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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 91
RESTRUCTURING AND DISTRESSED DEBT investing involves buying securities of companies:
Select an option first.
Correct answer: B — Prior to or during an expected bankruptcy filing, aiming to release value through restructuring or asset liquidation
Explanation: B is correct. The reading defines restructuring and distressed debt investing as: 'Investing prior to or during an expected bankruptcy filing. The goal is to release value through restructuring the distressed company or through the company having sufficient assets in liquidation to generate appropriate returns.' These investors analyze whether the distressed company's assets are worth more than the market price of its debt implies, betting that either a successful restructuring or liquidation will recover value.
Question 92
LOOK-AHEAD BIAS in backtesting is DIFFERENT from survivorship bias in that look-ahead bias:
Select an option first.
Correct answer: B — Uses information not available at the time of the supposed trade, rather than excluding failed companies from the data
Explanation: B is correct. Survivorship bias excludes failed companies (making the database incomplete). Look-ahead bias uses correct but unavailable information (like annual earnings released in March to generate January trades). Both inflate backtest returns, but through different mechanisms. Look-ahead bias is about timing of information availability, while survivorship bias is about complete exclusion of certain companies. Both are common pitfalls in quantitative backtesting.
Question 93
DATA MINING / OVERFITTING in quantitative strategy development occurs when:
Select an option first.
Correct answer: B — Excessive testing of historical data to find patterns that appear to work without rigorous statistical validation
Explanation: B is correct. The reading defines data mining/overfitting as: 'Excessive search analysis of past financial data to find data that shows a strategy working. This should not be construed as proof that the strategy works because data was mined until data was found that suggested the strategy worked.' Testing enough combinations of factors, parameters, and time periods will eventually find one that 'works' historically by chance. Without out-of-sample testing, these spurious patterns are likely to fail in live trading.
Question 94
Indicators that a quantitative strategy is OVERCROWDED might include:
Select an option first.
Correct answer: B — High correlation between short interest and price momentum, suggesting many managers hold the same short positions
Explanation: B is correct. The reading states: 'Indicators such as short interest and price momentum can be combined to estimate the potential overcrowding of markets. A high correlation between short interest (that is, number of declared short positions) and price momentum could indicate a short trade that could suddenly unwind aggressively.' When many quant managers are all short the same securities (evidenced by high short interest) and those securities have strong momentum, a reversal could force simultaneous covering, amplifying losses.
Question 95
Active return in an equity portfolio is BEST described as the return generated when a manager:
Select an option first.
Correct answer: B — Overweights securities that outperform the benchmark and underweights securities that underperform the benchmark
Explanation: B is correct. Active returns are driven by differences in weights between the active and benchmark portfolios: excess return will be positive if the manager overweights securities that outperform the benchmark and underweights securities that underperform. A manager who holds positive-return securities but weights them the same as the benchmark earns no active return.
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Question 96
Which is the THIRD source of active return, labelled 'luck' in the reading?
Select an option first.
Correct answer: C — Idiosyncratic risk from concentrated active positions that generates variable returns
Explanation: C is correct. The three sources are: (1) Strategic factor exposures (beta), (2) Alpha from tactical mispricings, and (3) Idiosyncratic risk from concentrated positions labeled luck because it is not due to market risk or value-added alpha. Concentrated positions expose the manager to company-specific events that generate positive or negative returns unrelated to skill or systematic risk.
Question 97
POSITION SIZING has its MOST DRAMATIC IMPACT on which source of active risk?
Select an option first.
Correct answer: B — Idiosyncratic risk, because concentrated positions maximize stock-specific exposure
Explanation: B is correct. The reading states position sizing will affect all three sources of active risk but the most dramatic impact will be on idiosyncratic risk. A concentrated position in a single stock creates maximum idiosyncratic exposure. The general rule is that smaller positions in a larger number of securities diversify away idiosyncratic risk. A factor-oriented manager spreading across many assets minimizes it; a stock-picker deliberately accepts it.
Question 98
BREADTH OF EXPERTISE in the fundamental law of active management is defined as:
Select an option first.
