these companies historically would look excellent — but this is spurious because the failures were not known in advance. The backtest database only contains survivors.
Question 72
LOOK-AHEAD BIAS in quantitative research occurs when:
Select an option first.
Correct answer: B — A model is tested using data that was not yet publicly available at the time the strategy would have been implemented
Explanation: B is correct. The reading defines look-ahead bias: 'Results from using information in the model to give trading signals at a time when the information was not available. An example would be using December financial accounting data to generate trading signals for the following January. It is likely that the accounting data was not known by the market until the company issued its financial accounts well into the year, and therefore was not actually available to act as a trading signal in January.' This inflates backtest performance by using information a real manager could not have had.
Question 73
QUANT OVERCROWDING poses a risk to quantitative strategies because:
Select an option first.
Correct answer: B — Many managers following similar strategies may simultaneously exit positions during poor performance, exaggerating losses and triggering margin calls
Explanation: B is correct. The reading states: 'Once a strategy becomes crowded, there is the risk that a period of poor performance could cause many managers [to] attempt to exit their positions at the same time. This rush for the exit could exaggerate losses and lead to margin calls from lenders forcing managers to further liquidate their positions at unfavorable prices.' The 2007 quant meltdown is cited as an example. Similar strategies create correlated crowded positions — when one unwinds, others must follow in a cascade.
Question 74
The SPEARMAN RANK IC is preferred over the Pearson IC when:
Select an option first.
Correct answer: C — There are outliers in the return data that would distort the Pearson correlation coefficient
Explanation: C is correct. The reading states: 'The Pearson IC of the raw data is sensitive to even a few outliers (extreme high or low historical return). The Spearman Rank IC addresses this issue and is often considered more robust (superior).' By ranking the factor scores and returns before calculating correlation, the Spearman approach reduces the influence of extreme outliers. The quiz confirms: 'a manager would use the Spearman Rank correlation coefficient when concerned about outliers in the data.' A is wrong — both measure predictive relationships. B would favor Pearson.
Question 75
A factor's INFORMATION COEFFICIENT (IC) is BEST described as:
Select an option first.
Correct answer: B — The correlation between the factor scores (exposures) and subsequent holding period returns across a cross-section of securities
Explanation: B is correct. The reading defines IC as follows: 'Assuming a linear relationship between the factor exposure and holding period return, IC is the correlation between the factor exposure and holding period return. This is called the Pearson IC.' Note that IC measures SUBSEQUENT returns (predictive), not contemporaneous returns. The reading also notes that 'A monthly value of even 5% to 6% is considered very strong.' A is a Sharpe-like ratio, not IC. C describes hit rate. D describes factor premium.
Question 76
In a long/short factor portfolio with equal weighting of three stocks each, if the top three (long) stocks have returns of 3.02%, 3.05%, and 5.20%, and the bottom three (short) have returns of 10.06%, -0.6%, and -0.5%, the factor portfolio return is closest to:
Select an option first.
Correct answer: C — 0.77%
Explanation: C is correct. Long portfolio return = (3.02% + 3.05% + 5.20%) / 3 = 11.27% / 3 = 3.76%. Short portfolio return = (10.06% - 0.6% - 0.5%) / 3 = 8.96% / 3 = 2.99%. Factor portfolio return = Long return - Short return = 3.76% - 2.99% = 0.77%. The long/short portfolio earns the long return and loses the short return. This matches the example in the reading exactly.
Question 77
The Morningstar Style Box classifies stocks along which TWO dimensions?
Select an option first.
Correct answer: B — Valuation (value/blend/growth) and size (small/mid/large)
Explanation: B is correct. The reading explains: 'In a style box, two factors—value and size—are each split into three groups.' The horizontal axis represents style (value, blend/core, or growth), and the vertical axis represents size (large, mid, small). The combination creates a 9-cell grid. Each cell represents a distinct style category (e.g., large-cap value, small-cap growth). A, C, and D are not the dimensions of the Morningstar Style Box.
Question 78
In returns-based style analysis, the regression coefficients on passive style indexes are constrained so that they:
Select an option first.
