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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 151
For a pension plan with BPV gap = $450,000 and swap BPV per 100 NP = 0.2571, the notional principal for a 50% HEDGE RATIO RECEIVE-FIXED SWAP is:
Select an option first.
Correct answer: B — $87.5 million
Explanation: B is correct. NP = (BPV gap x hedge ratio) / (BPV per 100 NP / 100) = (450,000 x 0.50) / (0.2571 / 100) = 225,000 / 0.002571 = $87,515,000 approximately $87.5 million. The reading confirms: (450,000 x 0.50) / (0.2571 / 100) = 87.515 million notional principal of a receive-fixed swap. The manager receives fixed to increase asset BPV because BPVA < BPVL.
Question 152
To reduce the hedge from 50% to 35% (adjust by 15%), the manager BUYS a payer swaption with NP approximately $26.25M. At 55 basis points premium, the initial cost is:
Select an option first.
Correct answer: A — $144,375
Explanation: A is correct. NP for 15% adjustment: (450,000 x 0.15) / (0.2571/100) = 67,500 / 0.002571 = $26,254,000. Premium cost = $26.254M x 0.0055 = $144,397 approximately $144,375. To reduce the receive-fixed hedge, the manager buys a payer swaption giving the right to enter a pay-fixed swap offsetting the receive-fixed position. The reading confirms both figures.
Question 153
A RECEIVER SWAPTION gives the plan the right to enter a receive-fixed swap. This swaption has value when:
Select an option first.
Correct answer: B — New swap fixed rates fall below the swaption strike rate, making the right to receive above-market rates valuable
Explanation: B is correct. The reading states: if the new SFR declines, this right to receive a now above-market SFR has positive value and effectively increases the BPV of the assets. When market SFRs fall below the swaption strike, the receiver swaption allows the plan to receive a higher-than-market fixed rate. If SFRs rise above the strike, the receive-fixed right has no value and the swaption expires worthless.
Question 154
A SWAPTION COLLAR involves buying a receiver swaption and selling a payer swaption. The primary reason for SELLING the payer swaption is:
Select an option first.
Correct answer: B — To reduce the upfront premium cost of the receiver swaption
Explanation: B is correct. The reading states: to reduce the initial premium cost outlay, the manager sells a payer swaption. The sold payer swaption generates premium income that offsets the cost of buying the receiver swaption. The trade-off is that selling the payer swaption limits upside if rates rise significantly because the payer swaption buyer will exercise against the plan, forcing the plan to pay a now below-market fixed rate.
Question 155
The RECEIVE-FIXED SWAP strategy is OPTIMAL versus the receiver swaption and collar when the manager expects new SFRs to be:
Select an option first.
Correct answer: C — At or below the swap SFR of 2.5%
Explanation: C is correct. The reading states: the receive 2.5% SFR swap is optimal if the manager expects the new SFR will be at or below 2.5%. When rates fall below 2.5%, the receive-fixed swap generates maximum benefit: the plan receives 2.5% when market rates are lower. The receiver swaption (right to receive only 2.3%) is suboptimal. The collar is suboptimal because the received rate of 2.3% is lower than 2.5%.
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Question 156
SPREAD RISK in liability-driven investing arises when:
Select an option first.
Correct answer: B — The portfolio yield and liability discount rate reflect different risk levels and may shift in unexpected non-parallel ways
Explanation: B is correct. The reading defines spread risk as arising when portfolio yield and liability discount rate may differ, reflecting different risk levels. This creates spread risk: the risk the asset and liability discount rates and their PVs may shift in unexpected ways. For example, the liability discount rate may reflect corporate debt rates and assets government bond rates. If the spread between corporate and Treasury rates changes, asset and liability values drift apart even if overall rate levels are stable.
Question 157
MEASUREMENT ERROR in LDI occurs when a manager uses which approach?
Select an option first.
Correct answer: B — Simple weighted averages of individual bond YTMs and durations instead of portfolio-level statistics
Explanation: B is correct. The reading warns: measurement error occurs when weighted average characteristics of the portfolio assets and liabilities are used instead of portfolio statistics based on portfolio cash flows and yield (IRR). In an upward-sloping yield curve, the portfolio IRR based on aggregate cash flows will be higher than the simple average YTM. Using the simpler average introduces systematic underestimation of duration and IRR.
Question 158
Requiring COLLATERAL for OTC derivatives reduces counterparty risk but INTRODUCES which new risk?
Select an option first.
