IFC Constructing Investment Portfolios 2 — Questions and Answers
Question 1: A portfolio manager wants to reduce unsystematic risk. Which strategy is most effective?
- Increasing bond duration
- Diversifying across uncorrelated asset classes (Correct answer)
- Concentrating in high-dividend stocks
- Holding more cash equivalents
Correct answer: Diversifying across uncorrelated asset classes
Diversifying across uncorrelated asset classes reduces unsystematic (company-specific) risk that cannot be eliminated by holding a single security type.
Question 2: Which of the following best describes the efficient frontier in portfolio construction?
- The set of portfolios with the highest return for a given level of risk (Correct answer)
- The portfolio with zero standard deviation
- The allocation that maximizes dividend income
- The benchmark index against which a fund is measured
Correct answer: The set of portfolios with the highest return for a given level of risk
The efficient frontier represents portfolios that offer the maximum expected return for each level of risk, forming the optimal trade-off curve.
Question 3: A balanced mutual fund typically holds which combination of assets?
- Only equities and cash
- Equities and fixed-income securities (Correct answer)
- Only government bonds and T-bills
- Real estate and commodities exclusively
Correct answer: Equities and fixed-income securities
A balanced fund holds both equities and fixed-income securities to provide growth and income while moderating risk.
Question 4: When constructing a client portfolio, what is the primary purpose of an Investment Policy Statement (IPS)?
- To guarantee a minimum rate of return
- To document the client's objectives, constraints, and investment guidelines (Correct answer)
- To select specific securities for the portfolio
- To satisfy CRA tax reporting requirements
Correct answer: To document the client's objectives, constraints, and investment guidelines
An IPS formalizes the client's goals, risk tolerance, time horizon, and constraints to guide ongoing portfolio management decisions.
Question 5: Which asset class typically has the lowest correlation with Canadian equities and provides the best diversification benefit?
- US large-cap equities
- Global real estate investment trusts
- Canadian government bonds (Correct answer)
- Emerging market equities
Correct answer: Canadian government bonds
Canadian government bonds typically have low or negative correlation with Canadian equities, providing the strongest diversification benefit during equity downturns.
Question 6: A portfolio with a beta of 1.4 relative to the TSX Composite would be expected to:
- Move 1.4% for every 1% move in the index (Correct answer)
- Outperform the index by 40% annually
- Have 40% lower volatility than the index
- Generate a 1.4% annual return above inflation
Correct answer: Move 1.4% for every 1% move in the index
Beta measures sensitivity to market movements; a beta of 1.4 means the portfolio moves approximately 1.4% for each 1% change in the benchmark index.
Question 7: In the context of portfolio construction, what does 'rebalancing' refer to?
- Shifting all assets to cash during market downturns
- Restoring a portfolio's asset allocation to its target weights (Correct answer)
- Replacing underperforming fund managers
- Increasing equity exposure when markets rise
Correct answer: Restoring a portfolio's asset allocation to its target weights
Rebalancing involves buying or selling assets to return the portfolio's actual allocation back to the originally intended target weights.
IFC Constructing Investment Portfolios 2
A portfolio manager wants to reduce unsystematic risk.
Which strategy is most effective?