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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 181
A manager expecting rates to FALL (bullish view) should position the portfolio by:
Select an option first.
Correct answer: B — Increasing portfolio duration through receive-fixed swaps, buying futures, or extending maturity
Explanation: B is correct. The reading states: 'An active manager can earn excess return from a bullish view that the benchmark yield curve will shift down by increasing the duration of the portfolio.' When rates fall, longer-duration portfolios benefit more from price appreciation. The reading confirms: 'entering a receive-fixed (and pay-floating) swap will increase the duration of the portfolio' and the quiz question 1 confirms A (receive-fixed swap) is correct for a downward rate shift view.
Question 182
A manager has a BEARISH view on rate levels and expects STEEPENING. The portfolio should:
Select an option first.
Correct answer: C — Be long short-dated bonds, short long-dated bonds, with OVERALL NEGATIVE duration
Explanation: C is correct. The reading quiz confirms: 'The negative overall duration of the manager implies that they expect rates to rise (bearish). The fact that the manager is long short-term bonds implies they expect short-term yields to rise by less than long-term rates. Similarly, the fact that the manager is short long-term bonds suggests they expect longer-term yields to rise by more than short-term rates. This implies the manager expects the curve to steepen.' Bears have negative duration; steepeners are long short/short long.
Question 183
A BEAR STEEPENER environment (long rates rise more than short rates) is BEST exploited by:
Select an option first.
Correct answer: B — Selling long-dated bonds and buying short-dated bonds with negative net duration
Explanation: B is correct. The reading explains: 'a manager expecting a steepening curve, where long-term rates are rising and short-term rates are falling, should short sell long-dated bonds and buy short-dated bonds.' For a BEAR steepener, overall rates are expected to rise (bearish = negative duration overall). The manager is short long-dated bonds (rates rise most here) and long short-dated bonds (rates rise least here), maintaining an overall bearish (negative) duration stance.
Question 184
A BULL FLATTENER environment is characterized by:
Select an option first.
Correct answer: B — Long-term rates falling more than short-term rates (flight to quality)
Explanation: B is correct. The reading states: 'A bull flattener is the view that long-term rates will fall by more than short-term rates. This might occur when there is a flight to quality in uncertain markets as investors sell risky assets and purchase risk-free benchmark securities.' Bull (rates fall overall) + flattener (long rates fall more) = investors buying long-duration government bonds in flight to quality, driving long rates down more than short rates. The correct trade: buy long-dated bonds, short sell short-dated bonds, with positive net duration.
Question 185
For a POSITIVE BUTTERFLY view (curvature DECREASING, medium-term rates falling relative to short and long rates), the correct trade is:
Select an option first.
Correct answer: B — Long the body (buy medium-term bullet) and short the wings (sell barbell)
Explanation: B is correct. The reading states: 'if the manager believes that curvature will decrease, they think that medium-term rates will fall relative to short- and long-term rates. In this scenario, the manager should buy a medium-term bullet and short sell a barbell (long the body and short the wings).' A positive butterfly view expects medium-term rates to FALL, so the medium-term bond (body) rises in price and is bought; the wings (barbell = short and long maturities) are sold as those rates rise.
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Question 186
A manager buys the WINGS (barbell) and sells the BODY (bullet) in a butterfly trade. This manager expects:
Select an option first.
Correct answer: B — Curvature to increase: medium-term rates will rise relative to short and long-term rates (negative butterfly twist)
Explanation: B is correct. The reading quiz confirms: 'A manager that is long the wings (short-term and long-term bonds) and short the body (medium-term bonds) will outperform if medium-term rates increase relative to short-term and long-term rates. This would be an increase in curvature and a corresponding rise in the butterfly spread. This increase in curvature is referred to as a negative butterfly twist.' Long wings/short body profits when the body (medium-term bond) falls in price, i.e., when medium-term rates rise.
Question 187
A BULL STEEPENING TRADE: a manager buys 100 million GBP of 2-year bonds (MD=1.86) and short sells 10-year bonds (MD=9.52) to remain DURATION NEUTRAL. The market value of the 10-year short position is:
Select an option first.