Correct answer: B — The number of independent investment decisions the manager makes per year
Explanation: B is correct. Breadth (BR) in the fundamental law E(RA) = IC x sqrt(BR) x sigma_A x TC is the number of independent investment decisions per year. More independent decisions lead to higher expected active return. A manager using a single factor with a single metric makes fewer truly independent decisions and has low breadth because all decisions are driven by the same dimension.
Question 99
A manager makes 10 independent decisions per month, has IC = 0.10, active risk = 5%, and TC = 0.50. The expected ANNUAL active return is closest to:
Select an option first.
Correct answer: C — 2.7%
Explanation: C is correct. Annual BR = 10 x 12 = 120. E(RA) = 0.10 x sqrt(120) x 0.05 x 0.50 = 0.10 x 10.954 x 0.025 = 0.02738 approximately 2.74%. The reading quiz confirms 2.7% as the answer. A uses only monthly breadth. D incorrectly omits the TC constraint.
Question 100
Which portfolio construction approach is MOST LIKELY to employ factor timing techniques?
Select an option first.
Correct answer: C — Discretionary top-down
Explanation: C is correct. The reading quiz confirms: factor timing techniques are difficult to use in a systematic rules-driven way and signals used to generate trading ideas are more often top-down versus bottom-up. Discretionary top-down managers form macro views on when value beats growth or when one sector outperforms another requiring judgment rather than systematic rules at the macro level.
Question 101
A HEURISTIC objective in portfolio construction would MOST LIKELY be expressed as:
Select an option first.
Correct answer: C — Overweight securities ranked in the top quartile by price-to-book ratio
Explanation: C is correct. A heuristic approach uses less scientific methods such as basing weighting on the ranking of securities by a specified characteristic, exactly what ranking by P/B and overweighting the top quartile represents. Options A and B are formal optimization objectives with precise mathematical constraints. D is a factor-maximization optimization objective, formal not heuristic.
Question 102
A DISCRETIONARY manager MOST LIKELY differs from a SYSTEMATIC manager in that the discretionary manager:
Select an option first.
Correct answer: A — Holds fewer positions with larger allocations and rebalances on judgment rather than a predetermined schedule
Explanation: A is correct. The reading contrasts the two: fundamental (discretionary) approaches use analyst judgment, tend to hold fewer larger positions with higher conviction, and rebalance based on opinion at any time. Quantitative (systematic) approaches use model-driven rules, spread bets across many smaller positions, and rebalance at preset intervals. Discretionary managers tend to hold concentrated portfolios and are less likely to use formal portfolio optimization.
Question 103
Active Share is defined as:
Select an option first.
Correct answer: B — Half the sum of the absolute differences between portfolio weights and benchmark weights
Explanation: B is correct. Active Share = half the sum of absolute(wi_portfolio - wi_benchmark). Because total overweighting must equal total underweighting, Active Share equals the total degree of overweighting. A value of 0 means the portfolio exactly matches the benchmark; a value of 1 means no overlap. (1 minus Active Share) is the percentage overlap between the portfolio and benchmark.
Question 104
A portfolio has Active Share of 0.35. The percentage of the portfolio that OVERLAPS with the benchmark is:
Select an option first.
Correct answer: B — 65%
Explanation: B is correct. (1 - Active Share) = percentage overlap = 1 - 0.35 = 0.65 = 65%. The reading confirms: if Active Share = 0.5, 50% of the portfolio is identical to the benchmark and 50% is not. Here 65% mirrors the benchmark and 35% differs.
Question 105
A manager substitutes a benchmark pharmaceutical holding with a SIMILAR non-benchmark pharmaceutical stock. This action will MOST LIKELY:
Select an option first.
Correct answer: B — Increase Active Share but NOT substantially increase active risk
Explanation: B is correct. The reading quiz confirms: by substituting a benchmark holding with a non-benchmark holding the manager will increase Active Share because Active Share measures overall differences in weights. But because the two pharmaceutical stocks are highly correlated, the portfolio will not behave markedly different from the benchmark, so active risk will not substantially increase.