Correct answer: B — Cash flow risk: counterparties must post cash or securities in response to market movements
Explanation: B is correct. The reading states: the move toward requiring collateral reduces the counterparty risk, but creates cash flow risk. Counterparties must be prepared to meet the demands to post cash or other collateral. Daily margining of OTC derivatives means that unrealized losses must be funded with cash, creating significant cash flow demands during periods when rates move adversely.
Question 159
MODEL RISK in DB pension fund LDI strategies arises primarily because:
Select an option first.
Correct answer: B — Multiple actuarial and financial assumptions are required to estimate uncertain future liability amounts, timing, and duration
Explanation: B is correct. The reading states: model risk can be significant in some cases. DB pension liabilities require actuarial estimates of future wage growth, years of service, mortality rates, and discount rates. Each assumption introduces potential error. If the estimated effective duration of liabilities is wrong, the hedge ratio will be wrong, potentially leaving the plan significantly mishedged.
Question 160
Bond index replication is MORE DIFFICULT than equity index replication primarily because:
Select an option first.
Correct answer: C — Bond markets are OTC with limited price transparency, most bonds trade infrequently, and issue characteristics are highly diverse
Explanation: C is correct. The reading lists multiple challenges: fixed-income markets are much larger, bond issues are outstanding in much greater numbers with highly varying characteristics, most bond trading is done OTC through dealers, and most individual bond issues do not trade in any given year requiring matrix pricing. This makes full replication impractical and price discovery difficult.
Question 161
MATRIX PRICING (evaluated pricing) for non-traded bonds works by:
Select an option first.
Correct answer: B — Using the traded prices of similar bonds to calculate a YTM, then applying that YTM to price the non-traded bond
Explanation: B is correct. The reading states: bond pricing for nontrade securities is based on matrix or evaluated pricing. The price of similar traded bonds is captured and used to calculate YTM. That YTM is then used to infer the price of nontraded bonds. The more unusual the features of a bond, the more difficult it is to find an appropriate traded bond to use as the basis of such pricing.
Question 162
MATCHING KEY RATE DURATIONS rather than just modified duration in bond indexing reduces which specific type of tracking error?
Select an option first.
Correct answer: B — Tracking error from nonparallel changes in the yield curve such as twists and reshaping
Explanation: B is correct. The quiz confirms: matching key rate durations minimizes tracking error due to nonparallel twists in the yield curve. Matching modified duration minimizes tracking error due to parallel shifts only. Key rate durations measure sensitivity at specific maturity points ensuring the portfolio responds similarly to the index when the yield curve steepens, flattens, or twists.
Question 163
ENHANCED INDEXING differs from PURE INDEXING in that enhanced indexing:
Select an option first.
Correct answer: B — Matches primary risk factor exposures but does not hold all index securities, avoiding the most costly transactions
Explanation: B is correct. The reading states: enhanced indexing matches all the primary risk exposures of the index but not all the holdings. The goal is more efficient tracking of the index by avoiding some of the overly costly transactions required for pure indexing. Enhanced indexing matches duration, key rate durations, sector weights, and quality ratings without holding every single bond, achieving low tracking error at lower transaction cost.
Question 164
STRATIFIED SAMPLING (cell matching) for bond index replication requires the manager to:
Select an option first.
Correct answer: B — Divide the index into cells by characteristics and match the index allocation to each cell without necessarily holding identical bonds
Explanation: B is correct. The reading explains: the manager first determines the most significant characteristics to match such as duration and sector groupings. For each cell, the manager holds approximately the same allocation as the index using bonds with those characteristics but need not hold the same specific bonds as the index. This reduces costs while maintaining the primary risk exposures.
Question 165
A TOTAL RETURN SWAP receiving the bond index return in exchange for paying MRR plus spread is EQUIVALENT to:
Select an option first.
Correct answer: B — Buying the index and borrowing the purchase price at MRR plus spread, a leveraged index exposure
Explanation: B is correct. The reading states: TRS are equivalent to buying the index and borrowing the funds needed for purchase at MRR plus spread. If the index return is positive, the receiver profits; if negative, the receiver pays. The receiver net position replicates owning the index with borrowed funds. The counterparty credit risk means the receiver does not own the underlying bonds directly.
Question 166
ESG restrictions can be incorporated into CELL MATCHING for bond indexing by:
Select an option first.
Correct answer: B — Matching cell weights while prohibiting bonds of excluded industries and favoring bonds of desired industries within each cell
Explanation: B is correct. The reading states: cell matching can incorporate ESG restrictions. ESG may prohibit or explicitly require securities with specific characteristics. For example, bonds of high carbon emission industries are prohibited and bonds of clean energy industries are desired. The manager will seek to satisfy both while still matching cell weights, finding substitute bonds within each cell that satisfy ESG criteria.
