Portfolio Management

CFA® Level I, published weight 8–12%. Risk and return, the CAPM, IPS construction, behavioural biases.

What the outline covers

Portfolio Risk and Return: Part I
Portfolio Risk and Return: Part II
Portfolio Management: An Overview
Basics of Portfolio Planning and Construction
The Behavioral Biases of Individuals
Introduction to Risk Management

Sample questions

These 5 questions are free in the app too. Try each one before opening the answer.

Question 1

Two assets have a correlation of exactly +1.0. Combining them in a portfolio will produce:

ρ₁,₂ = +1.0

A. A reduction in portfolio standard deviation
B. No diversification benefit
C. A risk-free portfolio at some weight
D. A portfolio with zero expected return

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B. With perfect positive correlation the portfolio standard deviation is the weighted average of the individual standard deviations — no benefit at all.

Reading: Portfolio Management — Portfolio Risk and Return: Part I, LOS 1.d

Question 2

A stock has a beta of 1.4. The risk-free rate is 3% and the expected market return is 9%. Its required return under the CAPM is:

β = 1.4 · R_f = 3% · E(R_m) = 9%

A. 9.0%
B. 11.4%
C. 12.6%
D. 15.6%

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B. E(R) = 3% + 1.4 × (9% − 3%) = 3% + 8.4% = 11.4%. Note the market risk premium is 6%, not 9%.

Reading: Portfolio Management — Portfolio Risk and Return: Part II, LOS 2.e

Question 3

A security plots above the security market line. It is best described as:

A. Overvalued, with a negative alpha
B. Undervalued, with a positive alpha
C. Correctly valued
D. Undervalued, but only if beta exceeds 1

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B. Plotting above the SML means the expected return exceeds what the CAPM requires for its beta — a positive alpha, so it is undervalued.

Reading: Portfolio Management — Portfolio Risk and Return: Part II, LOS 2.f

Question 4

A client has substantial wealth and a long horizon but becomes visibly anxious during drawdowns. The adviser should most appropriately:

A. Follow the higher ability to take risk
B. Follow the lower willingness to take risk and educate the client
C. Average the two assessments
D. Decline the engagement

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B. When willingness and ability conflict, the lower governs. The adviser should adopt the more conservative position while educating the client.

Reading: Portfolio Management — Basics of Portfolio Planning and Construction, LOS 4.b

Question 5

An investor holds a losing position because selling would confirm the loss. This bias is best classified and remedied as:

A. A cognitive error, to be corrected with information
B. An emotional bias, to be moderated
C. A cognitive error, to be moderated
D. An emotional bias, to be corrected with information

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B. Loss aversion is an emotional bias arising from feeling rather than faulty reasoning, so it is generally moderated and accommodated rather than corrected.

Reading: Portfolio Management — The Behavioral Biases of Individuals, LOS 5.b

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