Question 106
A portfolio manager can COMPLETELY CONTROL which measure?
Select an option first.
Correct answer: B — Active Share, because the manager fully controls the weights of each security
Explanation: B is correct. The reading explicitly states: A portfolio manager can completely control Active Share because they control the weights of the securities in the portfolio. However, a manager cannot completely control active risk because predicted active risk depends on estimations of correlations and variances that may be different from those actually realized.
Question 107
Active risk attributable to Active Share is INVERSELY PROPORTIONAL to:
Select an option first.
Correct answer: B — The number of securities held in the portfolio
Explanation: B is correct. The reading states: active risk attributable to Active Share is inversely proportional to the number of securities in the portfolio. As the portfolio holds more positions, the idiosyncratic risk of individual positions diversifies away, reducing active risk from stock-selection deviations. A concentrated 10-stock portfolio has far more idiosyncratic active risk per unit of Active Share than a 200-stock portfolio.
Question 108
A manager with HIGH Active Share but LOW active risk is MOST CONSISTENT with:
Select an option first.
Correct answer: D — A diversified manager holding many non-benchmark stocks that are highly correlated with the benchmark
Explanation: D is correct. Active Share is not affected by cross-correlation between securities, but active risk is. A manager who replaces many benchmark stocks with different but highly correlated non-benchmark stocks creates high Active Share (different holdings) but low active risk (the portfolio still behaves like the benchmark). This is distinct from a closet indexer who has both low Active Share AND low active risk.
Question 109
A CLOSET INDEXER is BEST identified by which combination of Active Share and active risk?
Select an option first.
Correct answer: B — Low Active Share and low active risk
Explanation: B is correct. Closet indexers have positions very similar to the benchmark (low Active Share) and returns that closely track the benchmark (low active risk), yet charge active management fees. The reading notes Active Share is used to assess the fees paid per unit of active management, so a fund with Active Share of 0.2 would be considered expensive versus one with Active Share of 0.5 charging the same fee.
Question 110
A SECTOR ROTATOR manager MOST LIKELY requires which type of portfolio constraint?
Select an option first.
Correct answer: B — Large permitted deviations in sector weights
Explanation: B is correct. The reading states: a sector rotator would need to have large permitted deviations in sector weights, while a stock picker would need to have large permitted deviations in individual security weights. A diversified multi-factor investor would not need such large deviations from index weights but would still need some flexibility for moderate active risk and return.
Question 111
If two portfolios have SIMILAR factor exposures, similar active risk, similar costs, but DIFFERENT Active Shares, which portfolio is PREFERRED?
Select an option first.
Correct answer: B — The higher Active Share portfolio, because it leverages the manager alpha skill more fully
Explanation: B is correct. The reading states: if two portfolios have similar active and absolute risks, similar costs, similar manager alpha skills, then the portfolio with the highest Active Share is preferable because this will leverage the alpha skill of the manager and have higher expected return. Higher Active Share means more of the portfolio is differentiated from the benchmark so more alpha is applied.
Question 112
The contribution to portfolio variance of Asset A (wA=20%, wB=30%, wC=50%, Cov(A,A)=0.050, Cov(A,B)=0.0067, Cov(A,C)=0.0013) is:
Select an option first.
Correct answer: B — 0.00253
Explanation: B is correct. CVA = wA x (wA x CovAA + wB x CovAB + wC x CovAC) = 0.20 x [(0.20 x 0.050) + (0.30 x 0.0067) + (0.50 x 0.0013)] = 0.20 x [0.0100 + 0.00201 + 0.00065] = 0.20 x 0.01266 = 0.002532 approximately 0.00253. This matches the reading example exactly.
Question 113
Given CV_A = 0.002532, CV_B = 0.001998, CV_C = 0.002880, the RELATIVE CONTRIBUTION of Asset A to total portfolio variance is:
Select an option first.
Correct answer: A — 34%
Explanation: A is correct. Total portfolio variance = 0.002532 + 0.001998 + 0.002880 = 0.007410. Relative contribution of A = 0.002532 / 0.007410 = 34.1% approximately 34%. This matches the reading example exactly.