Correct answer: B — 19.54 million GBP
Explanation: B is correct. For duration neutrality, BPV of long = BPV of short. BPV of long = 100,000,000 x 1.86 x 0.0001 = 18,600. Required BPV from short: MVs x 9.52 x 0.0001 = 18,600, so MVs = 18,600 / (9.52 x 0.0001) = 18,600 / 0.000952 = 19,537,815 approximately 19.54 million. This matches the reading example exactly. For a steepener with no rate level view, total BPV must be zero.
Question 188
For the steepening trade (long 100M GBP 2-year, short 19.54M GBP 10-year), if 2-year yields FALL 20 bps and 10-year yields RISE 20 bps, the profit on the LONG 2-year position is:
Select an option first.
Correct answer: B — Gain of 372,000 GBP
Explanation: B is correct. Price change of 2-year bond = (-1.86 x -0.002) + 0 = +0.00372 = +0.372%. Profit on long position = 0.372% x 100,000,000 = 372,000 GBP gain. The reading example confirms this calculation. The 2-year bond price RISES when its yield FALLS 20 bps, generating the gain. The 10-year short position also generates a gain as 10-year yields rise (price falls on the bond we are short).
Question 189
For the POSITIVE BUTTERFLY TRADE (long 100M 10-year bullet, short 52.63M each of 2-year and 20-year), if 2-year and 20-year yields RISE 10 bps and 10-year yields FALL 25 bps, the profit on the LONG 10-year position is closest to:
Select an option first.
Correct answer: B — Gain of 2,376,250 GBP
Explanation: B is correct. Price change of 10-year bond = (-9.52 x -0.0025) + (0.5 x 104.8 x 0.0025 squared) = +0.0238 + 0.000328 = +0.02413 = +2.413%. Profit on long 100M = 2.413% x 100,000,000 = 2,413,000 GBP approximately 2,376,250 (the reading calculates this as the gain on the body). The 10-year falls in yield (rises in price) generating the gain to the long position in the body.
Question 190
A CALLABLE BOND exhibits NEGATIVE CONVEXITY at low yields because:
Select an option first.
Correct answer: B — The embedded short call option gains value as yields fall, limiting price appreciation relative to an option-free bond
Explanation: B is correct. The reading states: 'A callable bond gives the issuer the right to buy the bond back from the investor before maturity. It can be viewed as a combination of an option-free bond and a short call option because this call has been granted to the issuer. The embedded short call option becomes more valuable as yields fall and underlying bond prices rise. This leads to negative convexity for callable bonds at low yields, as their prices will rise at a slower pace than option-free bonds.'
Question 191
When interest rates are EXPECTED TO RISE, a manager is LEAST likely to PREFER which bond type?
Select an option first.
Correct answer: C — Option-free bond
Explanation: C is correct. The reading quiz confirms: 'An upward shift in yields will cause option-free bonds to fall more than bonds with embedded options. The putable bond will fall by less than an option-free bond because the embedded long put option will increase in value and place a floor beneath the bond price. A callable bond will fall by less than an option-free bond because the embedded short call option will decrease in value, which will partially offset losses on the underlying bond.' So option-free bonds are MOST sensitive to rising rates.
Question 192
Adding a CALL OPTION on a bond futures contract to a fixed-income portfolio will:
Select an option first.
Correct answer: B — Increase portfolio duration because calls become more valuable as yields fall and prices rise
Explanation: B is correct. The reading states: 'Adding call options on either a bond price or a bond futures contract will increase the duration of a fixed-income portfolio because the calls will increase in value as yields fall and bond prices rise.' A long call position profits when rates fall (bond prices rise), behaving like a long bond position with positive duration. This is consistent with the summary table in the reading showing that long calls increase duration.
Question 193
A PAYER SWAPTION gives the holder the right to enter a PAY-FIXED swap and will DECREASE portfolio duration because:
Select an option first.
Correct answer: B — The payer swaption becomes more valuable as rates rise, just like a short bond position, adding negative duration to the portfolio
Explanation: B is correct. The reading states: 'A payer swaption gives the holder the right to enter a pay-fixed swap. This becomes valuable as rates rise; hence, a payer swaption decreases the duration of the portfolio.' A pay-fixed swap is like being short a fixed-rate bond (negative duration) while long a floating rate note (minimal duration). The payer swaption profits when rates rise (similar to a short bond position), so adding it reduces the portfolio's sensitivity to rate declines and lowers overall duration.
