CPS Portfolio Construction and Design 2 — Questions and Answers
Question 1: What is the efficient frontier in modern portfolio theory?
- A limit on the number of holdings
- The set of portfolios offering maximum return for a given risk level (Correct answer)
- A government regulation on portfolio size
- The boundary between stocks and bonds
Correct answer: The set of portfolios offering maximum return for a given risk level
The efficient frontier represents portfolios that offer the highest expected return for each level of risk.
Question 2: Which metric measures the return per unit of total risk in portfolio analysis?
- Alpha
- Beta
- Sharpe Ratio (Correct answer)
- R-squared
Correct answer: Sharpe Ratio
The Sharpe Ratio measures excess return per unit of total risk (standard deviation), helping compare portfolio efficiency.
Question 3: What does 'correlation' between assets indicate in portfolio construction?
- The size of the assets
- How assets move in relation to each other (Correct answer)
- The assets' dividend yield
- Their combined market cap
Correct answer: How assets move in relation to each other
Correlation indicates how two assets move relative to each other, with low or negative correlation providing diversification benefits.
Question 4: Which asset class is typically added to a portfolio to reduce equity risk through diversification?
- More equities
- Fixed income / bonds (Correct answer)
- Leveraged ETFs
- Commodities futures only
Correct answer: Fixed income / bonds
Fixed income securities like bonds typically have low or negative correlation with equities, providing diversification benefits.
Question 5: What is 'core-satellite' portfolio construction?
- Investing only in large-cap stocks
- Combining a stable core with opportunistic satellite positions (Correct answer)
- Using only index funds
- Building a portfolio of derivatives only
Correct answer: Combining a stable core with opportunistic satellite positions
Core-satellite construction pairs a low-cost, diversified core with smaller satellite positions targeting specific opportunities or alpha.
Question 6: In portfolio construction, what does 'liquidity' requirement affect?
- Only the equity portion
- The types and proportions of assets that can be held (Correct answer)
- Only cash allocation
- The portfolio's tax efficiency
Correct answer: The types and proportions of assets that can be held
A client's liquidity requirement affects which assets can be included and in what proportions, since illiquid assets cannot easily be sold quickly.
CPS Portfolio Construction and Design 2
What is the efficient frontier in modern portfolio theory?