Question 114
The CONTRIBUTION TO PORTFOLIO VARIANCE of a geographical country allocation is BEST calculated as:
Select an option first.
Correct answer: C — The country weight multiplied by the covariance of the country returns with the portfolio returns
Explanation: C is correct. The quiz confirms: analogous to the contribution to total variance of a single asset, the contribution to portfolio variance of a geography can be calculated as its weight in the portfolio multiplied by the covariance of the country with the portfolio. This applies the same CV formula at the country/sector/factor level.
Question 115
A manager with market factor coefficient 0.892 and size factor coefficient -0.283 uses a two-factor model. Var(market)=0.00178 and Cov(market,size)=0.00042. The variance attributed to the MARKET FACTOR is:
Select an option first.
Correct answer: B — 0.00131
Explanation: B is correct. CV_market = 0.892 x (0.892 x 0.00178 + (-0.283) x 0.00042) = 0.892 x (0.001588 - 0.000119) = 0.892 x 0.001469 = 0.001310 approximately 0.00131. Total portfolio variance = 0.0374 squared = 0.001399. Proportion explained by market = 0.00131/0.001399 = 93.7%.
Question 116
Given CV_market = 0.00131, CV_size = -0.00007, and total portfolio variance = 0.001399, the UNEXPLAINED proportion of total variance is:
Select an option first.
Correct answer: C — 11.4%
Explanation: C is correct. Total explained by factors = 0.00131 + (-0.00007) = 0.00124. Unexplained = 0.001399 - 0.00124 = 0.00016. Proportion unexplained = 0.00016 / 0.001399 = 11.4%. Note the proportions sum to more than 100% because the size factor makes a negative contribution to total portfolio variance.
Question 117
FORMAL RISK CONSTRAINTS differ from HEURISTIC constraints in that formal constraints:
Select an option first.
Correct answer: B — Introduce estimation error which is magnified by leverage and concentrated positions
Explanation: B is correct. The reading states: formal risk constraints require forecasts of return distributions which introduces estimation error. This estimation error can be magnified by leverage and the idiosyncratic risk of concentrated positions. Concentrated portfolios with few positions have higher estimation errors because each position specific risk contributes significantly, making distributional assumptions less reliable.
Question 118
CONDITIONAL VaR (CVaR) is MOST ACCURATELY described as:
Select an option first.
Correct answer: B — The expected loss given that the VaR threshold has already been exceeded
Explanation: B is correct. CVaR, also called expected tail loss or expected shortfall, is the expected loss given VaR has been exceeded. If the 1% daily VaR is 5 million, CVaR answers: when we have losses in the worst 1% of days, what is the average loss? CVaR is always greater than or equal to VaR. Incremental VaR is the change from adding a new position. Marginal VaR is the impact of a small change in position size.
Question 119
A benchmark-agnostic equity manager with an ABSOLUTE RETURN philosophy is MOST LIKELY to monitor:
Select an option first.
Correct answer: C — Portfolio drawdown and absolute volatility
Explanation: C is correct. The reading states: a benchmark-agnostic manager with an absolute return philosophy is less likely to be concerned with statistical measures such as active risk and more concerned with more practical measures such as portfolio drawdown. Because they target absolute returns, measures like tracking error and Active Share defined relative to a benchmark are irrelevant. Maximum drawdown and absolute standard deviation measure what matters: protecting absolute capital.
Question 120
IMPLEMENTATION CONSTRAINTS that limit short positions or leverage cause which effect on the information ratio as active risk INCREASES?
Select an option first.
Correct answer: B — The information ratio degrades because extra costs from circumventing constraints weigh on active returns
Explanation: B is correct. The reading states: constraints on short positions or leverage may limit the ability to under/overweight. Liquidity issues may increase costs as a manager increases active risk, which leads to a degradation of the information ratio as the extra costs weigh on active returns. As the manager pushes beyond comfortable constraints, frictional costs eat into active returns faster than active risk grows.
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