Learning Module: Portfolio Management: An Overview

Disclaimer: Following are the questions provided by CFA Institute to its registered
candidates for practice purpose.

1. Investors should use a portfolio approach to:

A. reduce risk.
B. monitor risk.
C. eliminate risk.

2. Which of the following is the best reason for an investor to be concerned with the
composition of a portfolio?
A. Risk reduction.
B. Downside risk protection.
C. Avoidance of investment disasters.

3. With respect to the formation of portfolios, which of the following statements is

most accurate?
A. Portfolios affect risk less than returns.
B. Portfolios affect risk more than returns.
C. Portfolios affect risk and returns equally.

4. With respect to the portfolio management process, the asset allocation is determined
in the:
A. planning step.
B. feedback step.
C. execution step.

5. The planning step of the portfolio management process is least likely to include an
assessment of the client’s
A. securities.
B. constraints.
C. risk tolerance.

6. With respect to the portfolio management process, the rebalancing of a portfolio’s

composition is most likely to occur in the:
A. planning step.
B. feedback step.
C. execution step.

7. An analyst gathers the following information for the asset allocations of three
portfolios:
 Portfolio Management: An Overview

Which of the portfolios is most likely appropriate for a client who has a high
degree of risk tolerance?
A. Portfolio 1.
B. Portfolio 2.
C. Portfolio 3.

8. Which of the following institutions will on average have the greatest need for
liquidity?
A. Banks.
B. Investment companies.
C. Non-life insurance companies.

9. Which of the following institutional investors will most likely have the longest time
horizon?
A. Defined benefit plan.
B. University endowment.
C. Life insurance company.

10. A defined benefit plan with a large number of retirees is likely to have a high need
for:
A. income.
B. liquidity.
C. insurance.

11. Which of the following institutional investors is most likely to manage investments in
mutual funds?
A. Insurance companies.
B. Investment companies.
C. University endowments.

12. Which of the following investment products is most likely to trade at their net asset
value per share?
A. Exchange traded funds.
B. Open-end mutual funds.
C. Closed-end mutual funds.

13. Which of the following financial products is least likely to have a capital gain
distribution?
A. Exchange traded funds.
B. Open-end mutual funds.
C. Closed-end mutual funds.

14. Which of the following forms of pooled investments is subject to the least amount
of regulation?
A. Hedge funds.

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 Portfolio Management: An Overview

B. Exchange traded funds.

C. Closed-end mutual funds.

15. Which of the following pooled investments is most likely characterized by a few large
investments?
A. Hedge funds.
B. Buyout funds.
C. Venture capital funds.

16. Which of the following types of investment clients most likely have the lowest
liquidity needs?
A. Insurance companies
B. Banks
C. Endowments and foundations

17. The execution step of the portfolio management process includes:

A. preparing the investment policy statement.
B. finalizing the asset allocation.
C. monitoring the portfolio performance.

18. With respect to the portfolio management process, asset allocation decisions are
most likely made in the:
A. execution step.
B. planning step.
C. feedback step.

19. ABC Fund invests in Singapore’s government debt with maturities up to three months.
It is most likely classified as a:
A. fixed-income arbitrage fund.
B. money market fund.
C. bond mutual fund.

20. Which of the following is most likely a feature of a defined-contribution pension plan?
The
A. employer accepts the investment risk.
B. employer provides a specified retirement benefit.
C. employee accepts the investment risk.

21. Which of the following types of institutions is most likely to have a long investment
time horizon and a higher level of risk tolerance?
A. An endowment
B. An insurance company
C. A bank

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 Portfolio Management: An Overview

22. Which of the following is least likely a part of the execution step of the portfolio
management process?
A. Security analysis
B. Portfolio construction
C. Performance measurement

23. Which of the following institutional investors is most likely to have a low tolerance
for investment risk and relatively high liquidity needs?
A. Insurance company
B. Defined-benefit pension plan
C. Charitable foundation

24. Security analysis is most likely a part of which step in the portfolio management
process?
A. The feedback step
B. The execution step
C. The planning step

25. Which of the following is least likely true for a separately managed account (SMA)
compared with a mutual fund?
A. Assets are directly owned by the individual.
B. The minimum investment required to open a SMA is lower than that of a mutual
fund.
C. Transactions can be tailored to the specific tax needs of the investor.

