Portfolio Management Exam 1 – Questions
with 100% Correct Solutions (2025 Update)
Questions with Answers
Below are 50 questions from the Portfolio Management Exam 1 (2025 update), covering the full
scope of the exam. These are based on verified CFA Level I curriculum and practice materials,
aligned with topics like investment policy statements, risk/return, asset allocation, and behavioral
finance.
1. Over time, the major source of investment return and risk can most likely be
attributed to:
A) Stock selection
B) Asset allocation
C) Risk management
Answer: B) Asset allocation
Solution: The asset allocation decision explains about 90% of a fund’s returns over time.
2. The risk-free interest rate is 5 percent, and the return on the market portfolio is 8
percent. A stock with a beta of 0.5 that has an estimated rate of return of 7 percent
is most likely:
A) Overvalued
B) Undervalued
C) Correctly valued
Answer: B) Undervalued
Solution: Required return = 5% + 0.5(8%-5%) = 6.5%. Since 7% > 6.5%, the stock is
undervalued.*
3. A university endowment fund is prohibited from investing in tobacco companies.
This prohibition is most likely classified as:
A) A liquidity constraint
B) A unique circumstances constraint
C) A legal constraint
Answer: B) A unique circumstances constraint
Solution: Unique needs and preferences include prohibitions on certain investments.
4. The diversification ratio is best described as:
A) The ratio of the standard deviation of a portfolio to the standard deviation of its
benchmark
B) The square root of the number of securities in a portfolio
C) The ratio of the standard deviation of an individual security to the standard deviation
of a well-diversified portfolio
Answer: C) The ratio of the standard deviation of an individual security to the
standard deviation of a well-diversified portfolio
Solution: It measures the reduction in risk from diversification.
5. In a defined contribution pension plan, the:
A) Employer guarantees a specific retirement benefit
, B) Employee bears the investment risk
C) Plan is funded solely by the employer
Answer: B) Employee bears the investment risk
Solution: DC plans shift risk to the employee, unlike DB plans.
6. The primary objective of an investment policy statement (IPS) is to:
A) Outline specific security selections
B) Establish the client's risk and return objectives
C) Provide a detailed performance report
Answer: B) Establish the client's risk and return objectives
Solution: The IPS defines objectives and constraints to guide portfolio construction.
7. Which of the following is NOT a component of total return?
A) Income return
B) Capital gain return
C) Inflation adjustment
Answer: C) Inflation adjustment
Solution: Total return = income + capital gains; inflation is separate.
8. The security market line (SML) plots:
A) Expected return against total risk
B) Expected return against beta
C) Beta against standard deviation
Answer: B) Expected return against beta
Solution: SML is from CAPM, showing required return vs. systematic risk.
9. Portfolio risk that cannot be diversified away is:
A) Unsystematic risk
B) Systematic risk
C) Idiosyncratic risk
Answer: B) Systematic risk
Solution: Market risk affects all assets and requires compensation.
10. An investor with a high risk tolerance would most likely prefer:
A) A conservative bond portfolio
B) High equity allocation
C) Short-term fixed income
Answer: B) High equity allocation
Solution: Equities offer higher expected returns but with higher risk.
11. The Sharpe ratio measures:
A) Total risk-adjusted return
B) Excess return per unit of total risk
C) Excess return per unit of systematic risk
Answer: B) Excess return per unit of total risk
Solution: Sharpe = (Rp - Rf) / σp.
12. In the portfolio management process, the execution step involves:
A) Developing the IPS
B) Rebalancing the portfolio
C) Monitoring and feedback
Answer: B) Rebalancing the portfolio
Solution: Execution implements the strategic asset allocation.
with 100% Correct Solutions (2025 Update)
Questions with Answers
Below are 50 questions from the Portfolio Management Exam 1 (2025 update), covering the full
scope of the exam. These are based on verified CFA Level I curriculum and practice materials,
aligned with topics like investment policy statements, risk/return, asset allocation, and behavioral
finance.
1. Over time, the major source of investment return and risk can most likely be
attributed to:
A) Stock selection
B) Asset allocation
C) Risk management
Answer: B) Asset allocation
Solution: The asset allocation decision explains about 90% of a fund’s returns over time.
2. The risk-free interest rate is 5 percent, and the return on the market portfolio is 8
percent. A stock with a beta of 0.5 that has an estimated rate of return of 7 percent
is most likely:
A) Overvalued
B) Undervalued
C) Correctly valued
Answer: B) Undervalued
Solution: Required return = 5% + 0.5(8%-5%) = 6.5%. Since 7% > 6.5%, the stock is
undervalued.*
3. A university endowment fund is prohibited from investing in tobacco companies.
This prohibition is most likely classified as:
A) A liquidity constraint
B) A unique circumstances constraint
C) A legal constraint
Answer: B) A unique circumstances constraint
Solution: Unique needs and preferences include prohibitions on certain investments.
4. The diversification ratio is best described as:
A) The ratio of the standard deviation of a portfolio to the standard deviation of its
benchmark
B) The square root of the number of securities in a portfolio
C) The ratio of the standard deviation of an individual security to the standard deviation
of a well-diversified portfolio
Answer: C) The ratio of the standard deviation of an individual security to the
standard deviation of a well-diversified portfolio
Solution: It measures the reduction in risk from diversification.
5. In a defined contribution pension plan, the:
A) Employer guarantees a specific retirement benefit
, B) Employee bears the investment risk
C) Plan is funded solely by the employer
Answer: B) Employee bears the investment risk
Solution: DC plans shift risk to the employee, unlike DB plans.
6. The primary objective of an investment policy statement (IPS) is to:
A) Outline specific security selections
B) Establish the client's risk and return objectives
C) Provide a detailed performance report
Answer: B) Establish the client's risk and return objectives
Solution: The IPS defines objectives and constraints to guide portfolio construction.
7. Which of the following is NOT a component of total return?
A) Income return
B) Capital gain return
C) Inflation adjustment
Answer: C) Inflation adjustment
Solution: Total return = income + capital gains; inflation is separate.
8. The security market line (SML) plots:
A) Expected return against total risk
B) Expected return against beta
C) Beta against standard deviation
Answer: B) Expected return against beta
Solution: SML is from CAPM, showing required return vs. systematic risk.
9. Portfolio risk that cannot be diversified away is:
A) Unsystematic risk
B) Systematic risk
C) Idiosyncratic risk
Answer: B) Systematic risk
Solution: Market risk affects all assets and requires compensation.
10. An investor with a high risk tolerance would most likely prefer:
A) A conservative bond portfolio
B) High equity allocation
C) Short-term fixed income
Answer: B) High equity allocation
Solution: Equities offer higher expected returns but with higher risk.
11. The Sharpe ratio measures:
A) Total risk-adjusted return
B) Excess return per unit of total risk
C) Excess return per unit of systematic risk
Answer: B) Excess return per unit of total risk
Solution: Sharpe = (Rp - Rf) / σp.
12. In the portfolio management process, the execution step involves:
A) Developing the IPS
B) Rebalancing the portfolio
C) Monitoring and feedback
Answer: B) Rebalancing the portfolio
Solution: Execution implements the strategic asset allocation.