Correct answer: B — Sum to 1 so they can be interpreted as the manager's style allocation
Explanation: B is correct. The reading states: 'By imposing a constraint on the regression that the sum of the slope coefficients should sum to a value of 1, the slope coefficients can be interpreted as the manager's allocation to that style during the period.' This constraint transforms the regression into a style exposure analysis, where each coefficient represents the fraction of the portfolio attributable to each style index. In the reading's example, b3=0.15 and b4=0.85 sum to 1.0, confirming 100% allocation across styles.
Question 79
Holdings-based style analysis has which ADVANTAGE over returns-based style analysis?
Select an option first.
Correct answer: C — It pinpoints the current, up-to-date style exposure of the fund at a specific point in time
Explanation: C is correct. The reading states: 'A holdings-based analysis pinpoints the current exposure of a fund. This is an advantage if the analyst wishes to know the most up-to-date positioning of a manager.' Returns-based analysis uses historical returns and captures average exposure over time. If an analyst wants to know exactly where the manager is positioned today, holdings-based analysis is superior. A describes the advantage of returns-based. B is the opposite — holdings-based is HURT by derivatives overlays (the quiz confirms this).
Question 80
A derivatives overlay strategy used by a manager to remove country exposure would MOST LIKELY HINDER which type of style analysis?
Select an option first.
Correct answer: A — Holdings-based analysis only, because the derivatives are not reflected in stock holdings
Explanation: A is correct. The reading confirms (quiz answer): 'A manager performing holdings-based analysis may come to erroneous conclusions about manager style if they do not have details regarding derivatives overlay strategies used to change the exposure of the fund. This is less likely to be a problem for returns-based analysis because the regression of historical returns carried out under this method will likely pick up the impact of any derivatives overlay strategies being used by the manager.' Derivatives show up in returns but may not be reflected in stock holdings disclosed to analysts.
Question 81
A stock with a value score of 60 and a growth score of 30 (using the Morningstar approach where scores range from 0-100) would have a net style score of:
Select an option first.
Correct answer: C — -30 (value classification)
Explanation: C is correct. In the Morningstar approach, the net style score = value score - growth score = 60 - 30 = 30... Wait — the reading says 'the difference can be taken as a net style score.' If value score = 60 and growth score = 30, net style score = 60 - 30 = 30. But the reading says 'If the net style score is strongly NEGATIVE, the stock is classified as value.' This means net style score = growth score - value score. So net = 30 - 60 = -30, which is negative, classifying the stock as value. C is correct.
Question 82
HIGH-QUALITY VALUE investing (the Warren Buffett approach) emphasizes:
Select an option first.
Correct answer: B — Equal emphasis on intrinsic value AND evidence of financial strength, high-quality management, and demonstrated profitability
Explanation: B is correct. The reading defines high-quality value as: 'Equal emphasis is placed on both intrinsic value and evidence of financial strength, high quality management, and demonstrated profitability (the Warren Buffett approach).' Unlike pure value investing (which focuses only on cheap prices), high-quality value requires the business to be fundamentally strong. This avoids value traps — cheap stocks that are cheap because their businesses are deteriorating.
Question 83
INCOME INVESTING as a value sub-style focuses primarily on:
Select an option first.
Correct answer: B — High dividend yields and positive dividend growth rates
Explanation: B is correct. The reading defines income investing as: 'Focus is on high dividend yields and positive dividend growth rates.' Income investors seek steady current income from dividends, prioritizing companies with established track records of paying and growing dividends. This is distinct from deep value (focused on assets), relative value (focused on multiples vs. peers), and contrarian (focused on depressed sentiment).
Question 84
The CONTRARIAN VALUE strategy would MOST LIKELY invest in:
Select an option first.
Correct answer: B — Depressed cyclical stocks with currently low or negative earnings, against prevailing market pessimism
Explanation: B is correct. The reading defines contrarian investing as 'Purchasing or selling securities against prevailing market sentiment. For instance, buying the securities of depressed cyclical stocks with low or negative earnings.' Contrarians buy when others are selling and sell when others are buying. Cyclical companies with negative earnings during a downturn may represent value opportunities if the cycle eventually turns — the contrarian bets against the prevailing pessimism.
