CFA Level 1 Practice Questions For Portfolio Management Page 1 of ...

CFA Level 1 Practice Questions for Portfolio Management
CFA Level 1 Practice Questions for Portfolio Management.
1. Which of the following constraints would most likely appear in the unique needs and preferences
section of a trust’s investment policy statement? The portfolio is:
A. subject to the prudent-man standard.
B. prohibited from investing in tobacco companies.
C. prohibited from holding less than 5% in cash instruments.
Answer: B
Unique needs and preferences include the prohibition of certain investments. The investment
constraints of liquidity, tax concerns, and legal and regulatory factors adequately address the portfolio’s
other constraints.
2. Over time, the major source of investment return and risk can most likely be attributed to:
A. stock selection.
B. asset allocation.
C. risk management.
Answer: B
The asset allocation decision explains about 90% of a fund’s returns over time. Across al funds, asset
allocation explains an average of 40% of the variation in fund returns, and slightly more than 100% of
the average fund’s level of return.
3. The risk-free interest rate is 5 percent, and the return on market portfolio is 8 percent. A stock with a
beta of 0.5 that has an estimated rate of return of 7 percent is most likely:
A. overvalued.
B. undervalued.
C. correctly valued.
Answer: B
- RFR) = 5 +0.5(8-5) = 6.5. But the estimated return is 7%.