Question 167
A CREDIT BARBELL benchmark strategy combines:
Select an option first.
Correct answer: B — Longer-term Treasuries for duration exposure and shorter-term investment-grade corporates for additional spread return
Explanation: B is correct. The reading describes the credit barbell: longer-term Treasuries with no credit or spread risk are used to give the portfolio the desired duration exposure. Shorter-term corporate securities are used to add additional spread return. Those shorter-term securities will be less vulnerable to relative price underperformance if spreads widen. This smart-beta approach separates duration exposure from credit spread income.
Question 168
For a STATIC bond portfolio used as a benchmark, duration will change over time because:
Select an option first.
Correct answer: B — The bonds age causing their remaining maturity and duration to shorten over time
Explanation: B is correct. The reading confirms: in a static (no changes) bond portfolio, duration will decline as the bonds age. As bonds approach maturity, both their remaining term and duration shorten. A 10-year bond becomes a 9-year bond after one year, then 8-year, etc. This duration drift means a static bond benchmark becomes progressively shorter-duration over time, potentially no longer matching the investor desired exposure.
Question 169
MATCHING THE PRESENT VALUE DISTRIBUTION OF CASH FLOWS in a bond portfolio simultaneously achieves:
Select an option first.
Correct answer: B — Matching duration contributions (key rate durations), total effective duration, and convexity all at once
Explanation: B is correct. The reading states: matching the PV weight of portfolio to the PV weight of the index will also match the duration contributions. This matching of present value distribution of cash flows is also matching the duration contributions and key rate durations. These actions minimize exposure risk from changes in shape of the yield curve and also match total duration and convexity simultaneously.
Question 170
OPEN-ENDED BOND INDEX MUTUAL FUNDS differ from ETFs in that open-ended funds:
Select an option first.
Correct answer: B — Can be redeemed or purchased at NAV only once per day and investors interact directly with the fund
Explanation: B is correct. The reading distinguishes: open-end mutual funds can be redeemed or purchased at NAV once per day. ETFs trade continuously on exchanges and investors can buy or sell continuously rather than once per day. The typical investor cannot purchase or redeem shares directly with the ETF fund; only authorized participants can do in-kind creation/redemption. The in-kind ETF mechanism is more tax-efficient but less available to typical investors.
Question 171
The THREE primary sources of yield curve change are, in order of importance for explaining bond price changes:
Select an option first.
Correct answer: B — Level (parallel shift), slope (twist), and curvature (butterfly)
Explanation: B is correct. The reading states: 'It is helpful to view yield curve changes as resulting from three sources: (1) Level - a parallel shift where all yields shift up or down by the same amount, (2) Slope - where the curve becomes flatter or steeper (a twist), (3) Curvature - where the curve becomes more or less curved (a butterfly movement).' The reading also clarifies that 'by far the most important yield curve change in explaining changes in bond prices is a parallel shift in rates.'
Question 172
The BUTTERFLY SPREAD is calculated as:
Select an option first.
Correct answer: B — (2 x medium-term yield) minus short-term yield minus long-term yield
Explanation: B is correct. The reading states: 'The curvature of the yield curve is measured through the butterfly spread: -short-term yield + (2 x medium-term yield) - long-term yield.' Equivalently this equals (2 x medium-term yield) minus short-term yield minus long-term yield. If the butterfly spread is increasing, medium-term yields are rising relative to short-term and long-term yields and curvature is increasing. An increase in curvature is called a negative butterfly twist.
Question 173
Under the five-step return decomposition, the ROLLDOWN RETURN is defined as:
Select an option first.
Correct answer: C — The projected bond price assuming no yield curve change minus beginning price, divided by beginning price
Explanation: C is correct. The reading defines: 'Rolldown return = (projected bond price assuming no yield curve change - beginning BP) / beginning BP.' This captures the price appreciation (or depreciation) that occurs simply because the bond moves to a shorter maturity along an upward-sloping yield curve, where shorter maturities have lower yields. It differs from the price change due to yield predictions in Step 3 which uses -MD x DeltaY + 0.5 x C x DeltaY squared.
Question 174
A BARBELL portfolio and a BULLET portfolio have the same modified duration. Under a PARALLEL shift UP of 50 bps, the barbell will:
Select an option first.
