CPS Portfolio Construction and Design 1 — Questions and Answers
Question 1: Which principle is fundamental to portfolio construction in the CPS framework?
- Maximizing return at any cost
- Diversification across asset classes (Correct answer)
- Concentrating in single sectors
- Avoiding alternative investments
Correct answer: Diversification across asset classes
Diversification across asset classes is a cornerstone of sound portfolio construction to manage risk while pursuing returns.
Question 2: What does asset allocation primarily determine in a portfolio?
- The exact stocks to purchase
- The overall risk and return profile (Correct answer)
- The timing of trades
- The brokerage fees
Correct answer: The overall risk and return profile
Asset allocation determines the overall risk and return profile of a portfolio by distributing investments among asset categories.
Question 3: In portfolio design, what is the purpose of a policy statement?
- To define trading hours
- To establish investment objectives and constraints (Correct answer)
- To list all securities held
- To calculate tax liability
Correct answer: To establish investment objectives and constraints
An investment policy statement establishes the client's objectives, risk tolerance, and constraints to guide portfolio construction.
Question 4: What is 'rebalancing' in portfolio management?
- Selling all holdings and reinvesting
- Restoring a portfolio to its target asset allocation (Correct answer)
- Adding new asset classes
- Removing underperforming stocks
Correct answer: Restoring a portfolio to its target asset allocation
Rebalancing restores a portfolio to its original or desired target allocation after market movements have caused drift.
Question 5: Which factor is most critical when designing a portfolio for a retired client?
- Maximizing long-term growth
- Ensuring sufficient income and capital preservation (Correct answer)
- Aggressive sector rotation
- Concentrated equity positions
Correct answer: Ensuring sufficient income and capital preservation
For retired clients, ensuring sufficient income and capital preservation is paramount since they typically cannot recover from large losses.
Question 6: What does 'tactical asset allocation' differ from 'strategic asset allocation' in?
- Strategic uses short-term deviations; tactical uses long-term targets
- Tactical makes short-term deviations; strategic sets long-term targets (Correct answer)
- Both are identical approaches
- Tactical only applies to bonds
Correct answer: Tactical makes short-term deviations; strategic sets long-term targets
Tactical asset allocation makes short-term deviations from the long-term strategic target to exploit market opportunities.
CPS Portfolio Construction and Design 1
Which principle is fundamental to portfolio construction in the CPS framework?