Therefore the stock is undervalued because its estimated return, given the risk, lies above the SML, i.e.
7% > 6.5%.
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Berkeley Middle East Inc.
Url: www.berkeleyme.com Email: info@berkeleyme.com Tel: 050-4401915
4. The minimum variance zero-beta portfolio most likely has some:
A. systematic and unsystematic risk.
B. unsystematic risk and no systematic risk.
C. systematic risk and no unsystematic risk.
Answer: B
Specifically within the set of feasible alternative portfolios, several portfolios exist where the returns are
completely uncorrelated with the market portfolio; the beta of these portfolios with the market
portfolio is zero. From among the several zero-beta portfolios, you would select one with minimum
variance. This portfolio does not have any systematic risk (beta = 0), but it does have some unsystematic
risk.
5. Which of the following statements is least likely to be an assumption about investor behaviour
underlying the Markowitz model?
A. Investors maximize one-period expected return
B. Investors base their decisions solely on expected return and risk
C. Investors have utility curves that are a function of expected returns and variance.
Answer: A
Investors maximize one-period expected utility, and their utility curves demonstrate diminishing
marginal utility of wealth.
6. Compared to the traditional Capital Asset Pricing Model (CAPM), where lending and borrowing are
carried out at the risk-free rate, a zero-beta CAPM would most likely result in a security market line
(SML) with:
A. unchanged intercept and slope.
B. a higher intercept and flatter slope.
C. a lower intercept and steeper slope.
Answer: B
Compared to the traditional CAPM, where lending and borrowing takes place at the
risk-free rate, a zero beta CAPM will result in a SML that has a higher intercept
and a flatter slope.
Page 2 of 18
7. In general, which of the following institutions will most likely have a high need for liquidity and a short
investment time horizon?
A. Banks
B. Endowments
C. Defined benefit pension plans
Answer = A
A is correct. Banks have a short term horizon and high liquidity needs. See Exhibit 14, page 291.
8. Which of the following is most likely a part of the feedback step in the portfolio management
process?
A. Portfolio construction
B. Performance measurement
C. Developing the investment policy statement
Answer = B
B is correct. Performance measurement along with portfolio monitoring and rebalancing is part of the
feedback loop.
9. The following table presents historical information for two stocks, RTF and KIU:
The covariance between RTF and KIU is closest to:
A. 0.0025.
B. 0.0338.
C. 0.0675.
Answer = B
Page 3 of 18
B is correct because Covij= σiσj rij = 0.06251/2 × 0.0901/2 × 0.450= 0.0338
10. Relative to an investor with a steeper indifference curve, the optimal portfolio for an investor with a
flatter indifference curve will most likely have:
A. a lower level of risk and return.
B. a higher level of risk and return.
C. the same level of risk and return.
Answer = B
B is correct because a less risk-averse investor’s highest utility, given the low slope of his indifference
curve, is likely to touch the capital allocation line at a point which would represent a portfolio with
higher risk and more expected return.
11. The following table shows data for the stock of JKU and a market-index.
Based on the capital asset pricing model (CAPM), JKU is most likely:
A. overvalued.
B. undervalued.
C. fairly valued.
Answer = B
B is correct because:
β JKU= ρJKU,M×σJKU / σM =0.75×0.2/0.15 = 1.0 E(RJKU) = RFR + β JKU x (RM – RFR) = 0.05 +1 x (0.12 –
0.05) = 0.12 The required rate of return of JKU is 12% and the expected return of JKU is 15% therefore
JKU is undervalued relative to the Security Market Line (SML). The risk-return relationship lies above the
SML.
Page 4 of 18
12. A portfolio with equal parts invested in a risk-free asset and a risky portfolio will most likely lie on:
A. the efficient frontier.
B. the security market line.
C. a capital allocation line.
Answer = C
C is correct. A capital allocation line shows possible combinations of a risky portfolio and the risk-free
asset.
13. Factors such as fluctuations in interest rates and changes in industrial production contribute to:
A. systematic risk.
B. unsystematic risk.
C. both systematic and unsystematic risk.
Answer: A
A is correct. Systematic (market-related) risk is caused by macroeconomic variables such as interest rate
volatility and variability in industrial production. Unsystematic risk is caused by company-specific
attributes.
14. When assessing the performance of a single investment fund, the asset allocation decision explains:
A. a little less than 100% of the level of a fund’s returns.
B. about 90% of the fund’s variation in returns across time.
C. an average of 40% of the variation in returns of a fund across time.
Answer: B
B is correct. Studies have shown that for a single fund, the asset allocation decision explains about 90%
of the fund’s variation in returns across time and more than 100% of the level of return. Across all funds
asset allocation explains an average of 40% of the variation in fund returns.
15. According to the Capital Asset Pricing Model (CAPM) if investors borrow at a rate that exceeds the
risk-free lending rate the resulting borrowing portfolios will:
A. plot on a flatter line.
B. plot on a steeper line.
C. no longer plot on a straight line.
Page 5 of 18
Answer: A
A is correct. If investors borrow at a rate that exceeds the lending rate, the resulting borrowing
portfolios will not be as profitable as the case where borrowing and lending is carried out at the same
risk-free rate. The result is that borrowing portfolios will plot on a line with a flatter slope compared to
borrowing portfolios constructed from borrowing at the risk-free lending rate.
16. Which of the following is not an assumption of the Markowitz model? Investors:
A. have homogeneous expectations.
B. maximize one-period expected utility.
C. base decisions solely on expected return and risk.
Answer: A
A is correct. This is not an assumption of the Markowitz model, it is an assumption of the Capital Asset
Pricing Model (CAPM).