26. A key difference between a wrap account and a mutual fund is that wrap accounts:
A. have assets that are owned directly by the individual.
B. cannot be tailored to the tax needs of a client.
C. have a lower required minimum investment.

Solutions
1. A is correct. Combining assets into a portfolio should reduce the portfolio’s volatility.
Specifically, “individuals and institutions should hold portfolios to reduce risk.” As
illustrated in the reading, however, risk reduction may not be as great during a period
of dramatic economic change.

2. A is correct. Combining assets into a portfolio should reduce the portfolio’s volatility.
The portfolio approach does not necessarily provide downside protection or
guarantee that the portfolio always will avoid losses.

3. B is correct. As illustrated in the reading, portfolios reduce risk more than they
increase returns.

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4. C is correct. The client’s objectives and constraints are established in the investment
policy statement and are used to determine the client’s target asset allocation, which
occurs in the execution step of the portfolio management process.

5. A is correct. Securities are analyzed in the execution step. In the planning step, a
client’s objectives and constraints are used to develop the investment policy
statement.

6. B is correct. Portfolio monitoring and rebalancing occurs in the feedback step of the
portfolio management process.

7. C is correct. Portfolio 3 has the same equity exposure as Portfolio 1 and has a higher
exposure to alternative assets, which have greater volatility (as discussed in the
section of the reading comparing the endowments from Yale University and the
University of Virginia).

8. A is correct. The excess reserves invested by banks need to be relatively liquid.

Although investment companies and non-life insurance companies have high liquidity
needs, the liquidity need for banks is on average the greatest.

9. B is correct. Most foundations and endowments are established with the intent of
having perpetual lives. Although defined benefit plans and life insurance companies
have portfolios with a long time horizon, they are not perpetual.

10. A is correct. Income is necessary to meet the cash flow obligation to retirees.
Although defined benefit plans have a need for income, the need for liquidity typically
is quite low. A retiree may need life insurance; however, a defined benefit plan does
not need insurance.

11. B is correct. Investment companies manage investments in mutual funds. Although

endowments and insurance companies may own mutual funds, they do not issue or
redeem shares of mutual funds.

12. B is correct. Open-end funds trade at their net asset value per share, whereas closed-
end funds and exchange traded funds can trade at a premium or a discount.

13. A is correct. Exchange traded funds do not have capital gain distributions. If an
investor sells shares of an ETF (or open-end mutual fund or closed-end mutual fund),
the investor may have a capital gain or loss on the shares sold; however, the gain (or
loss) from the sale is not a distribution.

14. A is correct. Hedge funds are currently exempt from the reporting requirements of
a typical public investment company.

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15. B is correct. Buyout funds or private equity firms make only a few large investments
in private companies with the intent of selling the restructured companies in three
to five years. Venture capital funds also have a short time horizon; however, these
funds consist of many small investments in companies with the expectation that only
a few will have a large payoff (and that most will fail).

16. C is correct. A typical investment objective of an endowment or a foundation is to

maintain the real capital value of the fund while generating income to fund the
objectives of the institution. Liquidity needs are typically rather low.

17. B is correct. Asset allocation occurs in the execution step.

18. A is correct. Asset allocation decisions are made in the execution step.

19. B is correct. Money market funds invest in short-term corporate or government debt.
The difference between a bond mutual fund and a money market fund is the maturity
of the underlying assets. In a money market fund, the maturity is as short as
overnight and rarely longer than 90 days.

20. C is correct. In a defined-contribution pension plan, the employee accepts the

investment risk and is responsible for ensuring that the plan contains enough funds
to meet retirement needs.

21. A is correct. Endowments have a long investment time horizon and a high level of risk
tolerance.

22. C is correct. Performance measurement is a part of the feedback step of the

portfolio management process. The execution step includes asset allocation, security
analysis, and portfolio construction.

23. A is correct. Insurance companies need to be relatively conservative and liquid, given
the necessity of paying claims when due.

24. B is correct. The execution step of the portfolio management process has three
parts: asset allocation, security analysis, and portfolio construction.

25. B is correct. The minimum investment required to open a separately managed account
is usually much higher than that to open a mutual fund.

26. A is correct. The key difference between a wrap account and a mutual fund is that in
a wrap account, the assets are owned directly by the individual.

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