Question 194
A manager expecting a DOWNWARD SHIFT in yields (bullish) and wishing to INCREASE portfolio duration would MOST LIKELY establish:
Select an option first.
Correct answer: C — Long a call option on bond futures contracts
Explanation: C is correct. The reading quiz confirms: 'As rates fall, bond futures prices will rise and a call on futures will increase in value.' This is the correct position to establish when expecting falling yields because: long calls on bond futures profit from rising bond prices (falling yields), increasing effective portfolio duration. A is wrong: short receiver swaption removes positive duration from the portfolio. B is wrong: payer swaption decreases duration. D is wrong: short futures reduce duration.
Question 195
A manager has active key rate durations of +3, -0.5, and -3 at the 10-year, 20-year, and 30-year maturities respectively. Using ONLY DERIVATIVES, which positions achieve this?
Select an option first.
Correct answer: A — Receive-fixed 10-year swap, short 20-year futures, pay-fixed 30-year swap
Explanation: A is correct. The reading quiz confirms: 'A manager should use receive-fixed to increase duration and pay-fixed to lower duration. Buying futures increases duration and selling futures decreases duration.' Active KRD of +3 at the 10-year means increasing duration there: receive-fixed 10-year swap. Active KRD of -0.5 at the 20-year means slightly decreasing duration: short 20-year futures. Active KRD of -3 at the 30-year means decreasing duration significantly: pay-fixed 30-year swap.
Question 196
The SUM of all key rate durations of a portfolio equals the portfolio's:
Select an option first.
Correct answer: C — Effective duration
Explanation: C is correct. The reading states: 'The sum of key rate durations for a portfolio will equal the effective duration of the portfolio because this sum represents the aggregate sensitivity of the portfolio to a move in all maturity yields at the same time (i.e., a parallel shift in the yield curve).' Modified duration assumes a flat yield curve and parallel shifts. Effective duration incorporates option-adjusted cash flows. For portfolios without embedded options they are very similar, but for portfolios with options, effective duration is the appropriate measure.
Question 197
A manager has a POSITIVE active key rate duration at the 5-year maturity and a NEGATIVE active key rate duration at the 30-year maturity. This positioning reflects the view that:
Select an option first.
Correct answer: B — 5-year rates will fall less than 30-year rates (bear steepener)
Explanation: B is correct. The reading states: 'A manager with a high positive key rate duration at a particular maturity has the view that this maturity rate is going to fall. Conversely, a manager with a high negative key rate duration at a particular maturity has the view that this maturity rate is going to rise.' Positive at 5-year = expects 5-year rates to fall (but has positive exposure there). Negative at 30-year = expects 30-year rates to rise. Combined view: 30-year rates rise MORE than 5-year rates = bear steepener.
Question 198
An Australian manager invests in a U.S. zero-coupon bond priced at 96.374. After one year the bond is priced at 99.939. The USD/AUD exchange rate was 0.90 at start and 0.80 at year-end. The foreign currency return RFC is closest to:
Select an option first.
Correct answer: A — 3.7%
Explanation: A is correct. RFC = (ending price - beginning price) / beginning price = (99.939 - 96.374) / 96.374 = 3.565 / 96.374 = 0.037 = 3.7%. This is the return earned in local USD terms ignoring exchange rate effects. The exchange rate effect (RFX) is calculated separately by looking at the change in the AUD/USD direct quote, and then the total domestic AUD return = (1 + RFC) x (1 + RFX) - 1.
Question 199
For the same Australian investor (RFC = 3.7%), the AUD/USD rate moves from 0.90 to 0.80 (USD per AUD). The DOMESTIC return RDC in AUD terms is closest to:
Select an option first.
Correct answer: C — 16.7%
Explanation: C is correct. To calculate RFX, use the direct quote (AUD/USD = domestic/foreign). Since the quote given is USD/AUD, we invert: AUD/USD (direct quote for AUD investor) = 1/0.90 = 1.1111 at start; 1/0.80 = 1.2500 at end. RFX = (1.2500 - 1.1111) / 1.1111 = 12.5%. The domestic return RDC = (1 + RFC) x (1 + RFX) - 1 = (1.037) x (1.125) - 1 = 1.1666 - 1 = 16.66% approximately 16.7%.
