CFA Portfolio Management 1 — Questions and Answers
Question 1: What is the primary goal of portfolio management?
- To maximize the wealth of the investor without regard for risk
- To balance risk and return based on the investor's preferences (Correct answer)
- To minimize risk regardless of return potential
- To avoid investing in high-growth assets
Correct answer: To balance risk and return based on the investor's preferences
The primary goal of portfolio management is to construct and maintain an investment portfolio that effectively balances risk and return according to the investor's specific financial goals, risk tolerance, and time horizon. This involves strategically allocating assets to achieve the best possible return for a given level of risk, or the lowest possible risk for a desired level of return. It's about finding the optimal trade-off tailored to the individual.
Question 2: How does diversification help in portfolio management?
- By concentrating investments in a single asset class
- By minimizing exposure to any particular asset or sector (Correct answer)
- By focusing investments on high-risk assets only
- By investing in only one industry sector
Correct answer: By minimizing exposure to any particular asset or sector
Diversification is a fundamental strategy in portfolio management that helps reduce unsystematic (specific) risk. By spreading investments across various asset classes, industries, and security types, the portfolio becomes less vulnerable to the poor performance of any single asset or sector. This minimizes exposure to individual risks, aiming to smooth out overall portfolio returns and protect against significant losses.
Question 3: What is an example of active management in portfolio management?
- Investing in an index fund that tracks the overall market
- Continuously buying and selling individual securities to outperform the market (Correct answer)
- Focusing on buying bonds for long-term growth
- Setting an asset allocation and maintaining it over time
Correct answer: Continuously buying and selling individual securities to outperform the market
Active management in portfolio management involves a manager making specific investment decisions, such as continuously buying and selling individual securities, with the goal of outperforming a specific market benchmark or index. This contrasts with passive management, which aims to replicate the performance of an index. Active managers often rely on research, market timing, and security selection to achieve their objectives.
Question 4: What is rebalancing in portfolio management?
- Buying more assets without selling any
- Adjusting the portfolio's asset allocation back to target levels (Correct answer)
- Selling off all assets to avoid losses
- Increasing the amount of cash holdings
Correct answer: Adjusting the portfolio's asset allocation back to target levels
Rebalancing in portfolio management is the process of adjusting a portfolio's asset allocation back to its original or target weights. Over time, market fluctuations can cause certain asset classes to grow or shrink, altering the portfolio's risk profile. This involves selling assets that have become a larger portion of the portfolio and buying assets that have shrunk, ensuring the portfolio remains aligned with the investor's desired risk and return objectives.
Question 5: What is the Capital Asset Pricing Model (CAPM) used for in portfolio management?
- To predict the future market prices of stocks
- To calculate the optimal asset allocation for a portfolio
- To assess the expected return of an asset based on its risk (Correct answer)
- To calculate the portfolio’s overall risk level
Correct answer: To assess the expected return of an asset based on its risk
The Capital Asset Pricing Model (CAPM) is a financial model used in portfolio management to calculate the expected return on an asset or investment, given its systematic risk (beta). It posits that the expected return is equal to the risk-free rate plus a risk premium, which is the asset's beta multiplied by the market risk premium. CAPM helps investors determine if an asset offers a sufficient expected return for the risk taken.
Question 6: How does the efficient frontier help in portfolio management?
- By identifying the optimal risk-free asset
- By showing the relationship between risk and return for efficient portfolios (Correct answer)
- By minimizing the portfolio’s total risk regardless of returns
- By showing portfolios with the highest expected returns only
Correct answer: By showing the relationship between risk and return for efficient portfolios
The efficient frontier is a concept in modern portfolio theory that represents the set of optimal portfolios offering the highest expected return for a defined level of risk, or the lowest risk for a given expected return. Investors aim to construct portfolios that lie on this frontier, as any portfolio below it is considered suboptimal. It helps in visualizing the trade-off between risk and return and guiding asset allocation decisions.
CFA Portfolio Management 1
What is the primary goal of portfolio management?