AAMS Asset Allocation & Selection 3 — Questions and Answers
Question 1: Which concept describes the tendency of asset class returns to move together during market crises, reducing diversification benefits?
- Correlation convergence
- Contagion (Correct answer)
- Factor drift
- Style rotation
Correct answer: Contagion
Contagion refers to the spread of financial distress across markets, causing correlations to spike toward 1.0 during crises.
Question 2: A tactical asset allocation shift increasing equity exposure based on a perceived market undervaluation is best described as:
- A permanent strategic change
- A short-term deviation from strategic allocation (Correct answer)
- Passive indexing
- Duration management
Correct answer: A short-term deviation from strategic allocation
Tactical asset allocation involves short-term, deliberate deviations from the strategic benchmark to exploit market inefficiencies.
Question 3: Which metric would an advisor use to evaluate whether additional portfolio diversification is still beneficial?
- Absolute return
- Marginal contribution to risk (Correct answer)
- Dividend yield
- Expense ratio
Correct answer: Marginal contribution to risk
Marginal contribution to risk measures how much each additional holding adds to total portfolio risk, indicating when diversification benefits diminish.
Question 4: In mean-variance optimization, which input has historically been the MOST difficult to estimate accurately?
- Asset variances
- Pairwise correlations
- Expected returns (Correct answer)
- Portfolio weights
Correct answer: Expected returns
Expected returns are notoriously difficult to forecast accurately, making them the most problematic input in mean-variance optimization.
Question 5: A 75-year-old retiree asks about increasing equity allocation for inflation protection. Which consideration should the advisor prioritize FIRST?
- Potential for higher nominal returns
- The client's remaining investment horizon and sequence-of-returns risk (Correct answer)
- Historical equity risk premiums over 30-year periods
- Tax efficiency of dividend-paying stocks
Correct answer: The client's remaining investment horizon and sequence-of-returns risk
Sequence-of-returns risk is critical for retirees, as early large losses can permanently impair a portfolio's ability to sustain withdrawals.
Question 6: Which type of real asset provides both inflation-linkage and income through lease payments?
- Gold bullion
- Commodity futures
- Real estate investment trusts (REITs) (Correct answer)
- TIPS mutual funds
Correct answer: Real estate investment trusts (REITs)
REITs provide inflation-linked income through rents and offer portfolio diversification as a real asset class.
Question 7: What does 'alpha' represent in the context of active asset selection?
- Total portfolio return
- Return attributable to market exposure
- Return in excess of a benchmark after adjusting for risk (Correct answer)
- The portfolio's sensitivity to interest rate changes
Correct answer: Return in excess of a benchmark after adjusting for risk
Alpha is the risk-adjusted excess return generated by active investment decisions beyond what market exposure (beta) would explain.
AAMS Asset Allocation & Selection 3
Which concept describes the tendency of asset class returns to move together during market crises, reducing diversification benefits?