Question 200
COVERED INTEREST RATE PARITY (CIRP) implies that a fully hedged foreign bond investment will earn:
Select an option first.
Correct answer: B — The domestic risk-free rate, because the forward discount offsets the higher foreign interest rate
Explanation: B is correct. The reading states: 'CIRP means that the manager fails to earn an overall higher return in their hedged foreign bond, instead only earning their domestic risk-free rate.' The reading's example confirms: an Australian investor hedging USD exposure earns exactly 5% (the Australian domestic risk-free rate). CIRP ensures that high-interest-rate currencies trade at a forward DISCOUNT that exactly offsets the interest rate differential when the currency is sold forward.
Question 201
For a 2-year Australian investor: U.S. bond price = 96.374, USD/AUD spot = 0.90, Australian 2-year zero yields 5%. Using CIRP, the FAIR 2-YEAR FORWARD AUD/USD RATE is closest to:
Select an option first.
Correct answer: C — 1.1806
Explanation: C is correct. Using CIRP: Forward rate (DC/FC) = Spot (DC/FC) x [(1 + rDC) / (1 + rFC)]^T. Spot AUD/USD = 1/0.90 = 1.1111. rDC (AUD) = 5%. rFC (USD) = (100/96.374)^0.5 - 1 = 1.864%. Forward = 1.1111 x [(1.05) / (1.01864)]^2 = 1.1111 x [1.05/1.01864]^2 = 1.1111 x 1.06256 = 1.1806. The reading confirms this exact calculation. The USD is at a forward premium because AUD has the higher interest rate.
Question 202
UNCOVERED INTEREST RATE PARITY (UIRP) tends NOT to hold in practice, which means:
Select an option first.
Correct answer: C — High-interest-rate currencies tend not to depreciate as much as UIRP predicts, creating a forward rate bias exploitable through the carry trade
Explanation: C is correct. The reading states: 'UIRP tends not to hold—high interest rate currencies on average tend not to depreciate over time according to their interest rate differential versus other currencies, which means the forward rate is not an unbiased predictor of future spot rates (called forward rate bias).' This forward rate bias means carry trade investors (borrow low rate, invest high rate without hedging) can earn excess returns on average because the high-rate currency does not depreciate as much as UIRP predicts.
Question 203
A carry trade borrows USD at 1% and invests in INR securities at 5% annualized. If 90-day INR rates evolve as 5%, 6%, 4%, 3% over the year and the INR/USD rate moves from 70 to 85 (INR per USD), the total carry trade return is closest to:
Select an option first.
Correct answer: C — -14.0%
Explanation: C is correct. Foreign returns from rolling INR quarterly = (1+0.05/4)(1+0.06/4)(1+0.04/4)(1+0.03/4) - 1 = 4.6%. USD borrowing cost = 1%. For FX impact: USD/INR (INR is base) starts at 1/70 = 0.014286, ends at 1/85 = 0.011765. RFX = (0.011765 - 0.014286) / 0.014286 = -17.6% (INR weakened against USD). Total return = 4.6% - 1.0% - 17.6% = -14.0%. The reading confirms this exact calculation, illustrating the major risk of carry trades: currency depreciation can completely wipe out the interest rate advantage.
Question 204
The EXCESS RETURN FROM THE CARRY TRADE violates which interest rate parity condition?
Select an option first.
Correct answer: B — Uncovered interest rate parity only
Explanation: B is correct. The reading quiz confirms: 'In order for the unhedged carry trade to earn excess profits, uncovered interest rate parity, which states that high interest rate currencies depreciate, must not hold. Covered interest rate parity relates to establishing a fair forward rate, which is not relevant for an unhedged carry trade.' CIRP is an arbitrage condition enforced through forward markets and always holds in developed markets. UIRP is an equilibrium condition that often fails, enabling carry trade excess returns.
Question 205
A manager believes a foreign yield curve will undergo a BULL STEEPENING while the domestic higher-yielding curve remains stable. To MAXIMIZE CARRY, the manager should:
Select an option first.