17. The table below provides a probability distribution of stock returns for shares of Orion Corporation:
The variance of returns for Orion Corporation stock is closest to:
A. 44.36
B. 50.94
C. 88.71
Answer: C
C is correct. The table below provides the calculation of the variance
Expected return E( R) = 9.3% Variance of returns = 88.71
Page 6 of 18
18. For a retired 65-year-old investor, with moderate risk tolerance and adequate insurance and cash
reserves, the appropriate portfolio will most likely have the following mix of bonds and stocks:
Answer: A
A is correct. A moderately risk tolerant retired 65-year-old can structure his or her portfolio so that it
provides income and some principal growth. The principal growth is needed because the time horizon is
still fairly long. Such a portfolio could have an allocation of 55-65% in bonds and 35-45% in stocks.
19. Which of the following statements is least accurate? An investor may construct a portfolio located
on the capital market line (CML) by:
A. investing a portion of his capital in the risk-free asset and the balance in a fully diversified
portfolio of all equities.
B. investing a portion of his capital in the risk-free asset and the balance in a fully diversified
portfolio of all risky assets.
C. borrowing capital at the risk-free rate and investing all his capital plus all borrowed capital in a
fully diversified portfolio of all risky assets.
Answer: A
A is correct. This statement is incorrect. Portfolios located on the CML may be constructed by: 1)
investing a portion of an investor’s capital in the risk-free asset and the balance in the market portfolio
which consists of all risky assets, or 2) borrowing capital at the risk-free rate and investing all of an
investor’s capital plus all borrowed capital in the market portfolio.
20. The least likely reason for constructing an investment policy statement is that it:
A. minimizes the costs of portfolio construction.
B. helps investors create realistic investment goals.
C. establishes a performance benchmark to judge manager performance.
Answer: A
A is correct. This is not a reason for constructing an investment policy statement. The two reasons are:
1) it helps investors create realistic investment goals, and 2) it identifies a benchmark portfolio that will
be used to judge the performance of the portfolio manager.
21. An analyst gathered the following information about two common stocks:
Page 7 of 18
Variance of returns for the Libby Company = 15.5 Variance of returns for the Metromedia Company =
22.3 Covariance between returns of Libby Company and Metromedia Company =
8.65
The correlation coefficient between returns for the two common stocks is closest to:
A. 0.025.
B. 0.388.
C. 0.465.
Answer: C
C is correct. The correlation coefficient = Standard deviation of Libby = 3.937 Standard deviation of
Metromedia = 4.722 Correlation between Libby and Metromedia = 0.465
22. According to the Capital Asset Pricing Model (CAPM), the market portfolio:
A. includes all risky assets invested in equal amounts.
B. is exposed to both unsystematic and systematic risk.
C. is perfectly positively correlated with other portfolios on the CML.
Answer: B
B is correct. According to the CAPM the market portfolio is perfectly positively correlated with all other
portfolio on the CML. All risky assets are included in the market portfolio in proportion to their market
value, not in equal amounts. The market portfolio contains only systematic risk since it is completely
diversified.
23. An investment strategy that seeks to grow portfolio value over time through capital gains and
reinvestment of current income is most likely appropriate if the investment objective is:
A. total return.
B. current income.
C. capital preservation.
Page 8 of 18
Answer: A
A is correct. A total return objective is consistent with an investment strategy that seeks to grow
portfolio value over time through capital gains and reinvestment of portfolio income.
24. The standard deviation of returns for shares of Oakmont Corporation and Sunrise Corporation are
14% and 12% respectively. If the correlation between the two stocks is 0.25, a portfolio consisting of
35% invested in Oakmont and 65% in Sunrise has a standard deviation closest to:
A. 10.2%
B. 12.7%
C. 35.0%
Answer: A
25. With respect to the portfolio management process, asset allocation decisions are made in the:
A. planning step.
B. feedback step.
C. execution step.
Answer = C
C is correct. Asset allocation decisions are made in the execution step.
26. A key difference between a wrap account and a mutual fund is that wrap accounts:
A. have a lower required minimum investment.
B. can not be tailored to the tax needs of a client.
C. have assets that are owned directly by the individual.
Answer = C
C is correct. The key difference between a wrap account and a mutual fund is that in a wrap account the
assets are owned directly by the individual.
Page 9 of 18
27. An analyst observes that the historic geometric returns are 9% for equities, 3% for treasury bills, and
2% for inflation. The real rate of return and risk premium for equities are closest to:
A. 5.8% and 3.7%.
B. 6.9% and 3.8%.
C. 6.9% and 5.8%.
Answer = C
C is correct. (1 + 0.09)/(1 + 0.02) – 1 = 6.9% (1 + 0.09)/(1 + 0.03) – 1 = 5.8%
28. If Investor A has a lower risk aversion coefficient than Investor B, on the capital allocation line, will
Investor B’s optimal portfolio have a higher expected return?
A. Yes.
B. No, since Investor B has a lower risk tolerance.
C. No, since Investor B has a higher risk tolerance.
Answer = B
B is correct. Investor B has a higher risk aversion coefficient, therefore a lower risk tolerance and a lower
expected return on the capital allocation line.
29. Information for Stock A and the market appear below:
The beta of Stock A is closest to:
A. 0.43.
B. 1.70.
C. 2.35.
Answer = B
B correct. 0.85*0.40/0.20=1.70
Page 10 of 18
30. A portfolio manager decides to temporarily invest more of a portfolio in equities than the
investment policy statement prescribes, because he expects equities will generate a higher return than
other asset classes. This decision is most likely an example of:
A. rebalancing.
B. tactical asset allocation.
C. strategic asset allocation.
Answer = B