Correct answer: C — Outperform the bullet due to its higher convexity
Explanation: C is correct. The reading quiz confirms: 'Portfolio B (barbell), being a barbell portfolio, will have higher convexity than Portfolio A (bullet). Higher convexity bonds benefit from falling less in price when yields rise and rising more in price when yields fall.' From the example: barbell loses 4.56% versus bullet loses 4.63%, demonstrating the convexity advantage applies for BOTH upward and downward parallel shifts, not just one direction.
Question 175
A 10-year bond with MD = 9.52 and convexity = 104.8 undergoes a parallel yield shift UP of 50 bps. The price change is closest to:
Select an option first.
Correct answer: B — -4.63%
Explanation: B is correct. Using Step 3 of the return decomposition: price change = (-MD x DeltaY) + (0.5 x C x DeltaY squared) = (-9.52 x 0.005) + (0.5 x 104.8 x 0.005 squared) = -0.0476 + (0.5 x 104.8 x 0.000025) = -0.0476 + 0.00131 = -0.04629 approximately -4.63%. The reading example confirms this calculation exactly. The convexity adjustment of +0.131% partially offsets the duration-based decline of -4.76%.
Question 176
A barbell portfolio consists of 46.68% in a 2-year bond (MD=1.86, convexity=5.2) and 53.32% in a 20-year bond (MD=16.23, convexity=292.8). For a 50 bps parallel shift UP, the barbell price change is closest to:
Select an option first.
Correct answer: C — -4.56%
Explanation: C is correct. Price change of 2-year = (-1.86 x 0.005) + (0.5 x 5.2 x 0.005 squared) = -0.0093 + 0.000065 = -0.92%. Price change of 20-year = (-16.23 x 0.005) + (0.5 x 292.8 x 0.005 squared) = -0.08115 + 0.003660 = -7.75%. Barbell change = (0.4668 x -0.92%) + (0.5332 x -7.75%) = -0.43% + (-4.13%) = -4.56%. This confirms the barbell outperforms the bullet (which loses 4.63%) due to higher convexity.
Question 177
For a STATIC (upward-sloping) yield curve environment, which strategy earns excess return from BOTH higher coupon income AND rolldown return?
Select an option first.
Correct answer: B — Rolling down the yield curve
Explanation: B is correct. The reading states: rolling down the yield curve 'differs from buy and hold in that the manager aims to earn excess return from both higher coupon income and rolldown return from the bond's price changing over time.' Buy-and-hold earns primarily higher coupon income from extending duration but does not actively capture rolldown through selling before maturity. The rolling strategy sells after the price has risen from the rolldown and reinvests at the steep part of the curve to repeat.
Question 178
The BUY-AND-HOLD strategy for a static yield curve is MOST at risk from which yield curve scenario?
Select an option first.
Correct answer: B — A parallel shift up in yields
Explanation: B is correct. The reading quiz confirms: 'A manager engaging in a buy-and-hold strategy is extending the duration of their portfolio in order to enhance returns when they forecast that the yield curve will not change. The risk is that yields do move and rise, causing prices to fall.' An inversion (C) with falling long-term rates would actually benefit the buy-and-hold strategy. A stable yield curve (A) is the base case where the strategy succeeds. A bull steepener (D) with falling short rates would also benefit long-duration positions.
Question 179
A manager expecting a STATIC yield curve enters a RECEIVE-FIXED swap. This profits because:
Select an option first.
Correct answer: B — The fixed leg income exceeds the floating leg payment, generating swap carry of fixed rate minus MRR
Explanation: B is correct. The reading states: 'A manager that receives the fixed leg increases their portfolio duration. They expect to earn the swap carry of the swap fixed rate - MRR.' In a static upward-sloping curve, the fixed rate received (say 3%) exceeds the floating rate paid (MRR, say 0.5%), generating net carry income of 2.5% per annum. The reading quiz confirms: 'A receive-fixed swap will increase the duration of the portfolio and enhance returns.'
Question 180
For the bond vs. swap example in a static curve environment (Trade A: 10-year 3% coupon bond at 104.3998, Trade B: receive-fixed 3% swap at MRR 0.5%), the SIX-MONTH SWAP CARRY on 50 million notional is:
Select an option first.
Correct answer: B — 625,000
Explanation: B is correct. Swap carry = (fixed leg income - floating leg outflow) for six months = [(0.03 - 0.005) / 2] x 50,000,000 = [0.025 / 2] x 50,000,000 = 0.0125 x 50,000,000 = 625,000. The reading confirms this exact calculation. The carry represents the net semi-annual payment the manager receives from the swap under a static curve environment.
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