Correct answer: C — Pay-floating in foreign currency, receive-fixed in domestic currency
Explanation: C is correct. The reading quiz confirms: 'A bull steepener occurs when rates fall and short-term rates fall faster than long-term rates. In order to maximize carry benefit, the manager should pay the foreign floating rate that is expected to fall by more than longer-term rates and receive the higher longer-term fixed domestic rate that is expected to remain stable.' Pay-floating in foreign (as floating rates fall, payments decrease enhancing carry) and receive-fixed in domestic (earning stable high domestic fixed rate).
Question 206
For a BARBELL portfolio (60% Bond A: 2-year, MD=1.86, convexity=5.2; 40% Bond B: 10-year, MD=9.52, convexity=104.8), a bear FLATTENING occurs with 50 bps rise in 2-year yields and 30 bps rise in 10-year yields. The portfolio price change is closest to:
Select an option first.
Correct answer: A — -1.68%
Explanation: A is correct. Price change of 2-year = (-1.86 x 0.005) + (0.5 x 5.2 x 0.005 squared) = -0.00930 + 0.000065 = -0.92%. Price change of 10-year = (-9.52 x 0.003) + (0.5 x 104.8 x 0.003 squared) = -0.02856 + 0.000471 = -2.81%. Portfolio change = (0.60 x -0.92%) + (0.40 x -2.81%) = -0.552% - 1.124% = -1.68%. This matches the reading quiz exactly. The 2-year bond suffers more than 10-year in a bear flattener (short rates rise more).
Question 207
For a STATIC zero-coupon bond portfolio (Canadian bonds), the BULLET (4-year, MD=4.89) has a rolldown return of 2.067% and yield change of -1.214% over one year. With a CAD/USD currency return of -0.5%, the total DOMESTIC USD return from the bullet is closest to:
Select an option first.
Correct answer: B — 0.35%
Explanation: B is correct. Foreign CAD return = coupon (0%) + rolldown (2.067%) + yield change (-1.214%) + spread change (0%) = 0.853%. Using the multiplicative approach for Step 5: Total domestic return = (1 + 0.00853) x (1 - 0.005) - 1 = (1.00853) x (0.995) - 1 = 1.0035 - 1 = 0.35%. The reading example confirms this calculation. The CAD weakened against USD, reducing the domestic return from 0.85% to only 0.35%.
Question 208
The two PRIMARY components of credit risk that together determine credit spread are:
Select an option first.
Correct answer: B — Probability of default (POD) and loss given default (LGD)
Explanation: B is correct. The reading states: 'The two crucial components of credit risk are: Probability of default (POD) - the chance that the issuer fails to make payments on its obligation when due. Loss given default (LGD) - the proportion of investment lost if a default occurs, calculated as 1 - recovery rate.' The simple credit spread formula: credit spread approximately equals POD x LGD. Together these determine the expected credit loss that investors must be compensated for.
Question 209
An issuer has first lien bonds with a spread of 1.5% and historical recovery rate of 50%. If second lien bonds have a recovery rate of 40%, the FAIR CREDIT SPREAD for second lien bonds is:
Select an option first.
Correct answer: B — 1.8%
Explanation: B is correct. First, solve for the POD implied by first lien bonds: 1.5% = POD x LGD = POD x (1 - 50%) = POD x 50%, so POD = 1.5% / 0.50 = 3.0%. Second lien LGD = 1 - 40% = 60%. Fair second lien spread = POD x LGD = 3.0% x 60% = 1.8%. This matches the reading example exactly. Both bonds share the same issuer POD; the difference in fair spread comes entirely from the different recovery rates (lower seniority = lower recovery = higher LGD = higher spread).
Question 210
At the PEAK of the economic cycle, the credit spread curve is MOST LIKELY:
Select an option first.
Correct answer: C — Rising and upward sloping
Explanation: C is correct. The reading quiz confirms: 'At the peak of the economic cycle, lower defaults and increased profitability cause short-term credit spreads to remain low. Longer-term credit spreads will likely increase due to higher leverage, increased inflation expectations over the longer term, and the pricing in of higher defaults when a contraction begins. The curve will likely be rising and upward sloping in this stage of the economic cycle.' Short-term spreads are at their lowest because near-term default risk is minimal at peak cycle.
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