B is correct. Tactical asset allocation is the decision to deliberately deviate from the policy exposures to
systematic risk factors with the intent to add value based on forecasts of the near-term returns of those
asset classes.
31. The execution step of the portfolio management process includes:
A. finalizing the asset allocation.
B. monitoring the portfolio performance.
C. preparing the investment policy statement.
Answer = A
A is correct. Asset allocation occurs in the execution step.
32. A correlation matrix of the returns for securities A, B, and C is reported below:
Assuming that the expected return and the standard deviation of each security are the same, a portfolio
consisting of an equal allocation of which two securities will be most effective for portfolio
diversification? Securities:
A. A and B.
B. A and C.
C. B and C.
Page 11 of 18
Answer = C
C is correct. The negative correlation of –0.5 between investment instruments B and C is lowest and
therefore is most effective for portfolio diversification.
33. The slope of the security market line (SML) represents the portion of an asset’s expected return
attributable to:
A. total risk.
B. market risk.
C. diversifiable risk.
Answer = B
B is correct. The slope of the SML is the market risk premium, E(Rm) – Rf. It represents the return of the
market less the return of a risk-free asset. Thus, the slope represents the portion of expected return that
reflects compensation for market or systematic risk.
34. Last year, a portfolio manager earned a return of 12%. The portfolio’s beta was 1.5. For the same
period, the market return was 7.5% and the average risk-free rate was 2.7%. Jensen’s alpha for this
portfolio is closest to:
A. 0.75%.
B. 2.10%.
C. 4.50%.
Answer = B
B is correct. Jensen’s alpha = 0.12 – [0.027 + 1.5(0.075 – 0.027)] = .021 or 2.10%.
35. Information about three stocks is provided below:
If the expected market return is 9.5% and the average risk-free rate is 1.2%, according to the capital
asset pricing model (CAPM) and the security market line (SML), which of the three stocks is most likely
overvalued?
A. Heisen Inc.
Page 12 of 18
B. Booraem Inc.
C. Gutmann Inc.
Answer = B
B is correct. Booraem Inc. is overvalued because it lies below the SML. The expected return, 12.85%, is
less than the required return. According to the CAPM, the required return for Booraem Inc. is 0.1365 or
13.65%: 0.1365 = 0.012 + 1.5(0.095 – 0.012).
36. In a strategic asset allocation, assets within a specific asset class are least likely to have:
A. low paired correlations.
B. high paired correlations.
C. low correlations with other asset classes.
Answer = A
A is correct. In a strategic asset allocation, assets within a specific asset class will have high paired
correlations and low correlations with assets in other asset classes.
37. An analyst collected the following data for an asset:
The variance of returns for the asset are closest to:
A. 121.
B. 188.
C. 213.
Answer: A
The variance of returns is = [(-10-3).2+(-5-3).3+(10-3).4+(25-3) .1]=121
Page 13 of 18
38. An analyst gathered the following information about a portfolio comprised of two assets:
If the correlation of returns for the two assets equals 0.75, and the risk-free interest rate 1 percent, then
the expected standard deviation of the portfolio is closest to:
A. 3.07%.
B. 4.23%.
C. 4.55%.
Answer: C
Portfolio expected standard deviation = [(0. × 0.) + (0. × 0.) + (2 × 0.75 × 0.25 × 0.75 × 0.05 × 0.04)]0.5 =
4.55%
39. An analyst has gathered monthly returns for two stock indexes A and B:
The covariance between Index A and Index B is closest to:
A. 10.37.
B. 13.82.
C. 19.64.
Answer: B
Calculation of the covariance proceeds as follows:
1) Compute the average for each index: Index A = (-6.4 + 6.6 + 12.9+3.2)/4 = 4.08 Index B = (-6.2 + 19.0 -
7.7 + 4)/4 = 2.28
2) Compute the following sum: (-6.4-4.08) × (-6.2-2.28) + (6.6-4.08) × (19.0-2.28) + (12.9-4.08) × (-7.7-
2.28) + (3.2-4.08) × (4.0-2.28) = 41.47 3) Divide the sum found in 2) by number of observation minus one
= 41.47/(4-1) =13.82
Page 14 of 18
40. A completely diversified portfolio will most likely result in the elimination of:
A. systematic variance.
B. unsystematic variance.
C. both systematic and unsystematic variance.
Answer: B
A completely diversified portfolio, such as the market portfolio, will eliminate all unsystematic risk.
Systematic risk cannot be diversified away.
41. Beta can be viewed as:
A. a measure of unsystematic risk.
B. covariance of an asset with the market portfolio.
C. correlation coefficient with the market portfolio.
Answer: B
Beta is a standardized measure of risk because it relates this covariance to the variance of the market
portfolio.
42. For an investor borrowing money at the risk-free interest rate to invest in the market portfolio, the
estimated rate of return of his portfolio is most likely to:
A. increase.
B. decrease.
C. remain unchanged.
Answer: A
An investor who wants to attain a higher estimated rate of return than the market portfolio may want to
use leverage by borrowing money at the risk-free of interest.
43. Which of the following types of institutions is most likely to have a long investment time horizon and
a higher level of risk tolerance?
A. A bank
B. An endowment
C. An insurance company
Page 15 of 18
Answer = B
B is correct. Endowments have a long investment time horizon and a high level of risk tolerance. (See
Exhibit 14 on pp. 295–296.)
44. An investor’s transactions in a mutual fund and the fund’s returns over a four-year period are
provided in the table below:
Based on these data, the money-weighted return (or internal rate of return) for the investor is closest
to:
A. 2.15%.
B. 3.96%.
C. 7.50%.
Answer = B
Page 16 of 18
45. Selected information about shares of two companies is provided below:
1 Correlation of returns between Cable Incorporated and GPTA Company
The standard deviation of returns of the portfolio formed with these two stocks is closest to:
A. 25.04%.
B. 26.80%.
C. 32.85%.
Answer = A
46. Risk that can be attributed to factor(s) that impact a company or industry is best described as:
A. market risk.
B. systematic risk.
C. unsystematic risk.
Answer = C
C is correct. Risk that is due to company-specific or industry-specific factors is referred to as