Question 85
The investment process STEP that involves analyzing a company's competitive position and financial reports comes AFTER which preceding step?
Select an option first.
Correct answer: B — Prescreening the investment universe
Explanation: B is correct. The fundamental investment process: (1) Define universe, (2) PRESCREEN the universe → (3) ANALYZE industry, competitive position, and financial reports → (4) Forecast performance → (5) Convert forecasts to valuations → (6) Construct portfolio → (7) Rebalance. Deep company analysis (Step 3) logically follows prescreening (Step 2) which reduces the universe to a manageable set. Without prescreening, analyzing all companies would be impractical.
Question 86
CONFIRMATION BIAS as a behavioral pitfall in fundamental investing means:
Select an option first.
Correct answer: B — The manager seeks information that confirms their existing view and ignores contradictory evidence
Explanation: B is correct. Confirmation bias is listed as a behavioral bias in fundamental investing that involves seeking information that confirms existing beliefs while discounting contradictory evidence. For example, a manager bullish on a stock may read positive analyst reports but dismiss negative news as noise. This can cause managers to hold losing positions too long (the contradictory evidence of declining fundamentals is ignored) or maintain overconfidence in their analysis.
Question 87
A portfolio manager who uses FACTOR TIMING believes:
Select an option first.
Correct answer: B — Different factors perform differently in different market conditions and the manager can identify when to rotate between factors
Explanation: B is correct. Factor timing is a subcategory of factor investing: 'A common subcategory of factor investing is equity style rotation, where the manager believes that different factors work well at different times. These strategies allocate to portfolios that represent factor exposures when that particular style is expected to outperform.' For example, rotating from value to quality factors ahead of a recession, or from defensive to cyclical factors before an economic expansion.
Question 88
The Morningstar Style Box classifies a stock with a NET STYLE SCORE of STRONGLY NEGATIVE as:
Select an option first.
Correct answer: C — Value
Explanation: C is correct. The reading states: 'Once a security has both a value score and a growth score, the difference can be taken as a net style score. If the net style score is strongly negative, the stock is classified as value.' Net style score = growth score − value score. A strongly negative net style score means the value score is much higher than the growth score — indicating strong value characteristics (high dividend yield, low P/E vs. peers). Strongly positive = growth. Near zero = core/blend.
Question 89
The KEY DIFFERENCE between event-driven strategies and activist strategies is:
Select an option first.
Correct answer: B — Event-driven managers exploit mispricings around existing corporate events; activist managers create or influence events themselves
Explanation: B is correct. The reading states: 'These events look a lot like the changes that activists may push for. The key difference here is that the event-driven manager simply tries to find pricing anomalies due to the event—the manager does not engage in activism to bring the event about.' An event-driven manager reacts to announced mergers or restructurings. An activist manager takes a stake in a company and pushes for changes — the event is partly of the activist's own making.
Question 90
RETURNS-BASED style analysis is most useful for assessing a manager's:
Select an option first.
Correct answer: B — Average style exposure over a historical period through regression on style indexes
Explanation: B is correct. The reading states: 'Returns-based style analysis aims to identify the style of a fund through regression of the fund's returns against a set of passive style indices.' The slope coefficients represent the manager's average allocation to each style over the regression period. 'A returns-based style analysis based on historical returns would capture this average exposure automatically through regressing historical returns.' Holdings-based analysis shows CURRENT positioning.
More free CFA topics
Economics2,066
Quantitative Methods1,213
Portfolio Management1,079
Fixed Income908
Financial Statement Analysis904
Corporate Issuers884
Portfolio Construction605
Alternative Investments540
Specialized Pathway - Private Markets500
Asset Allocation499
Derivatives498
Equity390
Performance Measurement295
Derivatives and Risk Management131
Ten questions in
- The ones you miss are saved as a drill you can repeat
- Your place is kept, on this device and any other
- A streak, if that is the thing that gets you back tomorrow
Every question on this page stays free and open either way.