CFA Level I Portfolio Construction

A portfolio is 60% in an asset expected to return 10% and 40% in one expected to return 5%. What is its expected return?

0.6 × 10% + 0.4 × 5%.

Two assets have a correlation of −1. Which is true?

With the right weights, perfect negative correlation removes variance.

Two uncorrelated assets have standard deviations of 20% and 10%. What is the risk of a 50/50 portfolio?

σ² = 0.25 × 0.04 + 0.25 × 0.01 = 0.0125, and √0.0125 ≈ 11.2%.

A portfolio returned 10%, the risk-free rate is 2% and its standard deviation is 16%. What is its Sharpe ratio?

(10% − 2%) / 16%.

A portfolio returned 10% with a beta of 0.8. The risk-free rate is 2%. What is its Treynor ratio?

(10 − 2) / 0.8, using percentage points.

A fund returned 12% with a beta of 1.2. The risk-free rate is 3% and the market returned 8%. What is Jensen's alpha?

CAPM return = 3% + 1.2 × 5% = 9%, and 12% − 9% = 3%.

Diversification can remove:

Only systematic risk is rewarded in the CAPM.

A stock's covariance with the market is 0.02 and the market variance is 0.04. What is its beta?

β = cov / var(market).

The capital market line shows portfolios made of:

Its slope is the market's Sharpe ratio.

The security market line plots expected return against:

Securities above the line are undervalued.

The efficient frontier shows:

Portfolios below it are dominated.

An investor's utility is U = E(r) − ½Aσ². With E(r) = 10%, A = 4 and σ = 20%, what is U?

0.10 − 0.5 × 4 × 0.04 = 0.02.

Which is a constraint in an investment policy statement?

Constraints: liquidity, time horizon, tax, legal and regulatory, and unique circumstances.

A young client wants low risk but has a stable job and a long horizon. Her:

When they conflict, the adviser usually leans to the lower and educates the client.

What is a strategic asset allocation?

Tactical allocation makes short-term deviations from it.

An investor holds a losing stock too long to avoid "making the loss real". This bias is:

People feel losses more strongly than gains of the same size.

In a defined benefit pension plan, who bears the investment risk?

In a defined contribution plan, employees bear it.

Why can university endowments usually take more risk?

They aim to fund spending forever.

What is tracking error?

Index funds aim for very low tracking error.

Active return is 2% and tracking error is 4%. What is the information ratio?

Active return / tracking error.

What does a robo-adviser do?

Most build ETF portfolios from a risk questionnaire.

Excluding tobacco and weapons makers from a portfolio is:

Positive screening picks the best ESG performers in each sector.

Splitting total portfolio risk between asset classes or managers is called:

It ties risk taken to expected reward.

Why rebalance a portfolio?

Calendar and percentage-range rules are common.