unsystematic risk.
47. A stock has a correlation of 0.45 with the market and a standard deviation of returns of 12.35%. If
the market has a standard deviation of returns of 8.25%, then the beta of the stock is closest to:
A. 0.30.
B. 0.67.
C. 1.50.
Answer = B
B is correct.
Page 17 of 18
𝛽= 𝜌𝑖𝑚𝜎2𝑖𝜎𝑚𝜎𝑚
0.45 × 0.1235 × 0.0825
= 0.67
0.08252
48. Which of the following factors is least likely to impact an individual’s ability to take risk?
A. Time horizon
B. Personality type
C. Expected income
Answer = B
B is correct. An individual’s ability to take risk is impacted by such factors as time horizon and expected
income. Personality type is most likely to impact an individual’s willingness to take risk.
Page 18 of 18

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CFA Level 1 Practice Questions for Portfolio Management.

A. subject to the prudent-man standard.

B. prohibited from investing in tobacco companies.

C. prohibited from holding less than 5% in cash instruments.

- RFR) = 5 +0.5(8-5) = 6.5. But the estimated return is 7%.

4. The minimum variance zero-beta portfolio most likely has some:

A. systematic and unsystematic risk.

B. unsystematic risk and no systematic risk.

C. systematic risk and no unsystematic risk.

A. Investors maximize one-period expected return

B. Investors base their decisions solely on expected return and risk

A. unchanged intercept and slope.

B. a higher intercept and flatter slope.

C. a lower intercept and steeper slope.

C. Defined benefit pension plans

C. Developing the investment policy statement

The covariance between RTF and KIU is closest to:

B is correct because Covij= σiσj rij = 0.06251/2 × 0.0901/2 × 0.450= 0.0338

A. a lower level of risk and return.

B. a higher level of risk and return.

C. the same level of risk and return.

A. the efficient frontier.

B. the security market line.

C. a capital allocation line.

C. both systematic and unsystematic risk.

A. a little less than 100% of the level of a fund’s returns.

B. about 90% of the fund’s variation in returns across time.

C. an average of 40% of the variation in returns of a fund across time.

A. plot on a flatter line.

B. plot on a steeper line.

C. no longer plot on a straight line.

A. have homogeneous expectations.

B. maximize one-period expected utility.

C. base decisions solely on expected return and risk.

The variance of returns for Orion Corporation stock is closest to:

C is correct. The table below provides the calculation of the variance

Expected return E( R) = 9.3% Variance of returns = 88.71

A. minimizes the costs of portfolio construction.

B. helps investors create realistic investment goals.

C. establishes a performance benchmark to judge manager performance.

A. includes all risky assets invested in equal amounts.

B. is exposed to both unsystematic and systematic risk.

C. is perfectly positively correlated with other portfolios on the CML.

C is correct. Asset allocation decisions are made in the execution step.

A. have a lower required minimum investment.

B. can not be tailored to the tax needs of a client.

C. have assets that are owned directly by the individual.

A. 5.8% and 3.7%.

B. 6.9% and 3.8%.

C. 6.9% and 5.8%.

C is correct. (1 + 0.09)/(1 + 0.02) – 1 = 6.9% (1 + 0.09)/(1 + 0.03) – 1 = 5.8%

B. No, since Investor B has a lower risk tolerance.

C. No, since Investor B has a higher risk tolerance.

29. Information for Stock A and the market appear below:

The beta of Stock A is closest to:

B. tactical asset allocation.

C. strategic asset allocation.

31. The execution step of the portfolio management process includes:

A. finalizing the asset allocation.

B. monitoring the portfolio performance.

C. preparing the investment policy statement.

A is correct. Asset allocation occurs in the execution step.