CPM Asset Allocation & Diversification 2 — Questions and Answers
Question 1: The correlation coefficient between two assets ranges from:
- 0 to 1
- −1 to +1 (Correct answer)
- −100 to +100
- 0 to infinity
Correct answer: −1 to +1
Correlation coefficients range from −1 (perfect negative correlation) to +1 (perfect positive correlation), with 0 indicating no linear relationship.
Question 2: A portfolio equally divided between stocks and bonds reduces risk primarily because:
- Bonds have higher returns than stocks
- Stocks and bonds historically have low or negative correlations with each other (Correct answer)
- Both asset classes move identically
- Bonds eliminate market risk
Correct answer: Stocks and bonds historically have low or negative correlations with each other
Stocks and bonds often move in opposite directions (especially during risk-off events), so combining them reduces overall portfolio volatility through diversification.
Question 3: Which portfolio construction technique allocates assets based on risk contribution rather than dollar value?
- Market-cap weighting
- Risk parity (Correct answer)
- Equal weighting
- Momentum investing
Correct answer: Risk parity
Risk parity allocates portfolio weights so that each asset class contributes equally to total portfolio risk, often using leverage to boost lower-volatility assets.
Question 4: A core-satellite portfolio structure involves:
- Investing entirely in index funds
- A passive core holding supplemented by active satellite positions targeting specific opportunities (Correct answer)
- Using only alternative investments
- Concentrating all assets in one sector
Correct answer: A passive core holding supplemented by active satellite positions targeting specific opportunities
Core-satellite combines a low-cost passive core (providing broad market exposure) with active satellite positions aimed at generating alpha or targeting specific themes.
Question 5: Which of the following best describes a glide path in asset allocation?
- A fixed allocation maintained throughout the investment period
- A systematic shift from higher-risk to lower-risk assets as a target date approaches (Correct answer)
- A strategy that increases equity exposure over time
- A technique for rebalancing daily
Correct answer: A systematic shift from higher-risk to lower-risk assets as a target date approaches
A glide path gradually reduces risk (e.g., by shifting from equities to bonds) as an investor approaches a target date such as retirement, aligning risk with decreasing time horizon.
Question 6: Rebalancing a portfolio to its strategic asset allocation targets serves to:
- Maximize short-term returns
- Maintain the desired risk profile and systematically buy low/sell high (Correct answer)
- Eliminate all market risk
- Increase portfolio concentration
Correct answer: Maintain the desired risk profile and systematically buy low/sell high
Rebalancing restores the original risk/return profile and has the side effect of systematically trimming outperformers (selling high) and adding to underperformers (buying low).
CPM Asset Allocation & Diversification 2
The correlation coefficient between two assets ranges from: