Asset Allocation & Diversification Flashcards

The correlation coefficient between two assets ranges from:

Answer: −1 to +1

Correlation coefficients range from −1 (perfect negative correlation) to +1 (perfect positive correlation), with 0 indicating no linear relationship.

A portfolio equally divided between stocks and bonds reduces risk primarily because:

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.

Which portfolio construction technique allocates assets based on risk contribution rather than dollar value?

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.

A core-satellite portfolio structure involves:

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.

Which of the following best describes a glide path in asset allocation?

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.

Rebalancing a portfolio to its strategic asset allocation targets serves to:

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).